You are on page 1of 102

Chapter 8, Long-Lived Assets

Blast from the past


BFTP8-1

You start a cleaning service business on May 1, 2016, Cleaning Services Inc., and had the below
noted transactions during the first month of business.

1. The owner invests $5,000 of cash into a business.


2. You borrow $2,500 from your parents to help start the business. The loan is for 2 years,
interest free.
3. Registered a business name with Service Ontario, $60, using a credit card.
4. Set up a business bank account with Royal Bank. The bank will withdraw $24.99 out of
the account at the end of every month.
5. Paid $1,700 cash to have a website developed which allows customers to schedule
appointments and submit payments.
6. You pay a $14.99 website fee every month, on the first day of the month. You pay using
your credit card.
7. Purchase a Dyson DC37 Turbinehead Animal vacuum cleaner for $599.99, plus HST.
This vacuum is specifically developed to remove pet hair and dander. Also purchased
the Dyson DC37 Tool Kit for $131.97, plus HST, which is used to repair and maintain the
vacuum. Paid by credit card.
8. Purchased a 1 year insurance policy for $1,800, plus 8% sales tax, paying cash.
9. Purchased cleaning supplies for $480, plus HST, using a credit card.
10. Purchased 1,000 fliers advertising your cleaning services, $189, plus HST, using a credit
card.
11. Develop a Facebook page to advertising your services. Your page directs potential
customers to your website.
12. Hired a local teen to deliver 500 of the fliers throughout Oakville, $250 cash.
13. You will use you own car to travel to your customers. You can deduct the business
portion of all your car expenses (gas, oil, insurance, license and registration, and
maintenance and repairs). To help you track you business usage you purchases MileIQ,
an iPhone app which tracks mileage, for $59.99 plus HST, using a credit card.
14. Received payment through the website, paid directly into your bank account, from
customers for cleaning services provided, $1,730.
15. You determine that, by the end of month, you only have $375 of your cleaning supplies
remaining.

1|Page
16. MileIQ shows that you have travelled 1,650 kilometers over the last month, 1,000 for
business. Total vehicle expenses paid for the month are $286.00 and you pay cash out
of the businesss bank account for the business portion.
17. You used your cell phone 80% for business. Your monthly phone charge is $192 (taxes
included). You pay the business portion directly from your business bank account.
18. By the end of the month you had used up 1 month of the insurance.
19. Paid $1,500 towards your credit card charges using cash from the business bank
account.
20. Online you see that Royal Bank has charged the business account the monthly service
fee.
21. You record the income tax you expect to pay, equal to 25% of your profit before taxes.

Required:

A. Analyze the transactions using the critical and enhancing questions and record the business
activities using the expanded accounting equation and account names. A chart is provided on
the next page.

B. Produce the income statement, statement of retained earnings, and balance sheet for your
1st month of operations.

C. Answer the questions which follow the financial statements.

NOTE: the chart on the next page is an image and must be printed off to be completed.

2|Page
Equity
Profit
Assets Liabilities Owner's
Capital Revenue Expenses

Owner's Capital
Cash

Trans. 1
Trans. 2
Trans. 3
Trans. 4
Trans. 5
Trans. 6
Trans. 7
Trans. 8
Trans. 9
Trans. 10
Trans. 11
Trans. 12
Trans. 13
Trans. 14
Trans. 15
Trans. 16
Trans. 17
Trans. 18
Trans. 19
Trans. 20
Trans. 21
Totals:

3|Page
BFTP8-1, continued

Part B

4|Page
BFTP8-1, continued

Part C

Why do you record the cost of the cleaning supplies, insurance, and fliers as assets? Would you
consider these items current or long term assets? Explain why.

Why do you adjust the value of the cleaning supplies, insurance, and fliers in transactions 12,
15, and 18? Explain using the definition of the elements you affected.

Why do you record the cost of the vacuum, business license, software, and website design as
assets? Would you consider these items current or long term assets? Explain why. Is it equally
important to record all of these as assets, regardless of the magnitude ($ amount) of each
asset?

Your answers to the above questions are based on information from previous chapters.

5|Page
So what are you going to learn in this chapter?

As noted in previous chapters, in order to be successful businesses have to look not only at the
financial statements as a whole but also focus on each account within the statements.
Analyzing the details of each account will allow you, the business owner, to gain a deeper
understanding of how the balances can be used to better understand, manage, and control
your business activities.

In all of the past chapters the businesses rented office space and equipment. This if often a
good idea....after all, when you start a business you're not sure if it will continue into the future.
Renting might be a good way to save money in the short term; however, eventually, if your
business lasts a long time, buying land, buildings, and equipment will become a better option.

Why?

Let's use a lawn care business as an example. You rent the lawnmower you use to generate
revenue from your father for $50 per month. That's pretty cheap and you didn't need to pay
the $499 it would cost to buy a new lawnmower. That sounds pretty good because, if the
lawnmower stops working due to wear and tear, it's not your problem (as long as you didn't
break it that is!) You can bring it back to the owner (your father) and they have to fix it for you -
pretty sweet.

Now, say your business is going well, running from April until September. How much have you
spent on renting the lawnmower? In those 6 months you have spent $300 ($50 * 7)!! What do
you have to show for the $300 you spent? Nothing....because the lawnmower does not belong
to you. If you had bought the lawnmower you could continue to use next year to generate
more revenue. Instead, you have spent $300 and you have nothing.

So why would anyone rent instead of buying? If you start your own business you may not have
the cash necessary to buy land, a building or all the equipment you require. Or you may not
want to buy land and a building now because you are uncertain if the location is where you
want to be long term. You might not be able to buy in the location you want because there is
nothing for sale. Or you might rent because, when you rent, you can change your mind about
your location without a problem (like renting a riding lawnmower one week and a regular
lawnmower the next). Renting has benefits (easier to change, cheaper in the short term, for
instance) and drawbacks (may, in the long term, cost you more, and you own nothing at the
end of the rental period).

If you rent you charge the cost of rental to your expenses (Rent Expense, for instance). What
happens if you buy instead?

6|Page
In BFTP8-1 Cleaning Services Inc. purchased equipment. The equipment will be used by the
business to help make a profit in the future, long term. Equipment, when purchased, is
capitalized, meaning the cost is recorded as an asset (similar to supplies). WHY? Because it
meets the definition of the element asset: owned, will benefit the business in the future by
helping to generate revenue, and due to a past purchase.

What's the difference between supplies and equipment?

Cleaning supplies are used up in a short period of time, less than 1 year (12 months). Assets
that are used up quickly are recorded as current assets on the balance sheet. Equipment, on
the other hand, is a long-lived asset, meaning it will last, and be used, for many years. Long-
lived assets are divided into two groups; tangible assets (physical assets you can see and touch
or move around) and intangible assets (non-physical assets which represent legal rights).

Can you explain intangible assets?

An intangible assets provides the owner with legal right. For instance, a trademark is a symbol,
word, or words which are registered to a company for their exclusive use. The Nike
checkmark that you see on their products has been trademarked for their exclusive use,
meaning no one else can use that mark on their products. Another intangible asset is a patent;
a license which gives a company the right, for 20 years, to making, using, or selling an invention.
Apple has the right to manufacture and sell their iWatch. No other company is allowed to
copy that design for the period that Apple holds the patent on that technology.

Where are long-lived assets reported on the balance sheet?

Long-lived assets are divided into two groups on the balance sheet. Tangible assets are
grouped under the subtitle Property, Plant, and Equipment. They are also sometimes called
Fixed Asset (because they are fixed in place and can't be moved) or Capital Asset (meaning
they are part of the capital or value that the business owns).

NOTE: in BFTP8-1 Cleaning Services Inc. does not have property (land) or a plant (factory).
Because of that the equipment was placed under the subheading Capital Assets on the balance
sheet.

Cleaning Services Inc. also owns intangible assets (non-physical assets which represent legal
rights). One type of intangible asset is a licensing right, which is the permission to use
something (ability to run a business) for a specific period of time (5 years). In BFTP8-1 you
capitalized (recorded as an asset because it has future benefit) the business license using the
account named Business License. Similarly, the cost of developing the website and the
purchase of software were both capitalized. These are technology assets, which include

7|Page
website development and software purchases. Intangible assets are recorded on the balance
sheet under the subtitle Intangibles. In order to record long-lived assets businesses have to be
able to determine how much they cost.

How do you determine what a long-lived asset costs?

Recall from Chapter 1 that assets must be reported at what it costs to acquire (buy) them. That
is part of the GAAP assumptions.

Assumption Description:
Historic Cost All purchases will be recorded at the amount that
was paid for them.

How is this assumption applied to long-lived assets? The cost of long-lived assets, both tangible
and intangible, is made up of all the costs incurred to buy and make the asset ready for use.
These costs must be capitalized, meaning the cost is recorded as an asset. This is because it
meets the definition of the element asset: owned, will benefit the business in the future by
helping to generate revenue, and due to a past purchase.

Notice that the costs that are capitalized are not just the cost to buy an asset but also to get it
ready for use. That means costs such as legal fees to transfer ownership of a piece of land from
one business to another would be included as part of the cost of the land (capitalized), even
though it is not part of the purchase price. Similarly, if equipment requires a platform to be
built before it can be installed then the cost of building the platform, and installing the
equipment, would be capitalized as part of the cost of the equipment.

The decision regarding what costs should be capitalized requires a lot of judgment. This is
because most costs that are not capitalized are expensed. The key is to consider the nature of
the cost: is it REQUIRED to get the asset into use? Is it closely connected to the USE of the
asset? Is it NECESSARY or just nice to have?
What about an example?

Deciding what to include as the cost of a long-lived asset and what to


exclude requires judgment. Remember to review all costs carefully
to consider if it is necessary to purchase and get the asset ready for
use or if the cost should be recorded as something else entirely
(either an expense or even a different asset.)

Let's say you own a merchandising business, distributing tools to


hardware stores. Many of the inventory items are too heavy for you
to lift and therefore you purchase a used electrical forklift truck.
During the next month you pay the following costs in cash.

8|Page
Description Cost
Delivery 290
Invoice price 3,000
Maintenance supplies 150
New battery 175
One (1) year insurance 600
policy
Painting (body) black 100
Repairs to lift bars 320
Servicing/testing 275

Which costs would be included in the cost of the forklift? You have to analyze each of the costs
and determine if it is necessary to the purchase of the long-lived asset, referring to the concept
of cost to buy AND get it ready for use.

Delivery: this is required to get it ready for use since it is the only way to get it to your location.
Include in cost of forklift. The account Equipment would increase and Cash would decrease.

Invoice price: this is the cost to buy and therefore must be included in the cost of the forklift.
The account Equipment would increase and Cash would decrease.

Maintenance supplies: these are for the future and are not required right now. They should
not be included in the cost of the forklift. How should you record it then? Using the critical and
enhancing questions! What did you get? Supplies for the forklift, which have future benefit for
the business: Supplies, an asset, increases. Paid, so Cash decreases.

New battery: whether it is included in the cost of the equipment or not depends on what it was
bought for. If the forklift was purchased WITHOUT a working battery and will not work without
the new battery then this is required to get it ready for use: Equipment increases. If the new
battery was purchased as a supply for the future and is not required right now: Supplies
increase.

