Operating Assets – Expense and Disposal
Practice As You Learn
Practice As You Learn
5 things to know how to do:
1) Compute and record depreciation expense using all 4 methods
2) Compute and record amortization expense using straight-line
3) Revise the depreciation expense estimate
4) Record the sale of an asset
5) Determine the amount of an impairment loss
1) Compute and record depreciation expense using all methods
Memorize the formulas. Always expense over the time you expect to use the asset
Straight-line:
Cost – RV / Useful life
Double Declining Balance:
100% / life X 2 = % X Book Value
Sum of Years Digits:
Useful Life / Total Sum of the Years
X Cost – Residual Value
Units of Production:
Cost – RV / Total Estimated Units = $ cost per unit
then: $ Cost per unit x units produced
Journal entry for all methods:
Depreciation Expense $XXX
Accumulated depreciation $XXX
2) Compute and record amortization expense using straight-line
Only costs paid outside the company are recorded as an asset
Cost / Useful life, limited to the legal life = Amortization expense
| Amortization Expense $XXX Asset or Accumulated Amortization $XXX |
3) Revise the depreciation expense estimate, follow these steps:
1) Add the additional subsequent expenditure to the original cost
2) Determine the current book value:
“new” total cost – accumulated depreciation
3) Revised annual depreciation expense =
Current book value – new residual value
number of years left to use now
4) Record the sale of an asset
1) Record the cash you receive as a debit
2) Credit the asset you are selling for historical cost
3) Debit accumulated depreciation for the total up to the date sold
Expense partial year if sold in the middle of the year.
4) Record a gain or a loss for the amount that will make the journal entry balance
| Realized Loss on Sale ** or Cash Accumulated Depreciation Asset Realized Gain on Sale ** or |
5) Determine the impairment loss. It is different for different types of long term assets
Definite Life Assets
Book value > fair market value is the impairment loss
Step 1.
Total estimated future cash flows
– Book value of the asset
= if positive, no impairment loss
if negative, go to step 2
Step 2.
Book value of the asset
– Fair market value of the asset
= Impairment loss (if positive)
Goodwill
Book value of reporting unit
– Fair market value of reporting unit
= Impairment if Book value is greater
(Implied value = purchase price – fair market value of net assets)
A company purchased a new machine at the beginning of the year at a cost of $260,000. The machine is expected to have a 10-year life and a $20,000 residual value. The company expects to use the new machine for a period of 8 years and then sell it for $25,000. The machine is expected to produce 300,000 total units. Calculate depreciation expense for the first 3 years using the following methods:
A. Straight-line
B. Double Declining Balance
C. Units of Production, 35,000 units the first year and 42,000 units the second year, and 28,000 units the third year.
D. Sum of Years Digits
Answer
The asset is depreciated over the amount of time the company expects to USE it and the expected residual value when they are finished using it, regardless of how long the asset will last.
The life used will be 8 years and the residual value used is $25,000.
1.A. Straight-line:
Cost – RV / Useful life = expense every year
$260,000 – 25,000
/ 8 years = $29,375 each year
Straight-line gives equal expense every year
1.B. Double Declining Balance:
100% / life x 2 x Book Value
1st year 100% / 8 = 12.5% x 2 = 25%
25% x $260,000 = $65,000
No accumulated depreciation for first year.
Book value is Cost – A/D $260,000 – 0
2nd year 100% / 8 = 12.5% x 2 = 25%
25% x $195,000 = $48,750
Book value is $260,000 – $65,000 = $195,000
3rd year 100% / 8 = 12.5% x 2 = 25%
25% x $146,250 = $36,563
Book value is $260,000 – $65,000 – $48,750 = $146,250
The amount of depreciation expense is lower each year because the book value is lower each year
The total accumulated depreciation cannot be higher than cost – residual value
(may need to stop depreciating before the end of 8 years)
1.C. Units of Production
Cost – RV / Total units = cost per unit
Cost per unit x units this period = expense
$260,000 – $25,000 = $235,000
/ 300,000 units = $0.783 per unit
1st year: $0.783 per unit x 35,000 units = $27,405 depreciation expense
2nd year: $0.783 per unit x 42,000 units = $32,886 depreciation expense
3rd year: $0.783 per unit x 28,000 units = $21,924 depreciation expense
1.D. Sum of Years Digits:
Useful life / total of sum of years
x (Cost – Residual Value)
Sum of the years: 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 = 36
Start with the highest year / total and reduce it by 1 each year
1st Year: $260,000 – 25,000 x 8/36 = $52,222 deprec. exp.
2nd Year: $260,000 – 25,000 x 7/36 = $45,694 deprec. exp.
3rd Year: $260,000 – 25,000 x 6/36 = $39,167 deprec. exp.
