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# Operating Assets – Expense and Disposal

## 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:

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)

Operating Assets – Practice Problem 1 – Calculate depreciation expense

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

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.

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.

Operating Assets – Practice Problem 3 – Revise depreciation estimate

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.

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

Operating Assets – Practice Problem 4 – Record the sale of an asset

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

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 \$35,000 – \$18,400 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.