HINT: When you purchase something broken (battery does not work) the cost of fixing the
long-lived asset is required to make it ready for use. As such it can be added to the cost of the
long-lived asset. If you purchase something in good condition and YOU use it up or break it,
then the cost to replace it (new battery since the old one wears out) or to fix it (repair) would
be an operating expense on the income statement.

Let's assume that the battery did not work when you bought it so the cost of the battery is
required to make it ready for use: Equipment, increase, Cash decrease.

One (1) year insurance policy: this is not required to make the forklift ready for use. Instead, it
is insurance coverage when the forklift is operating for the upcoming year. You need to analyze

9|Page
the purchase using the critical and enhancing questions. What did you get? The rights to
insurance converge for the upcoming year on the forklift; assets increase, Prepaid Insurance.
What did you give away? Cash, so assets also decrease.

Painting body black: is this really required (necessary) to make it ready for use? This is where
professional judgment comes in. Even if you paint it so that it matches your other equipment
the cost is not necessary to make it ready for use and should be expensed (Repairs &
Maintenance Expense increase, Cash decrease).

What if you plan to use this forklift in an advertisement, in which case the paint is necessary to
make it ready for use (part of that use is advertising photos)? Then you could capitalize the
cost to the Equipment account but that would be a matter of professional judgment regarding
whether it was required to make it ready for use. You have to make a decision based on the
facts presented. Assume in this case you plan to use the forklift in some of your fliers (photos)
and therefore you consider it necessary to make it ready for use. Assets increase, Equipment,
asset decreases, Cash.

Testing Tip:

Support your decision to include or exclude costs based on reasoning and the concept of "ready
for use". As long as you have strong support for your position then your answer will be assessed
based on that reasoning.

Repairs to lift bars: again, whether it is included in the cost of the equipment or not depends
on the information provided. If the forklift was purchased WITH broken bars then this is
required to get it ready for use: Equipment increases. If YOU broke the lift bars while you were
testing the forklift then you are repairing something, not making it better: Repairs and
Maintenance Expense increases.

In this case you have no information so assume that the lift bars were broken when you bought
the forklift and therefore repairs are required to make it ready for use: Equipment increases,
Cash decreases.

Service/testing: you purchased the forklift used and service/testing is required to make it ready
and safe to use: Equipment increases, Cash decreases.

Notice how each cost was measured against the question: was this cost required (necessary) to
purchase the asset or get it ready for use? If the answer was yes then the cost is added into the
cost of the asset. If the answer is no then the cost must be recorded otherwise. Use the critical
and enhancing questions to determine how it should be recorded.

So what is the final cost of your equipment? Let's record all the transactions into the expanded
accounting equation with account names to see the total cost of the equipment (forklift).

10 | P a g e
Assets

Prepaid Insurance

Equipment
Supplies
Cash
Opening N/A
Trans. 1 -290 290
Trans. 2 -3,000 3,000
Trans. 3 -150 150
Trans. 4 -175 175
Trans. 5 -600 600
Trans. 6 -100 100
Trans. 7 -320 320
Trans. 8 -275 275
N/A 150.00 600.00 4,160.00

In this case the total cost of the forklift (equipment) is $4,160 and that is what you will report
on the balance sheet under Capital Assets.

Testing Tip:

When reviewing costs to determine if they should be capitalized or recorded in another way
(e.g. expensed) consider the difference between betterment and maintenance/repair. For
instance, rebuilding the engine of the forklift is a betterment: it makes the asset more efficient,
effective, or extends the life of the asset. Those costs should be capitalized and added into the
cost of the asset. When you provide an oil change to the forklift after it has been in use then it is
a maintenance/repair cost. It does not make the forklift better, it simply allows it to work the
way the manufacturer intended it to work. The cost of an oil change also happens multiple
times. Repeating costs are always expensed because they don't improve the long-lived asset,
they simply allow it to work the way it was suppose to anyway.

Check your understanding (CYU8-1)

You are a merchandiser that bundles (packages together) products for retail stores, creating gift
baskets. You purchase a new stretch wrap machine and incur the following costs, all on
account. The list price was $26,095 but you negotiated a price of $25,000. Delivery was $2,000
and insurance on the shipping was $90. You had to replace the electrical cables in the shipping
department to install the new machine, $2,800. Installation and testing charges were $1,100.
During installation you, in error, damaged a portion of the machine and it costs $320 to buy and

11 | P a g e
install the replacement part. You purchase a 1 year insurance policy for $1,200 plus 8% sales
tax. Training for yourself and your other employees cost $260.

Required: determine which costs should be capitalized (included as part of the cost of the
forklift truck). Support your decision with reasoning (be sure to mention purchase costs or
necessary to make it ready for use). If the cost is not capitalized as part of the forklift how
would you record it? Provide the account name and the reason you would record it that way.
Then record all the costs in the accounting records, using the expanded accounting equation
and account names.

Account
Description Cost to record Reasoning
into:

Invoice price 25,000


D
El 2,000

90

Electrical cables 2,800

Installation and
testing 1,100

Rail replacement 320

1 year insurance
policy 1,200

Training (employee
and you) 260
The expanded accounting equation is provided for you on the next page.

12 | P a g e
Note: for the chart three of the accounts have been provided for you. The remainder you will
have to fill in yourself.

Equity

Retained Earnings
Asset Liabilities Owners'
Capital Profit
Revenue Expenses
Prepaid Insurance

Accounts payable

Training Expense
Repair Expense
Equipment
Cash

Opening N/A N/A N/A N/A N/A N/A N/A N/A


Trans. 1
Trans. 2
Trans. 3
Trans. 4
Trans. 5
Trans. 6
Trans. 7
Trans. 8

How do you determine the cost of long-lived assets which are intangible?

Although intangible assets don't have any physical substance (you can't see or touch a website,
the code for the software you buy, or the trademark that you use for your business) you have
paid for the legal right to use it. As such you have to review all the costs that were necessary to
purchase and make the intangible assets useful. For instance, if you pay the government to
register your trademark and you also pay legal fees to a lawyer in order to register that same
trademark, all those costs, the costs required to purchase and use your trademark, would be
capitalized into an account called Trademark.

Determining the cost of both long-lived tangible and intangible assets requires you to review all
the costs incurred and assess whether they were either part of the cost of purchasing the asset
or necessary to make it ready for use. If the answer is yes, record the cost into the long-lived
asset account. If not, assess using the critical and enhancing questions to determine how you
should record those costs.

13 | P a g e
Should you capitalize all long-lived asset purchases, regardless of how much they cost?

Recall from Chapter 1 the qualitative characteristic relevant.

Quality: Description:
Relevant Applicable or pertinent to your decision making,
helps you predict the future and/or confirm
decisions you made in the past.

Related to the concept of relevance is materiality. Materiality is the idea that trivial costs
(meaning small, minor, or insignificant) DO NOT have to follow the rules of GAAP but important
costs (meaning key, essential, or significant) HAVE to follow the rules of GAAP.

So material costs are relevant (important) for decision making and must be recorded following
the rules of GAAP. Immaterial costs are irrelevant (don't change anyone's mind) and don't have
to be recorded following the rules of GAAP. NOTE: those costs still have to BE recorded but
they do not have to follow the same rules.

How can you apply the concept of materiality to the recording of long-lived assets?

With care! What is material or immaterial is a decision made by the individuals who prepare
the financial statements and it requires professional judgment. It is dependent on many factors
and must be assessed (reviewed) on a regular basis.

What about an example?

The simplest example is something you see often: a penny (...more likely a nickel
since Canada no longer has a penny!) on the ground. Do you pick it up? Some
people do....and that is because that amount is material (makes a difference) to
them.

Other people don't stop to pick up even a dime or a quarter because these
amounts are immaterial (don't matter) to them.

Notice that the idea of materiality is different to different people...and at different times in
their lives. You may not pick up a nickel now but, if you ever became homeless, you might
change your mind about how material that amount, 5, would be to you.

Would materiality affect how you recorded the intangible assets in BFTP8-1?

Absolutely.

14 | P a g e
In past chapters you capitalized all of your intangible assets no matter how little they cost ($60
for a business license); however, businesses consider the materiality of their purchases before
they decided how to record them. The cost of the business license would not be capitalized
(recorded as an asset) because, even in a small business, it would not be considered material
(meaning it is therefore immaterial to the decision making of the stakeholders). Instead, the
$60 would be expensed (Business License Expense) as a cost of doing business.

Aren't you violating the definition of the elements asset and expense?

Yes you are. The business license, when it is purchased, has not been used, consumed, or
incurred to generate revenue so, technically, it cannot be recorded as an expense. The license
can be used for 5 years and will help to generate future revenue so it SHOULD be recorded as
an asset. However, the concept of materiality TRUMPS (overrides, sets aside, counteracts) the
definition of the elements. Since the license only costs $60 the amount is considered
immaterial. Recording it as a business expense on the income statement instead of an asset on
the balance sheet will not affect the decisions of the stakeholders who use the statements
(including you, the owner of the business) and it is therefore considered acceptable.

Why would GAAP allow materiality to change how businesses record transactions?

GAAP allows for materiality because of two qualitative characteristics and one assumption.

Quality: Description:
Relevant Applicable or pertinent to your decision making,
helps you predict the future and/or confirm
decisions you made in the past.
Understandable Group and present information so it is clear and
concise.

Assumption Description:
Full If something will affect the decisions of the external
Disclosure stakeholders, it must be reported.

Immaterial amounts are not relevant (don't change anyone's mind) for decision making and
financial statements need to be grouped in a clear and concise manner to improve
understandability. In addition, full disclosure requires only those items which will affect the
stakeholders, who use the statements for decision making, to be reported as required by GAAP.
You are actually following GAAP when you expense items which are immaterial.

15 | P a g e
So how do you decide what is material and what is immaterial?

Businesses measure the importance of transactions in relation to the remainder of their


business. A business which has $1,000,000 in assets would not consider a business license of
$60 to be material (and, if you had a million dollars you likely would not either!) Is $60 material
for a business like Cleaning Services Inc., with assets of $8,395.25? To decide figure out what
percentage $60 is of $8,395.25: 0.71%. That is less than 1% of the total assets!

As a rule of thumb (meaning a general rule) anything less than 5% of total assets is considered
immaterial. Therefore, in the example of Cleaning Services Inc., the business license and the
software would both be expensed when they are purchased because, even together, they make
up less than 1.42% of the total assets on the balance sheet ([60.00 + 67.79]/8,395.25). The
website design cost of $1,700 is 20.2% of the total assets Clean Services Inc. owns (1,700 /
8,395.25) and therefore should be recorded as an intangible asset.

Consider materiality in future questions when deciding whether to capitalize (record as an


asset) or expense the purchase costs of long-lived assets.

Check your understanding (CYU8-2)

Review the following costs that were incurred to purchase either long-lived tangible or
intangible assets. Consider, using materiality, if you would record the item as an asset or as an
expense. Assume your business has total assets of $11,248.