Important to notice for all methods:
Depreciation expense is for one year only
If the asset was not purchased at the beginning of the year, the expense for the
first year is calculated the same way and then multiplied by
the number of months used during the year / 12 to get partial year expense
The journal entry to record the expense for this year only is:
| Depreciation expense $XXX Accumulated Depreciation $XXX |
Total accumulated depreciation is depreciation expense for all years combined
Operating Assets – Practice Problem 2 – Intangibles and Amortization Expense
A company has two intangible assets they acquired this year:
Description |
Date Acquired |
Cost |
Legal Life |
Future Benefit Life |
| Franchise | January 1 | $125,000 | 10 years | 10 years |
| Patent | March 1 | $ 75,000 | 17 years | 12 years |
A. Compute and record amortization expense for the first two years.
B. Show what would be reported on the balance sheet at the end of the 1st year.
Answer
Intangible assets are expensed using the straight-line method
Franchise
$125,000 / 10 years = $12,500 each year, 1st and 2nd
Patent
$75,000 / 12 years = $6,250 x 10/12 = $5,208 1st year
(10 months only)
$75,000 / 12 years = $6,250 2nd year (full year)
2.A. 1st year journal entry:
| Amortization Expense $17,708 Franchise $12,500 Patent $ 5,208 |
2.B. 1st year – on the balance sheet:
| Intangible Assets: Franchise, net of amortization $112,500 Patents, net of amortization $ 69,792 |
Notice:
Remember to consider partial year use
Always use the life the company will get benefit over, which is sometimes different than the legal life and cannot be greater than the legal life.
A company purchased a new machine at the beginning of the year at a cost of $200,000. The machine is expected to have a 10-year life and a $20,000 residual value. At beginning of the 4th year, the company did an overhaul on the machine which cost $45,000 and extended the life of the machine by 5 years. The residual value is revised to be $10,000. Calculate depreciation expense for year 4 using straight-line.
Answer
1st – Calculate the original depreciation expense for the first 3 years:
Cost – RV / Life
$ 200,000 – $20,000 / 10 years = $18,000 each year
At the end of year 3, accumulated depreciation is $54,000
($18,000 x 3 years = $54,000)
2nd – Recognize that the overhaul extended the useful life and the cost is capitalized and added to the cost of the asset.
| Original Cost | $200,000 |
| + Overhaul cost | $ 45,000 |
| = Total cost now | $245,000 |
3rd – Revise the estimate for depreciation expense for future years to include the
additional years, the additional cost, and the new estimate for residual value.
New Cost – New Residual Value / New Life = Depreciation Expense
$245,000 – $10,000 / 12 years ** = $19,583 each year for the next 12 yrs
** New life = 10 original – 3 already + 5 more from overhaul = 12 yrs
A company purchased an automobile for its salesman for $35,000 on January 1st. The auto was expected to be used for 5 years and sold for $8,000. The car was used for 3 years and depreciation expense was recorded using straight-line. On June 1st of the 4th year, the auto was sold for $12,000. Record the sale of the car
Answer
1) Debit cash for $12,000 cash received
2) Credit “Automobile” for the original cost of $35,000
3) Debit accumulated depreciation for the total up to the date you sell it (add partial year use)
Compute depreciation expense each year
$35,000 – 8,000 / 5 years = $5,400 each year for 3 years
For the 4th year – $5,400 x 5/12 = $2,250
Record depreciation for the 5 months used
Determine total accumulated depreciation up to the time it is sold:
| first 3 years | $5,400 x 3 = | $16,200 |
| part of 4th year | $ 2,250 | |
| Total Accumulated Deprecation | $18,450 | |
Remove the total Accumulated Depreciation amount.
4) Record a realized gain or a loss for the amount to balance the journal entry (debits equal credits)
| Realized Loss on Sale $ 4,550 (4) Cash $12,000 (1) Accumulated Depreciation $18,450 (3) Automobile $35,000 (2) |
Double-check the loss:
| Cash received $12,000
Book Value $16,550 Difference is the loss ($4,550) |
Loss: Receive less than book value
Gain: Receive more than book value
Operating Assets – Practice Problem 5 – Determine Goodwill Impairment
The company has goodwill reported on the balance sheet of $1,000,000. The company is testing for impairment and determined the following:
| Appraised fair market value of operating unit assets | $1,750,000 |
| Implied value of Goodwill | $ 900,000 |
| Book Value of operating unit assets | $1,950,000 |
Make the entry to record any necessary goodwill impairment.
Answer
| Book Value of operating unit | $1,950,000 |
| Fair Market Value of operating unit | $1,750,000 |
| Impairment – Yes, BV > FMV | $ 200,000 |
Journal Entry to Record
| Loss on Impairment 200,000 Goodwill 200,000 |