Capitalize
Description Cost or
Expense?
Annual cost of software license. $199
Registration of a trademark. $1,450
Stapler that you expect to last 10 years. $29
New printer for the office. $89
New desktop computer. $1,899
Annual business license fee. $60
QuickBooks accounting software. $210
QuickTax tax software. $49

So you have your long-lived assets. What do you do with them now?

You are going to use them in order to generate revenue. That word, USE, should tell you what
happens as time moves forward: your asset will be expensed over time. You already
understand this in relation to your current assets: supplies and prepaid insurance are
consumed (supplies) or used (insurance) over time and therefore your asset decreases and your

16 | P a g e
expense increases. For instance, in BFTP8-1 you moved $169.50 from the Prepaid Insurance
account to the Insurance Expense account. Why? Because you has used up one month of
insurance so your asset, Prepaid Insurance, no longer had the same future benefit. Why not?
Because, having used the coverage, it no longer exists. The same is true of long-lived assets but
they are used up over a longer period of time.

How is the use of a long-lived asset recognized?

Before you recognize the use of long-lived assets you have to gather together the information
you need in order to determine the cost of that use. There are four (4) pieces of information
you need to calculate the cost of use: the acquisition cost (which you already did), the date the
asset was ready for use, the estimated useful life, and the residual (or salvage) value.

Determined by reviewing all related costs and


Cost determining the purchase price plus all costs
necessary to make it ready for use.
This is the date that the asset is ready for use,
Ready for Use Date when the business has set it all up and they
can start using it.
How long YOU will keep the asset and use it in
Estimated useful life your business.

An estimate of how much money you will get


Residual value (or salvage when you sell the asset at the end of its useful
value) life.

It is important to realize that the estimated useful life is NOT the total life of the asset but the
period of time when YOUR business will own and use the asset. For instance, from the previous
example of the forklift, you may only use the forklift for 6 years but the forklift's total life may
be 10 years. That means the useful life for you is 6 years and the useful life for someone else
after they buy it from you is 4 years.

Note also that, as your useful life increases, the residual (salvage) value decreases. For
instance, if the useful life of a car to your business is 3 years (after that you sell it and buy a new
one) then the residual value is likely high. This is because you have not used a lot of the total
live of the car, which can be 10 or 15 years. However, if the useful life of the car to your
business is 10 years then the residual value, the amount you can sell the car for at the end of its
useful life, is much lower. Why? Because you have used up much of its TOTAL life, which will
reduce the amount you can sell if for (the residual or salvage value).

17 | P a g e
Remember - useful life does not mean total life. Even if you sell your car after 10 years it is
possible that the business that buys it will use it for many more years.

Finally, not all assets have a residual value. First, in order to calculate the residual value you
must have a reliable secondary market for the asset. What does that mean? A secondary
market means a place to sell used assets. For instance, type "forklift truck" into Kijiji and you
will see that there is a strong secondary market for forklift trucks. A business can use the
information they get on Kijiji to help them estimate the resale value of the forklift truck even if
they will not sell it for a number of years.

Sometimes it is not possible to estimate the residual value because there is no secondary
market, in which case the residual value is zero (0). In addition, sometimes you plan to use the
asset until it can't be used by anyone anymore, in which case residual value will also be zero (0).

Who decides what the estimated useful life and residual value is?

Management of the business, such as the owner or the accountant, decide on the cost (what to
include and what to exclude), the estimated useful life, and the residual value. They do so
based on knowledge that they gain from what has happened in the past with other long-lived
assets and research into what is currently happening.

Do you need the same information for intangible assets?

No. Management has to decide the cost of intangible assets in the same way as tangible assets
(all costs to purchase and make it ready for use). However, intangible assets are different in
two important ways.

1. Intangible assets rarely have a secondary market. For instance, it is difficult to sell a
trademark or brand name. If you do sell them the selling price (residual value) is often
determined (negotiated) on a case by case basis. Therefore, residual value is zero (0) for
intangible assets because it is unknown.

2. The estimated useful life of intangible assets is more complex than for tangible assets.
Intangible assets are divided into two groups: ones that have a useful life (limited life) and ones
that last forever (unlimited life).

Unlimited life intangible assets don't decrease in value due to use because they are never used
up. Limited life intangible assets ARE used up, have an estimated useful life, and decrease in
value just like tangible assets do.

18 | P a g e
Below is listed the different types of intangible assets and whether they have limited (are used
up) or unlimited (last forever) life.

Trademark: a special name, image, or statement (slogan): The words "I'm lovin' it" is a
registered trademark of McDonald's. Trademarks have an endless life (they never
expire). This is because businesses can pay a renewal fee every 15 years. As long as a
business renews the trademark then the trademark will never be used up.

Patent: The exclusive right to use, manufacture, and sell an invention: The legal life of a
patent is 20 years in Canada. The Apple iWatch is patented in that no other business
can create the iWatch for the next 20 years. Like copyrights, the legal life of a patent
(20 years) may be different from the useful life that is decided on by management (how
long the business will actually use and generate revenue from the patent).

Copyright: The rights to publish, use, and sell what you write, sing, draw, paint, or act.
Copyrights have a limited life: 50 years after the author's death. The limited life of a
copyright is long but note that the useful life (how long the business uses it) is often
shorter than the copyright's actual life (life of the author plus 50 years). The estimated
useful life is therefore determined by management on an individual basis.

Technology asset: purchased software and web development. There are used up in a
short period of time (generally 3 to 7 years) and the useful life is decided by
management.

Every intangible asset will have a cost that must be recorded in the business's accounting
system. For trademarks (unlimited life) that value remains on the business's balance sheet for
as long as the business uses the trademark. For all other intangible assets (limited life)
management must use their professional judgment to determine the useful life. Remember,
the residual value of intangibles is always zero (0) so management only has to determine the
useful life.

What accounts are used to record the use of the long-lived asset?

Use of long-lived assets is a factor of time: as you use your asset, the value of the asset
decreases (due to that use) and is moved over to an expense account. There are two accounts
used to record the use of the long-lived assets over their useful life: accumulated depreciation
and depreciation expense.

Accumulated depreciation: an asset account that is negative (like the allowance for
doubtful accounts) and records the total use of the asset since the day it was purchased.

19 | P a g e
Depreciation expense: an expense account that that records the use of the asset for
the current period only, up to one year.

Can you explain depreciation with an example?

It's better to explain with an example.

Say you bought a car for $10,000 and you used it for the year. If the car is estimated to last for
10 years, then you have used up $1,000 ($10,000 / 10 years) of its value in the 1st year.
Depreciation expense (the amount you use up in ONE PERIOD) would be $1,000. It is reported
on the income statement as part of Operating Expenses. Accumulated Depreciation (the
amount that has been used up since the day you bought the asset) would be reported on the
balance sheet as a NEGATIVE.

Why?

Because, on the balance sheet, the car must be kept at its historical cost of $10,000 but it is no
longer worth $10,000 because you used up $1,000 of its value over the last year. Therefore, in
order to show HOW MUCH HAS BEEN USED UP since the day you bought the car, you use the
account called Accumulated Depreciation. This account is on the balance sheet, immediately
under the car's historical cost of $10,000. It is subtracted from the car's historical cost and the
value that results, the historical cost less the accumulated depreciation, is called the book value
(also the net book value).

What would you see on the balance sheet?

Balance Sheet
Assets
Property, plant, and equipment
Vehicles $10,000
Accumulated depreciation, vehicles (1,000)
Book value $9,000

Now, say you are at the end of Year 2 of owning this asset. You have used it for another year
and the depreciation expense for Year 2 is again $1,000 (remember, expense accounts return to
zero at the beginning of every year so the balance in depreciation expense is ONLY $1,000).
What would accumulated depreciation be? $2,000!! The word accumulated means to gather
together so it makes sense that the accumulated depreciation is the total of all depreciation
expense amounts since the day the business bought the asset.

20 | P a g e
What would you see on the balance sheet at the end of Year 2?

Balance Sheet
Assets
Property, plant, and equipment
Vehicles $10,000
Accumulated depreciation, vehicles (2,000)
Book value $8,000

Notice that the book value of the asset is now $8,000. The historical cost has not changed but
the accumulated depreciation is now 2 years of depreciation expense, each for $1,000. The
book value is still the historical cost less the amount of the accumulated depreciation.

Are all long-lived assets depreciated?

No. Recall that trademarks, an intangible asset, are never depreciated even though we use the
trademark to generate revenue. That's because trademarks last forever (seriously....has Coke
ever not generated revenue?) For tangible assets land, the property a business owns, is never
depreciated.

Why not?

Because land does not get used up and it last forever; therefore, land is never depreciated. On
the balance sheet the land account is therefore listed first under the heading "Property, plant,
and equipment". But you'll be introduced to the balance sheet presentation of long lived assets
later in this chapter.

How is depreciation calculated?

Remember: Depreciation is the value of the long-lived asset that is used up over time. There
are a few different ways to calculate the cost of using your long-lived assets but you will focus
on the most commonly used method: the straight line method. The steps in the process for
calculating depreciation are:

1. Calculate the depreciable amount. This is the amount you will depreciate over the
useful life. It is calculated as: cost less residual value.

2. Determine the annual depreciation. This is the value of the asset that you will use up
every year. It is calculated as: depreciable amount / estimated useful life.

21 | P a g e
3. If required, determine the monthly depreciation. This is the value of the asset that you
will use up every month. It is calculated as: annual depreciation / 12 months.

4. Determine the accumulated depreciation. This is the value of the asset that has been
used up since the day the asset was placed in use. It is calculated as: past year's
depreciation + current year's depreciation.

5. Determine the book value (also called carrying value). This is the value of the asset that
is left over to use in the future. It is calculated as: cost - accumulated depreciation.

Once the above information is determined the depreciation for the period can be recorded into
the two accounts, accumulated depreciation and depreciation expense.

What about an example?

Watch the video and complete all the steps which follow (see the next few pages).

https://youtu.be/MlWhW-GGVR8
Here is the information that management of the business who purchased the forklift truck
determined, based on past history and research into the asset:

Cost $4,160
Ready for use date January 1, 2016
Estimated useful life 6 years
Residual value (or salvage value) $560

Be sure to follow the steps:

1. Calculate the depreciable amount (cost less residual value).

2. Determine the annual depreciation (depreciable amount / estimated useful life).

3. If required, determine the monthly depreciation (annual depreciation / 12 months).

22 | P a g e
Year ended Depreciation expense Accumulated Book value
depreciation (cost - acc. depr.)
31-Dec-16
31-Dec-17
31-Dec-18
31-Dec-19
31-Dec-20
31-Dec-21

2016:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Accumulated depreciation

Depreciation Expense
2016

Accounts payable
Equipment

Revenue
Cash

Balance N/A 4,160 0 N/A N/A N/A 0

23 | P a g e
2017:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense

Accumulated depreciation

Depreciation Expense
2017

Accounts payable
Equipment

Revenue
Cash

Balance N/A 4,160 -600 N/A N/A N/A 0

Check your understanding (CYU8-3)

Let's continue from where you left off in CYU8-1: you had an asset that had a cost of $30,990.
Let's determine the remainder of the necessary information.

Cost $30,990
Ready for use date January 1, 2016
Estimated useful life 6 years
Residual value (or salvage value) $3,990

Follow the steps and calculate the following:

1. Calculate the depreciable amount (cost less residual value).

___________________________

2. Determine the annual depreciation (depreciable amount / estimated useful life).

___________________________

24 | P a g e
3. If required, determine the monthly depreciation (annual depreciation / 12 months).

____________________________

Complete the chart:

Year ended Depreciation Accumulated Book value


expense depreciation (cost - acc.
depr.)
31-Dec-16
31-Dec-17
31-Dec-18
31-Dec-19
31-Dec-20
31-Dec-21

Record the depreciation expense for 2016 and 2017. Remember to carry forward the balances
from the prior year!!

2016:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Accumulated depreciation

Depreciation Expense
Accounts payable
Equipment

Revenue
Cash

Balance N/A 30,990 N/A N/A N/A

25 | P a g e
2017:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense

Accumulated depreciation

Depreciation Expense
Accounts payable
Equipment

Revenue
Cash

Balance N/A 30,990 N/A N/A N/A

How does the calculation of depreciation change for a partial year?

Businesses don't purchase long-lived assets at the beginning of every year. They buy long-lived
assets when they need them! That can be at any time in the year. How would this change the
calculation of depreciation?

Assume that you purchased the forklift truck on March 1, 2016, instead of on January 1, 2016.

Watch the video and complete the charts to see the impact of purchasing the asset during the
year.

https://youtu.be/-GjmtdYfHgI
Cost $4,160
Ready for use date March 1, 2016
Estimated useful life 6 years
Residual value (or salvage value) $560

Follow the steps:

1. Calculate the depreciable amount (cost less residual value).

____________________________
26 | P a g e
2. Determine the annual depreciation (depreciable amount / estimated useful life).

______________________________

3. If required, determine the monthly depreciation (annual depreciation / 12 months).

_________________________________

While you watch the video complete the chart for steps 4 and 5. In addition, complete the
expanded accounting equation, with account names, for 2016 and 2017.

Year ended Depreciation expense Accumulated Book value


depreciation (cost - acc. depr.)
31-Dec-16
31-Dec-17
31-Dec-18
31-Dec-19
31-Dec-20
31-Dec-21
28-Feb-22

2016:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Accumulated depreciation

Depreciation Expense
2016

Accounts payable
Equipment

Revenue
Cash

Balance N/A 4,160 0 N/A N/A N/A 0

27 | P a g e
2017:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense

Accumulated depreciation

Depreciation Expense
2017

Accounts payable
Equipment

Revenue
Cash

Balance N/A 4,160 -500 N/A N/A N/A 0

Check your understanding (CYU8-4)

Let's do the same thing for our asset which costs $30,990. This time assume that, this time, you
bought it on April 1, 2016.

Cost $30,990
Ready for use date April 1, 2016
Estimated useful life 6 years
Residual value (or salvage value) $3,990

Follow the steps and calculate the following:

1. Calculate the depreciable amount (cost less residual value).

___________________________

2. Determine the annual depreciation (depreciable amount / estimated useful life).

___________________________

28 | P a g e
3. If required, determine the monthly depreciation (annual depreciation / 12 months).

____________________________

Complete the chart:

Year ended Depreciation expense Accumulated Book value


depreciation (cost - acc. depr.)
31-Dec-16
31-Dec-17
31-Dec-18
31-Dec-19
31-Dec-20
31-Dec-21
31-Dec-22

Record the depreciation expense for 2016 and 2017. Remember to carry forward the balances
from the prior year!!

2016:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Accumulated depreciation

Depreciation Expense
Accounts payable
Equipment

Revenue
Cash

Balance N/A 30,990 N/A N/A N/A

29 | P a g e
2017:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense

Accumulated depreciation

Depreciation Expense
Accounts payable
Equipment

Revenue
Cash

Balance N/A 30,990 N/A N/A N/A

What happens if you sell the asset before the end of its useful life?

A business may decide to sell their long-lived asset instead of keeping it for its useful life. They
might purchase a new long-lived asset that is more efficient or, if they are no longer making a
product, they might decide to sell the long-lived asset because it is not longer useful to them.

If the long-lived asset is sold, then it must be recorded on the records of the business. There
are two steps to the process:

1. Calculate the depreciation expense for the year of disposal. It is likely that the business
sold the asset DURING the year so you have to record only the depreciation only the
amount that you used this period.

2. Record the depreciation up to the date of the disposal. The business has used the asset
up to the date of disposal and that use must be recognized as an expense. You need to
record the amount you calculated in (1).

3. Determine the selling price, which is what you sold the asset for.

4. Determine if you will record a gain or a loss on the sale of this long-lived asset. Do that
by comparing the book value at the disposal date to the selling price. If you sold it for
more you have a gain. If you sold it for less you have a loss.

30 | P a g e
5. Record the sale. That means you have to think about what you gave away (the long-
lived asset) and what you got (cash). You have to record that in your records.

Let's go back to the forklift truck. Assuming you purchased it on March 1, 2016, you have
already calculated what the depreciable amount is, the annual depreciation, and the monthly
depreciation. You have been using the forklift for 2016, 2017, and 2018 and your chart would
be as follows:

Year ended Depreciation expense Accumulated Book value


depreciation (cost - acc. depr.)
31-Dec-16 $500 $500 $3,600
31-Dec-17 $600 $1,100 $3,060
31-Dec-18 $600 $1,700 $2,460

Now, assume you sell the forklift truck on August 31, 2019. How would you record that?

Watch the video and fill in the charts, and accounting equation, that follow.

https://www.youtube.com/watch?v=yLAnkFn8pkQ

Assume you sold the forklift for $2,500 on August 31, 2019:

Year ended Depreciation expense Accumulated Book value


depreciation (cost - acc. depr.)
31-Dec-16 $500 $500 $3,600
31-Dec-17 $600 $1,100 $3,060
31-Dec-18 $600 $1,700 $2,460
31-Aug-19
Calculations:

31 | P a g e
Record the sale in the expanded accounting equation:

Equity
Liabilit Retained Earnings
Asset
ies Owners' Capital Profit
Revenue Expense

Accumulated depreciation

Depreciation Expense
2018

Accounts payable

Gain on sale

Loss on sale
Equipment

Revenue
Cash

Balance N/A 4,160 -1,700 N/A N/A N/A

NOW, instead, assume that you sold the forklift for $1,500 on August 31, 2019:

Year ended Depreciation expense Accumulated Book value


depreciation (cost - acc. depr.)
31-Dec-16 $500 $500 $3,600
31-Dec-17 $600 $1,100 $3,060
31-Dec-18 $600 $1,700 $2,460
31-Aug-19
Calculations:

32 | P a g e
Record the sale in the expanded accounting equation:

Equity
Liabilit Retained Earnings
Asset
ies Owners' Capital Profit
Revenue Expense

Accumulated depreciation

Depreciation Expense
2018

Accounts payable

Gain on sale

Loss on sale
Equipment

Revenue
Cash

Balance N/A 4,160 -1,700 N/A N/A N/A

Check your understanding (CYU8-5)

Let's continued with our example of the long-lived asset that cost $30,990. Again, assume you
bought it on April 1, 2016.

Cost $30,990
Ready for use date April 1, 2016
Estimated useful life 6 years
Residual value (or salvage value) $3,990
Sold July 31, 2020
Selling price $12,000
Follow the steps and calculate the following:

1. Calculate the depreciation to the date of disposal.

___________________________

33 | P a g e
2. Record the depreciation in the expanded accounting equation.

See the chart on the next page.

3. Determine the selling price: $12,000

4. Calculate the loss or the gain:

_____________________________________

5. Record the disposal in the expanded accounting equation.

Complete the chart:

Year ended Depreciation expense Accumulated Book value


depreciation (cost - acc. depr.)
31-Dec-16 3,375 3,375 27,615
31-Dec-17 4,500 7,875 23,115
31-Dec-18 4,500 12,375 18,615
31-Dec-19 4,500 16,875 14,115
31-July-20

See the expanded accounting equation, below.

34 | P a g e
Equity
Liabil Retained Earnings
Asset
ities Owners' Capital Profit
Revenue Expense

Accumulated depreciation

Depreciation Expense
2020

Accounts payable

Gain on sale

Loss on sale
Equipment

Revenue
Cash

Balance N/A 30,990 -16,875 N/A N/A N/A 0

Check your understanding (CYU8-6)

Let's continued with our example of the long-lived asset that cost $30,990. Again, assume you
bought it on April 1, 2016 but this time you sold it on July 31, 2020 for $9,000.

Cost $30,990
Ready for use date April 1, 2016
Estimated useful life 6 years
Residual value (or salvage value) $3,990
Sold July 31, 2020
Selling price $9,000
Follow the steps and calculate the following:

1. Calculate the depreciation to the date of disposal.

___________________________

35 | P a g e
2. Record the depreciation in the expanded accounting equation.

See the chart on the next page.

3. Determine the selling price: $9,000

4. Calculate the loss or the gain:

_____________________________________

5. Record the disposal in the expanded accounting equation.

Complete the chart:

Year ended Depreciation expense Accumulated Book value


depreciation (cost - acc. depr.)
31-Dec-16 3,375 3,375 27,615
31-Dec-17 4,500 7,875 23,115
31-Dec-18 4,500 12,375 18,615
31-Dec-19 4,500 16,875 14,115
31-July-20

See the expanded accounting equation, below.

36 | P a g e
Equity
Liabil Retained Earnings
Asset
ities Owners' Capital Profit
Revenue Expense

Accumulated depreciation

Depreciation Expense
2020

Accounts payable

Gain on sale

Loss on sale
Equipment

Revenue
Cash

Balance N/A 30,990 -16,875 N/A N/A N/A 0

How do you calculate depreciation for an intangible asset?

Exactly the same!! The only difference is residual value is zero but, otherwise, you record the
same thing for the depreciation and for the disposal if you should sell the intangible asset!

Check your understanding (CYU8-7)

Assume, after years of research, you develop a product that uses a new technology. You patent
the technology because you want to protect what you have developed. You use a lawyer and it
costs you $7,500 in total. Although the legal life of the patent in Canada is 20 years you
estimate that, due to the rapid pace of technology development in the 21st century, your
patent will only generate revenue over the next 5 years.

37 | P a g e
Cost $7,500
Ready for use date May 1, 2016
Estimated useful life 5 years
Residual value (or salvage value) $0

Follow the steps and calculate the following:

1. Calculate the depreciable amount (cost less residual value).

___________________________

2. Determine the annual depreciation (depreciable amount / estimated useful life).

___________________________

3. If required, determine the monthly depreciation (annual depreciation / 12 months).

____________________________

Complete the chart:

Year ended Depreciation Accumulated Book value


expense depreciation (cost - acc.
depr.)
31-Dec-16
31-Dec-17
31-Dec-18
31-Dec-19
31-Dec-20
31-Dec-21

Record the depreciation expense for 2016 and 2017. Remember to carry forward the balances
from the prior year!!

38 | P a g e
2016:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense

Accumulated depreciation

Depreciation Expense
Accounts payable

Revenue
Patent
Cash

Balance N/A N/A N/A N/A

2017:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Accumulated depreciation

Depreciation Expense
Accounts payable

Revenue
Patent
Cash

Balance N/A N/A N/A N/A

39 | P a g e
How are long-lived assets reported on the financial statements?

Long-lived assets are reported in two places. First, the depreciation expense is recorded as an
operating expense on the income statement. Second, the asset and its related accumulated
depreciation is reported on the balance sheet, under long term assets, under the heading
Property, plant, and equipment.

Here is an example of what a business which owns multiple long lived assets would look like:

Property, plant, and equipment


Land 100,000
Building 120,000
Less: accumulated depreciation 60,000 60,000
Equipment 24,000
Less: accumulated depreciation 9,600 14,400
Total property, plant, and equipment 174,400
Intangibles
Patent 10,000
Less: accumulated depreciation 2,000 8,000
Website design 6,000
Less: accumulated depreciation 3,000 3,000
Total intangibles 11,000

Note that intangibles are sometimes amalgamated (added together) and reported as one line
item.

Property, plant, and equipment


Land 100,000
Building 120,000
Less: accumulated depreciation 60,000 60,000
Equipment 24,000
Less: accumulated depreciation 9,600 14,400
Total property, plant, and equipment 174,400
Intangibles 11,000

40 | P a g e
Putting it all together!

This chapter has shown you the importance of managing and appropriately recording your long
lived assets. Businesses, as they grow and expand, will purchase long-lived assets in order to
help the business generate a profit in the future. Long lived assets are first recorded as assets
(have future benefit as they will help the business generate more revenue) and then expensed
(because they are being used up). By understanding how to record business activities that
involve long-lived assets you can, as a business owner or manager, make better decisions about
how to manage one of the most important assets on your balance sheet.

Going forward!

Up to now you have focused on the asset side of the balance sheet, both current and long lived
assets. What about liabilities? When a business purchases assets they use either the cash
generated by the business (profit) or they finance the purchase of those assets through debt
(liabilities) or equity (owners' capital contributions). In the next chapter you will develop an
understanding of the liabilities that businesses records as they grow and expand.

41 | P a g e
What do you need to know for the final exam?

A. Define long-lived assets, accumulated depreciation, and depreciation expense. Which


elements are they in and explain why they belong there.
B. Define tangible and intangible assets. List common tangible and intangible asset
examples.
C. Determine the cost of a long-lived assets, both for intangible and tangible assets. If a
cost is not included how should it be recorded?
D. What is materiality? What GAAP concepts does materiality violate and follow? Be able
to define each of these GAAP concepts.
E. Be able to apply the concept of materiality to business purchases.
F. Explain why the use of long-lived assets has to be recorded.
G. Explain which long-lived assets are never depreciated and why.
H. Record the purchase of a long lived asset.
I. Calculate and record depreciation when a long lived asset is purchased at the beginning
of the year or part way through the year.
J. Record the disposal (sale) of a long-lived assets.
K. Calculate and record depreciation on intangible assets.
L. Present long-lived assets on the balance sheet and the income statement.

Watch out for....

The most common error on the final exam is when students forget to check when a long-lived
asset was put into use. They often calculate depreciation from the date of purchase instead of
from the date it is available for use. In addition, students regularly forget to check if the long-
lived asset was purchased sometime during the year, meaning a partial year calculation must be
made in both the year of purchase and the final year of use.

42 | P a g e
In Class Demo Questions
ICDQ8-1

Divito Inc. bought equipment on January 1, 2016, for $55,000. The business also paid the
following amounts: $800 for shipping, $200 for insurances while the equipment was being
shipped, $2,400 for a two-year insurance policy, $2,000 to train employees on how to use the
equipment and $3,800 for testing and installing the equipment.

Required: determine which costs should be capitalized (included as part of the cost of the
equipment). Support your decision with reasoning (be sure to mention purchase costs or
necessary to make it ready for use). If the cost is not capitalized as part of the equipment how
would you record it? Provide the account name and the reason you would record it that way.
Then record all the costs in the accounting records, using the expanded accounting equation
and account names (see chart, below).

Account
Description of Cost Cost to record Reasoning
into:
aSSET
eQUIP PURCH 55000 eQUIP
D aSSET
ElsHIPPIG 800 eQUIP

Ins. IN tRANSIT 200 eQUIP aSSET


aSSET
iNSTAllation 3800 eQUIP

testing 1,100

Rail replacement 320


The expanded accounting equation is provided for you on the next page.

43 | P a g e
Note: for the chart three of the accounts have been provided for you. The remainder you will
have to fill in yourself.

Equity

Retained Earnings
Asset Liabilities Owners'
Capital Profit
Revenue Expenses

Accounts payable
Equipment
Cash

Opening N/A N/A N/A N/A N/A N/A N/A N/A


Trans. 1 55000
Trans. 2 800
Trans. 3 200
Trans. 4 3800
Trans. 5
Trans. 6
Total: 59800

ICDQ8-2

What is accumulated depreciation? Which element does it belong in?

In Asset account

What is depreciation expense? Which element does it belong in?

44 | P a g e
ICDQ8-3

You are running a business and you purchase equipment on January 1, 2016, for $59,800. You pay
$10,000 cash and the remainder is on account. The equipment has an estimated useful life of 4 years
and the residual value is expected to be $7,000 at the end of its useful life.

1. Record the purchase of the equipment in the appropriate accounts. The chart is provided on the next
page, denoted with a "2016".

2. Record the payment of the Accounts Payable on February 12, 2016, on the 2016 chart.

3. Calculate the depreciation expense and the accumulated depreciation for the life of the asset (see
chart, below).

4. Record the depreciation expense for December 31, 2016 in the expanded accounting equation in
2016. In addition provide the balance sheet and income statement presentation.

5. Record the depreciation expense for December 31, 2017 in the expanded accounting equation in the
"2017" chart. In addition provide the balance sheet and income statement presentation.

4. Calculate the depreciable amount (cost residual value).

59800-7000=52800

5. Determine the annual depreciation (depreciable amount / estimated useful life).

52800:4=13200

6. If required, determine the monthly depreciation (annual depreciation / 12 months).

13200/12=1100/month

Complete the chart, below.

Year ended Depreciation expense Accumulated Book value


depreciation (cost - acc. depr.)
31-Dec-16 13200 13200 46600
31-Dec-17 13200 26400 33400
31-Dec-18 13200 39600 20200
31-Dec-19 13200 52800 7000

52800/4=13200

45 | P a g e
ICDQ8-3 continued

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense

Accumulated depreciation

Depreciation Expense
2016

Accounts payable
Equipment

Revenue
Cash

Jan1 -10000 59800 49800


Feb12 -49800 -49800
Dec31/16 -13200 -13200
59800 13200
Dec 31/17 -13200 13200

Balance 59800 -26400

How would this long-lived asset be presented on the balance sheet on December 31, 2016? What would
show up on the income statement and where?

Equip 59800
Loss:Acc.Dep. 13200
Net Book Value -46600

46 | P a g e
ICDQ8-3 continued

NOTE: You are required to complete the opening balances. Carry them forward from 2016, above,
after you complete the chart. NOTE that revenue and expenses are ZERO because it is a new year!

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense

Accumulated depreciation

Depreciation Expense
2017

Accounts payable
Equipment

Revenue
Cash

Balance N/A 59800 -13200 N/A N/A 0


Dec 31 -13200 13200

total 59800 -26400 -13200

How would this long-lived asset be presented on the balance sheet on December 31, 2017? What would
show up on the income statement and where?

Equip 59800
Loss : Acc.Dept 26400
Net Book Value 33400

47 | P a g e
ICDQ8-4

Your business purchases a truck for delivery purposes on May 1, 2016, paying $75,000 in cash. The
equipment has an estimated useful life of 6 years and the residual value is expected to be $6,600 at the
end of its useful life.

1. Record the purchase of the equipment in the appropriate accounts. The chart is provided on the next
page, denoted with a "2016".

2. Calculate the depreciation expense and the accumulated depreciation for the life of the asset (see
chart, below).

3. Record the depreciation expense for December 31, 2016 in the expanded accounting equation in
2016. In addition provide the balance sheet and income statement presentation.

4. Record the depreciation expense for December 31, 2017 in the expanded accounting equation in the
"2017" chart. In addition provide the balance sheet and income statement presentation.

Calculate the depreciation expense and the accumulated depreciation for the life of the asset.

1. Calculate the depreciable amount (cost residual value).

75000-6600=68400

2. Determine the annual depreciation (depreciable amount / estimated useful life).

68400/6=11400

3. If required, determine the monthly depreciation (annual depreciation / 12 months).

11400/12=950/month

Complete the chart, below.

Year ended Depreciation expense Accumulated Book value


depreciation (cost - acc. depr.)
31-Dec-16 7600 7600 68400
31-Dec-17 11400 19000 56000
31-Dec-18 11400 30400 44600
31-Dec-19 11400 41800 33200
31-Dec-20 11400 53200 21800
31-Dec-21 11400 64600 11400
30-Apr-22 3800 68400 6600

48 | P a g e
Record the depreciation expense for December 31, 2016, in the expanded accounting equation. The
chart is below.

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense

Accumulated depreciation

Depreciation Expense
2016

Accounts payable
Equipment

Revenue
Cash

N/A N/A N/A 0


Dec 31 7600 7600

Dec
31/17 11400 11400

How would this long-lived asset be presented on the balance sheet on December 31, 2016? What would
show up on the income statement and where?

Equipment 75000
Loss:acc.Dep 7600
Net Book Value 67400

2017
Equip 75000
Loss:acc.Dep 19000
Net Book Value 56000

49 | P a g e
ICDQ8-5

On August 1, 2016, you buy a computer system for $14,000 cash. The computer system has an
estimated useful life of 4 years and a residual value of $2,000. You are not satisfied with the way the
system works and, on May 31, 2018, you sell the system for $7,000 cash.

1. Using the chart, below, calculate the depreciation expense and the accumulated depreciation for the
life of the asset, up to the date of sale.

2. In the expanded accounting equation record the following:

The purchase of the computer system in 2016


Depreciation in 2016
Deprecation in 2017
All required entries in 2018

Depreciation Accumulated Book value (cost -


Year ended
expense depreciation acc. depr.)
31-Dec-16 1250 1250 12750
31-Dec-17 3000 4250 9750
31-May-18 1250 5500 8500

Calculate the depreciation expense for the year of disposal.

5*250=1250

Record the depreciation expense to the date of disposal (see the expanded accounting equation, below)

Cost 14,000 cost 14000, acc dept 5500, nbv 8500, proceeds 7000,loss 1500

Determine the selling price.

Determine the gain or loss on sale (compare book value after you record the depreciation to the selling
price).

50 | P a g e
Equity
Liabil Retained Earnings
Asset
ities Owners' Capital Profit
Revenue Expense
2016 - 2018

Accumulated depreciation

Depreciation Expense
Accounts payable

Gain on sale

Loss on sale
Equipment

Revenue
Cash

Balance N/A N/A 0


-
1400
0 14000

-1250 -1250
14000 -1250

-3000 -3000
14000 -4250

-1250 -1250
14000 5500

+700 -
0 14000 +5500 -1500

51 | P a g e
ICDQ8-6

Assume the same information as for ICDQ8-5 but, instead of selling the computer system for $7,000,
you sell it for $9,000. Record the sale in the expanded account equation, using account names.

Calculate the depreciation expense for the year of disposal.

1250

Record the depreciation expense to the date of disposal (see the expanded accounting equation, below)

NBV8500,Proceeds9000,Gain500

Determine the selling price.

Determine the gain or loss on sale (compare book value after you record the depreciation to the selling
price).

Record ALL the necessary entries for 2018 ONLY in the expanded accounting equation, below. NOTE:
take the opening balances from your chart in ICDQ8-5, above, for the end of 2017!
Equity
Liabil Retained Earnings
Asset
ities Owners' Capital Profit
Revenue Expense
Accumulated depreciation

Depreciation Expense
2018

Accounts payable

Gain on sale

Loss on sale
Equipment

Revenue
Cash

2017 Bal. 14000 -4250

May 31 -1250 -1250


14000 -5500

-
9000 14000 +5500 500

52 | P a g e
Practice Questions
PQ8-1

Waybridge Inc. has profit of $38,000 on December 31, 2016, accounts receivable of $98,500,
and an allowance for doubtful accounts of $-4,560. Net credit sales were $650,000 during the
year. None of the following activities, below, have been reflected in the accounting records of
the business (but all other entries have been made):

Write off of accounts receivables that are determined to be uncollectible. $6,500


Customers who were previously written off sent in a cheque. $1,250
Waybridge Inc. estimates that 14% of their ending accounts receivable will
be uncollectible in the upcoming year.

Record the above noted transactions into the expanded accounting equation using account
names and answer the questions which follow. Be sure to do all the entries!

Equity
Retained Earnings
Profit
Assets Liabilities Owner's
Capital
Revenue Expense
Earnings(Deficit)
Owner's Capital

Retained
Cash

Dec 31
Trans. 1
Trans. 2

Trans. 3

Totals:

53 | P a g e
If you calculate the outstanding accounts receivable as a percentage of net sales that were
made on credit, what percentage of credit sales has not, as yet, been collected?

Calculation:

Assume the percentage you calculated in the past two years was 12.3% in 2014 and 12.8% in
2015. Would this concern you? Why or why not?

The business used a percentage of outstanding accounts receivable to calculate their estimated
uncollectible accounts. Is there are better method for estimating uncollectable accounts
receivable? What is it and why would you recommend it?

The balance sheet of Waybridge Inc. would show:

Continued on the next page.

54 | P a g e
What would be the profit for Waybridge Inc. after the entries have all been made? Show your
calculations.

PQ8-2

You are a manufacturer that makes puzzles for retail stores. You purchase new equipment that
cuts the puzzles and incur the following costs. The new equipment costs $125,000. You take out
a $100,000 loan to purchase the equipment and the rest you pay in cash. In addition, you pay
the following costs in cash: $5,000 to deliver the equipment, $500 for delivery insurance costs,
$3,000 to install and test the equipment, $1,200 for a 1 year insurance policy, $450 to train
employees on the use of the equipment. During installation you damage the equipment and it
costs $600 to fix. At the end of the first month you spend $100 on routine maintenance for the
equipment.

Required:

Determine which costs should be capitalized (included as part of the cost of the equipment).
Support your decision with reasoning. If the cost is not capitalized as part of the equipment
how would you record it? Provide the account name and the reason you would record it that
way. Then record all the costs in the accounting records, using the expanded accounting
equation and account names (see chart, below).

Continued on the next page.

55 | P a g e
Account
to record
Description of Cost Cost into: Reasoning

The expanded accounting equation is provided for you on the next page.

56 | P a g e
Note: for the chart three of the accounts have been provided for you. The remainder you will
have to fill in yourself.

Equity

Retained Earnings
Asset Liabilities Owners'
Capital Profit

Expenses
Cash

Opening N/A N/A N/A N/A N/A N/A N/A N/A

Trans. 1

Trans. 2

Trans. 3

Trans. 4

Trans. 5

Trans. 6

Trans. 7

Trans. 8

N/A

57 | P a g e
PQ8-3

Alexa Inc. sold merchandise to B.C. Brown Ltd. on August 15, 2015, for $5,000, terms 2/10,
n/30. Unfortunately, B.C. Brown Ltd. Experienced serious cash flow problems and was unable
to pay their outstanding accounts receivable. On August 10 Alexa Inc. stopped trying to collect
the from B.C. Brown Ltd. And wrote off the account. On December 18th Alexa Inc. received a
$1,000 cheque from B.C. Brown Ltd. in settlement of their account. On December 31, 2015,
Alexa Inc. estimated that their uncollectible accounts for the upcoming 2016 year would be
$6,250.

Provide all of the required entries for Alexa Inc. assuming that their accounts receivable was
$125,000 and their allowance for doubtful accounts had a balance of $-3,500 at the start of
2015 and no other accounts receivable were written off during the year.

The expanded accounting equation, with account names, is provided below. More spaces are
provided then August be necessary.

Equity
Retained Earnings
Assets Liabilities Owner's
Capital
Profit
Revenue Expense
Dates

Retained
Earnings
Owner's
Capital
Cash

Opening

Totals:

58 | P a g e
PQ8-4

UR Printing Company purchased a patent for a new laser printer for $1,500,000 on May 1,
2016, for $1,000,000 cash and a bank loan for the remaining balance. The patent has a legal life
of 20 years but the company believes that newer and better technology for printers will be
developed in the next 15 years. The company uses the straight line method to record
depreciation. At the same time the company registered a trademark for the new name of the
technology, "PrintU" on June 1, 2016. They paid cash of $7,850 for the registration with the
Canadian government and $2,500 to the lawyer who registered the trademark for them.

Why do intangibles have no residual (also called salvage) value?

Should the company depreciate both the patent and the trademark? Explain why.

Should the company use 20 years or 15 years to depreciate the patent? Explain why.

Continued on the next page.

59 | P a g e
PQ8-4 continued

Complete the chart for the first 5 years and record all the necessary entries for 2016 AND 2017
in relation to the patent and the trademark in the accounting records.

Year ended Depreciation Accumulated Book value


expense depreciation

31-Dec-16
31-Dec-17
31-Dec-18
31-Dec-19
31-Dec-20

Equity
Owner's
Retained Earnings
Capital
Assets Liabilities
Profit
Revenue Expense

Retained Earnings(Deficit)
Date

Owner's Capital
Cash

Opening

60 | P a g e
PQ8-5

You purchase equipment and have following information:

Cost $133,500
Ready for use date January 1, 2016
Estimated useful life 5 years
Residual value (or salvage value) $13,500

Do the following:

Calculate the depreciable amount.

___________________________

Determine the annual depreciation.

___________________________

Determine the monthly depreciation.

____________________________

Complete the chart:

Year ended Depreciation Accumulated Book value


expense depreciation

31-Dec-16

31-Dec-17

31-Dec-18

31-Dec-19

31-Dec-20

Continued on the next page.

61 | P a g e
Record the depreciation expense for December 31, 2016 and December 31, 2017.

2016:
Equity

Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Cash

Balance

2017:
Equity

Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Cash

Balance

Continued on the next page.

62 | P a g e
Show the balance sheet presentation for the December 31, 2017.

PQ8-6

Handy Tools Inc. (HTI) is a merchandiser, distributing tools to hardware stores across Canada.
Their terms for all customers are n/45. For accounts that are current HTI estimates that there is
a 99% probability (likelihood) of collecting from these customers. Unfortunately, overdue
accounts are less likely. For accounts 0-30 days overdue there is a 90% probability of collection,
for accounts 31 - 60 days overdue there is only a 80% probability of collection and for accounts
>61 days outstanding there is only a 50% probability of collection.

On December 31, 2015, the balance in the allowance for doubtful accounts was
$-4,590. The aging schedule was as follows:

Category Amount Estimated Estimated


Uncollectable Allowance for
Doubtful
Accounts
Current 250,000
1 - 30 days overdue 98,000
31 - 60 days overdue 48,250
Over 61 days overdue 39,650
Total $435,900

Continued on the next page.

63 | P a g e
PQ8-6, continued

What is the estimated uncollectible accounts at December 31, 2015? Show your calculations!

Estimated Uncollectible Amount: $

Calculations:

Provide the entry at December 31, 2015.

Equity
Retained Earnings
Assets Liabilities Owner's
Capital
Profit
Revenue Expense
Dates

Retained
Earnings
Owner's
Capital
Cash

Opening 0 0 0 0 0

Totals:

Continued on the next page.

64 | P a g e
PQ8-6, continued

Show how accounts receivable would be presented on the December 31, 2015, balance sheet.

PQ8-7

Hillsdale Inc. and Erinwood Inc. have the following transactions with each other during the
month of August, 20XX.
Date Transaction description Amount
August 2 Hillsdale Inc. purchased inventory from Erinwood Inc., credit terms $2,800
1/15, n/30, FOB shipping point.
August 2 The cost of the inventory sold to Hillsdale Inc. $1,120
August 3 The appropriate party paid freight costs to UR Transport Inc. $175
August 9 Hillsdale Inc. sold inventory on account to Eastcoast Inc., 1/15, $1,600
n/45.
August 9 The cost of the inventory sold to Eastcoast Inc. $720
August 10 Hillsdale Inc. returned a portion of the inventory purchased from $280
Erinwood Inc. on August 2, FOB shipping point.
August 10 The cost of the returned inventory for Erinwood Inc. (You should ??
be able to figure this out!)
August 11 The appropriate party paid the return shipping costs. $15
August 16 Hillsdale Inc. paid Erinwood Inc. for the goods purchased on ??
August 2.
August 20 Eastcoast Inc. paid Hillsdale for the goods purchased on August 9. ??

Required 1: Record the transactions for Hillsdale Inc. into the expanded accounting equation
using account names. The chart is available on the next page.

Required 2: Record the transactions for Erinwood Inc. into the expanded accounting equation
using account names. The chart is available on the next page.

HINT: it is important that you read the transactions, above, and ask yourself....if I am
representing Hillsdale Inc. what would I record? If the answer is nothing then input NO ENTRY.

65 | P a g e
Then, for Required 2, ask yourself....if I am NOW representing Erinwood Inc. would I record the
entry this time? If the answer is NO then input NO ENTRY.

Hillsdale Inc.

Equity
Owner's
Retained Earnings
Capital
Assets Liabilities
Profit
Revenue Expenses

Retained Earnings(Deficit)
Date

Owner's Capital
Cash

66 | P a g e
Erinwood Inc.

Equity
Owner's
Retained Earnings
Capital
Assets Liabilities
Profit
Revenue Expenses

Retained Earnings(Deficit)
Date

Owner's Capital
Cash

PQ8-8

Similar to PQ8-3, let's assume you purchase the same asset BUT, this time, you buy it on June 1,
2016.

Cost $133,500
Ready for use date June 1, 2016
Estimated useful life 5 years
Residual value (or salvage value) $13,500

Do the following:

Calculate the depreciable amount.

___________________________

Determine the annual depreciation.

___________________________

67 | P a g e
PQ8-8, continued

Determine the monthly depreciation.

____________________________

Complete the chart:

Year ended Depreciation Accumulated Book value


expense depreciation

31-Dec-16

31-Dec-17

31-Dec-18

31-Dec-19

31-Dec-20

31-May-21

Record the depreciation expense for December 31, 2016 and December 31, 2017.

See the charts on the next page.

68 | P a g e
2016:
Equity

Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Cash

Balance

2017:
Equity

Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Cash

Balance

69 | P a g e
PQ8-8, continued

Show the balance sheet presentation for the December 31, 2017.

PQ8-9

Alda Inc. sells shoes made in Italy. At the beginning of August the company had 75 pairs of
shoes that cost the company $185 each. The company purchases and sells all inventory on
account, terms n/30. All inventory is purchased with shipping terms FOB destination and sold
with shipping terms FOB shipping point.

The company had the following transactions during the month of August.

Date Description Units Cost per Selling Price


unit per unit
August 1 Opening Inventory 75 $185
August 5 Sale 60 $425
August 14 Purchase 120 $192
August 15 Sale 105 $425
August 25 Purchase 100 $212
August 27 Sale 90 $425

Calculate the cost of goods sold and the ending inventory, using FIFO and the perpetual
inventory system. NOTE: more rows have been provided than you require.

70 | P a g e
PQ8-9 continued

Date Purchases Cost of goods sold Inventory on hand


Quantity Unit Total Quantity Unit Total Quantity Unit Total
cost Cost cost Cost cost Cost

Totals:

Using the inventory record you produced, above, record EACH inventory purchase and sale in
the expanded accounting equation using account names.

A chart has been provided for you. You may not need all of the rows.

71 | P a g e
Equity
Owner's
Retained Earnings
Capital
Assets Liabilities Profit

Revenue Expense
Date

Retained Earnings(Deficit)
Owner's Capital
Cash

Opening

This question continues on the next page.

72 | P a g e
PQ8-9 continued

The price of the shoes has been increasing over the last month quite quickly. Provide reasons
WHY you believe this may be happening.

Prepare an income statement to the gross profit line. Be sure to calculate the gross profit
margin percentage in addition to the gross profit.

Why is the gross profit margin percentage considered a better measure than the gross profit
amount?

If you are the owner of the business would you be happy with the results? Explain.

73 | P a g e
PQ8-10

Review the following costs that were incurred to purchase either long-lived tangible or
intangible assets. Consider, using materiality, if you would record the item as an asset or as an
expense. Assume your business has total assets of $20,000.

Capitalize
Description Cost or
Expense?
Annual cost of software license. $199
Registration of a trademark. $1,450
Stapler that you expect to last 10 years. $29
New printer for the office. $89
New desktop computer. $1,899
Annual business license fee. $60
QuickBooks accounting software. $210
QuickTax tax software. $49

PQ8-11

Let's continued with our example of the long-lived asset that costs $133,500. Again, assume
you bought it on June 1, 2016.

Cost $133,500
Ready for use date June 1, 2016
Estimated useful life 5 years
Residual value (or salvage value) $13,500
Sold September 30, 2020
Selling price $20,000

Follow the steps (note that, for your final exam, you will not be given the steps!)

6. Calculate the depreciation for the year of the disposal.

___________________________

7. Record the depreciation in the expanded accounting equation.

See the chart on the next page.

74 | P a g e
8. Determine the selling price:

___________________________________

9. Calculate the loss or the gain:

_____________________________________

10. Record the disposal in the expanded accounting equation.

See the chart on the next page.

Year ended Depreciation expense Accumulated Book value


depreciation (cost - acc. depr.)
31-Dec-16 14,000 14,000 119,500
31-Dec-17 24,000 38,000 95,500
31-Dec-18 24,000 62,000 71,500
31-Dec-19 24,000 86,000 47,500
31-Sept-20

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
2020

Cash

Balance

75 | P a g e
PQ8-12

Let's continued with our example of the long-lived asset that cost $133,500. Again, assume you
bought it on June 1, 2016 but this time you sold it on September 30, 2020, for $35,000.
Cost $133,500
Ready for use date June 1, 2016
Estimated useful life 5 years
Residual value (or salvage value) $13,500
Sold September 30, 2020
Selling price $35,000

Follow the steps (note that, for your final exam, you will not be given the steps!)

1. Calculate the depreciation for the year of the disposal.

___________________________

2. Record the depreciation in the expanded accounting equation.

See the chart.

3. Determine the selling price:

___________________________________

4. Calculate the loss or the gain:

_____________________________________

5. Record the disposal in the expanded accounting equation.

See the chart.

Year ended Depreciation expense Accumulated Book value


depreciation (cost - acc. depr.)
31-Dec-16 14,000 14,000 119,500
31-Dec-17 24,000 38,000 95,500
31-Dec-18 24,000 62,000 71,500
31-Dec-19 24,000 86,000 47,500
31-Sept-20

76 | P a g e
Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
2020

Cash

Balance

77 | P a g e
PQ8-13

Singn Ltd. Has an August 31, 2016, year ending. Using the below noted information provide the
multiple step income statement, the statement of retained earnings, and the balance sheet in
good form. Answer the questions which follow.

Financial
Account name: Amount: Element
Statement
Buildings 409,559
Repair and maintenance expense 15,706
Accounts receivable 72,528
Depreciation expense 33,686
Utilities expense 22,773
Salaries expense 176,940
Cash 18,461
Accounts payable 119,547
Retained earnings, start of year 235,532
Insurance expense 12,275
Allowance for doubtful accounts 12,450
Land 149,690
Inventory 192,100
Sales returns and allowances 36,902
Supplies 7,868
Sales discounts 9,606
Equipment 173,596
Bank loan payable, due 2020 178,796
Income tax expense 32,233
Prepaid insurance 7,493
Bad debt expense 10,404
Salaries payable 7,284
Accumulated depreciationequipment 69,446
Interest revenue 4,996
Sales revenue 1,917,528
Accumulated depreciationbuildings 194,546
Supplies expense 8,033
Interest expense 18,367
Owners' capital 83,167
Cost of goods sold 1,428,443

78 | P a g e
79 | P a g e
80 | P a g e
What is the company's gross profit margin percentage? Is this percentage good or bad?

What is the company's profit at the end of the period? Would you consider this profit good or
bad? Explain.

What percentage of accounts receivable does the company believe they will not be able to
collect in the upcoming year? Show your calculations.

Calculations:

81 | P a g e
PQ8-14

You purchase equipment and have following information:

Cost $74,000
Ready for use date September 1, 2016
Test and install equipment $8,000
1 year insurance policy $1,200
Shipping cost $2,000
Estimated useful life 5 years
Residual value (or salvage value) $6,000

Do the following: Calculate the total value of the equipment

____________________________

Calculate the depreciable amount.

___________________________

Determine the annual depreciation.

___________________________

Determine the monthly depreciation.

____________________________

Complete the chart:

Year ended Depreciation Accumulated Book value


expense depreciation

31-Dec-16

31-Dec-17

31-Dec-18

31-Dec-19

31-Dec-20

31-Dec-21

82 | P a g e
PQ8-14 continued

Record the depreciation expense for December 31, 2016 and December 31, 2017.
2016:
Equity

Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Cash

Balance

2017:
Equity

Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Cash

Balance

Continued on the next page.

83 | P a g e
Show the balance sheet presentation for the December 31, 2017.

Explain to your friend what the difference between depreciation expense and accumulated
depreciation is.

Explain to your friend what residual value is.

84 | P a g e
PQ8-15

Classic Kitchen Inc. designs and installs kitchen cabinets, counter tops and back splashes. They
have been in business for over 10 years.

On June 1, 2012 they purchased computers for $4,760. They use the computers to design the
kitchens for their clients. They estimated that the computers would have a useful life of 5 years
and a residual value of $200.

On March 1, 2016 they sell the computers for $1,400 so that they can buy news computer that
can design in 3D.

Calculate the depreciable amount.

___________________________

Determine the annual depreciation.

___________________________

Determine the monthly depreciation.

____________________________

Complete the chart:

Year ended Depreciation Accumulated Book value


expense depreciation

31-Dec-12

31-Dec-13

31-Dec-14

31-Dec-15

1-March-16

85 | P a g e
PQ8-15 Continued

Record the entries required in 2016.

2016:
Equity

Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Cash

Balance

How would your answer change if the company sold the computers for $1,250 instead of
$1,400?

86 | P a g e
Blast from The Past - SOLUTIONS
See the chart on the next page.

87 | P a g e
BFTP8-1
Equity
Profit
Assets Liabilities Owner's
Capital Revenue Expenses

Cleaning supplies expense


Transaction #

Bank Charges Expense


Advertising Expense

Income tax expense


Telephone Expense
Prepaid advertising

Income tax payable

Insurance expense
Website Expenses
Prepaid Insurance
Cleaning supplies

Accounts payable
Business License

Service Revenue
Website Design

Owner's Capital

Wages expense
Loan payable

Car expense
Equipment

Software
Cash

Trans. 1 5000 5,000.00


Trans. 2 2500 2500
Trans. 3 60.00 60.00
Trans. 4
Trans. 5 -1,700.00 1,700.00
Trans. 6 14.99 14.99
Trans. 7 827.11 827.11
Trans. 8 -1,944.00 1,944.00
Trans. 9 542.40 542.40
Trans. 10 213.57 213.57
Trans. 11
Trans. 12 -250.00 -106.79 106.79 250.00
Trans. 13 67.79 67.79
Trans. 14 1,730.00 1,730.00
Trans. 15 -167.40 167.40
Trans. 16 -173.33 173.33
Trans. 17 -153.60 153.60
Trans. 18 -162.00 162.00
Trans. 19 -1,500.00 -1,500.00
Trans. 20 -24.99 24.99
Trans. 21 169.23 169.23
3,484.08 375.00 1,782.00 106.79 827.11 60.00 67.79 1,700.00 225.86 169.23 2,500.00 5,000.00 1,730.00 14.99 106.79 167.40 153.60 162.00 24.99 250.00 173.33 169.23

88 | P a g e
BFTP8-1, continued

Part B
Cleaning Services Inc.
Income Statement
Period ending May 31, 2016

Revenues
Service Revenue 1,730.00
Operating Expenses
Wages expense 250.00
Car expense 173.33
Cleaning expenses 167.40
Insurance expense 162.00
Telephone Expense 153.60
Advertising Expense 106.79
Bank Charges Expense 24.99
Website Expenses 14.99
Total operating expenses 1,052.10
Profit before income tax 676.90
Income tax expense 169.23
Profit (net income) 507.68

Cleaning Services Inc.


Statement of Retained Earnings
Period ending May 31, 2016

Opening retained earnings 0


Add Profit 507.68
Deduct Dividend -
Closing retained earnings $507.68

89 | P a g e
Cleaning Services Inc.
Balance Sheet
At May 31, 2016

Assets
Current Assets

Cash 3,484.08
Cleaning supplies 375.00
Prepaid Insurance 1,782.00
Prepaid advertising 106.79
Total current assets 5,747.86
Capital assets
Equipment 827.11
Intangibles
Business License 60.00
Software 67.79
Website Design 1,700.00
Total intangibles 1,827.79
Total assets 8,402.76
Liabilities
Current liabilities
Accounts payable 225.86
Income tax payable 169.23
Total current liabilities 395.08
Long term liabilities
Loan payable 2,500.00
Total liabilities 2,895.68
Equity
Owner's Capital 5,000.00
Closing retained earnings 507.68
Total equity 5,507.68
Total liabilities and equity 8,402.76

90 | P a g e
BFTP8-1, continued

Part C
Why do you record the cost of the cleaning supplies, insurance, and fliers as assets? Would you
consider these items current or long term assets? Explain why.
They meet the definition of the element asset
They have future benefit for the business because they will be used in the future to help
the business generate revenue, they are purchased in the past, and they are owned by
the business
They are current assets because they will be used up within the upcoming 12 months
Why do you adjust value of the cleaning supplies, insurance, and fliers in transactions 12, 15,
and 18?
Because a portion of the value of the asset has been used or consumed to help generate
revenue. That means the asset is no longer equal to its future benefit to the business
and the asset must therefore be reduced
The use or consumption of the asset in order to help generate revenue matches the
definition of the element expense; therefore, the reduction in the value of the asset
must be moved over to the depreciation expense account.
Why do you record the cost of the vacuum, business license, software, and website design as
assets?
They also meet the definition of the element asset
They have future benefit for the business because they will be used in the future to help
the business generate revenue, they are purchased in the past, and they are owned by
the business.
Would you consider these items current or long term assets? Explain why?
Although a portion of these assets WILL be used up in the upcoming 12 months the
asset will last longer than 1 year.
They therefore have to be recorded as long term assets. There are two types of long
term assets: tangible assets (which are physical assets in that you can touch them) and
intangible (which is a legal right but is not a physical asset which you can touch)
Is it equally important to record all of these as assets, regardless of the magnitude ($ amount)
of each asset?
No.
When long lived assets are purchased, businesses look at the dollar value of what they
purchase.
If the purchase is small, such as the business license, then they are written off as an
expense immediately.
Why?

91 | P a g e
Because the information is not relevant (see Chapter 1) to the decisions made by the
stakeholders of the business.
These costs are expensed because they are not considered material.
Material means it has the capacity to change a stakeholders decision, which is the same
as relevance.

92 | P a g e
Check Your Understanding - SOLUTIONS
CYU8-1

Account to record
Description Cost Reasoning
into:
Invoice price 25,000 Equipment Part of cost to purchase.
Necessary to make it ready for
Delivery 2,000 Equipment
use.
Necessary to make it ready for
Delivery insurance 90 Equipment
use.
Can't work without cable so
Electrical cables 2,800 Equipment necessary to get it ready for
use.
Can't work unless it is
Installation and testing 1,100 Equipment
installed and tested.
Additional cost wasd because
you damaged the machine. It
does not add anything to the
Rail replacement 320 Repair Expense
value of the machine but to
RETURN it to its original
condition.
This is the cost of protection
WHILE it is in use. It is a
1 year insurance policy 1,200 Prepaid insurance prepaid asset and will be
expensed as it is used in the
future.
Even though you need to train
employees to USE the
machine the machine itself
Training (employee and you) 260 Training Expense did not required this! In
addition, the employee is not
part of the machine. Expense
as incurred.

93 | P a g e
CYU8-1, continued

Equity
Retained Earnings
Asset Liabilities Owners'
Capital Profit
Revenue Expenses

Prepaid Insurance

Accounts payable

Training Expense
Repair Expense
Equipment
Cash

Opening N/A N/A N/A N/A N/A N/A N/A N/A


Trans. 1 25,000 25,000
Trans. 2 2,000 2,000
Trans. 3 90 90
Trans. 4 2,800 2,800
Trans. 5 1,100 1,100
Trans. 6 320 320
Trans. 7 1,200 1,200
Trans. 8 260 260
N/A 1,200 30,990 32,770 N/A N/A 320 260

CYU8-2

Capitalize
Description Cost or
Expense?
Annual cost of software license. $199 Expense
Registration of a trademark. $1,450 Capitalize
Stapler that you expect to last 10 years. * $29 Expense
New printer for the office. * $89 Expense
New desktop computer. $1,899 Capitalize
Annual business license fee. $60 Expense
QuickBooks accounting software. * $210 Expense
QuickTax tax software. * $49 Expense

* Even though these are long-lived assets, either tangible or intangible,


they are immaterial purchases and therefore can be expensed as they are
purchased.

94 | P a g e
CYU8-3

Cost $30,990
Ready for use date January 1, 2016
Estimated useful life 6 years
$3,990
Residual value (or salvage
value)

Follow the steps and calculate the following:

1. Calculate the depreciable amount (cost less residual value).

30,990 - 3,990 = 27,000

2. Determine the annual depreciation (depreciable amount / estimated useful life).

27,000 / 6 years = 4,500

3. If required, determine the monthly depreciation (annual depreciation / 12 months).

4,500 / 12 months = $375/month

Depreciation Accumulated
Year ended Book value
expense depreciation
31-Dec-16 $4,500 $4,500 $26,490
31-Dec-17 $4,500 $9,000 $21,990
31-Dec-18 $4,500 $13,500 $17,490
31-Dec-19 $4,500 $18,000 $12,990
31-Dec-20 $4,500 $22,500 $8,490
31-Dec-21 $4,500 $27,000 $3,990

Record the depreciation expense for 2016 and 2017. Remember to carry forward the balances
from the prior year!!

95 | P a g e
2016:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense

Accumulated depreciation

Depreciation Expense
Accounts payable
Equipment

Revenue
Cash

Balance N/A 30,990 0 N/A N/A N/A 0


Dec 31 0 -4500 4500
Balance 30990 -4500 4500

2017:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Accumulated depreciation

Depreciation Expense
Accounts payable
Equipment

Revenue
Cash

Balance N/A 30,990 -4500 N/A N/A N/A 0


Dec 31 0 -4,500 4,500
Balance 30,990 -9,000 4,500

96 | P a g e
CYU8-4

Cost $30,990
Ready for use date April 1, 2016
Estimated useful life 6 years
$3,990
Residual value (or salvage
value)

Follow the steps and calculate the following:

1. Calculate the depreciable amount (cost less residual value).

30,990 - 3,990 = 27,000

2. Determine the annual depreciation (depreciable amount / estimated useful life).

27,000 / 6 years = 4,500

3. If required, determine the monthly depreciation (annual depreciation / 12 months).

4,500 / 12 months = $375/month

Depreciation for 2016: $375 * 9 months = $3,375

Depreciation for 2022: $375 * 3 months = $1,125

Depreciation Accumulated
Year ended Book value
expense depreciation
31-Dec-16 $3,375 $3,375 $27,615
31-Dec-17 $4,500 $7,875 $23,115
31-Dec-18 $4,500 $12,375 $18,615
31-Dec-19 $4,500 $16,875 $14,115
31-Dec-20 $4,500 $21,375 $9,615
31-Dec-21 $4,500 $25,875 $5,115
31-Mar-22 $1,125 $27,000 $3,990

Record the depreciation expense for 2016 and 2017. Remember to carry forward the balances
from the prior year!!

97 | P a g e
Record the depreciation expense for 2016 and 2017. Remember to carry forward the balances
from the prior year!!

2016:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense

Accumulated depreciation

Depreciation Expense
Accounts payable
Equipment

Revenue
Cash

Balance N/A 30,990 0 N/A N/A N/A 0


Dec 31 0 -3,375 3,375
Balance 30,990 -3,375 3,375

2017:

Equity
Retained Earnings
Asset Liabilities Owners'
Profit
Capital
Revenue Expense
Accumulated depreciation

Depreciation Expense
Accounts payable
Equipment

Revenue
Cash

Balance N/A 30,990 -3,375 N/A N/A N/A 0


Dec. 31 0 -4500 4,500
Balance 30,990 -7,875 4,500

98 | P a g e
CYU8-5

Cost $30,990
Ready for use date April 1, 2016
Estimated useful life 6 years
$3,990
Residual value (or salvage
value)

Sold July 31, 2020


Selling price $12,000
Follow the steps and calculate the following:

11. Calculate the depreciation to the date of disposal.

$375 * 7 months = 2,625

12. Record the depreciation in the expanded accounting equation.

See the chart on the next page.

13. Determine the selling price: $12,000

14. Calculate the loss or the gain:

12,000 - 11,490 = $510 GAIN

15. Record the disposal in the expanded accounting equation.

See the chart on the next page.

99 | P a g e
Year ended Depreciation expense Accumulated Book value
depreciation (cost - acc. depr.)
31-Dec-16 3,375 3,375 27,615
31-Dec-17 4,500 7,875 23,115
31-Dec-18 4,500 12,375 18,615
31-Dec-19 4,500 16,875 14,115
31-July-20 2,625 19,500 11,490

Equity
Lia
Retained Earnings
Asset bili
Owners' Capital Profit
ties
Revenue Expense
Accumulated depreciation

Depreciation Expense
2020

Accounts payable

Gain on sale

Loss on sale
Equipment

Revenue
Cash

N/
N/A 30,990 -16,875 N/A N/A 0
Bal A
July
31 0 -2,625 2,625
Bal 30,990 -19,500 2,625
July
31 +12,000 -30,990 +19,500 +510
Bal 12,000 0 0 510 2,625

100 | P a g e
CYU8-6

Cost $30,990
Ready for use date April 1, 2016
Estimated useful life 6 years
$3,990
Residual value (or salvage
value)

Sold July 31, 2020


Selling price $9,000
Follow the steps and calculate the following:

1. Calculate the depreciation to the date of disposal.

$375 * 7 months = 2,625

2. Record the depreciation in the expanded accounting equation.

See the chart on the next page.

3. Determine the selling price: $9,000

4. Calculate the loss or the gain:

9,000 - 11,490 = $2,490 LOSS

5. Record the disposal in the expanded accounting equation.

See the chart on the next page.

101 | P a g e
Year ended Depreciation expense Accumulated Book value
depreciation (cost - acc. depr.)
31-Dec-16 3,375 3,375 27,615
31-Dec-17 4,500 7,875 23,115
31-Dec-18 4,500 12,375 18,615
31-Dec-19 4,500 16,875 14,115
31-July-20 2,625 19,500 11,490

Equity
Lia
Retained Earnings
Asset bili
Owners' Capital Profit
ties
Revenue Expense
Accumulated depreciation

Depreciation Expense
2020

Accounts payable

Gain on sale

Loss on sale
Equipment

Revenue
Cash

N/
N/A 30,990 -16,875 N/A N/A 0
Bal A
July
31 0 -2,625 2,625
Bal 30,990 -19,500 2,625
July
31 +9,000 -30,990 +19,500 2,490
Bal 9,000 0 0 2,625 2,490

102 | P a g e

You might also like