Fixed and Intangible Assets

Fixed Assets

Fixed assets are sometimes referred to as PP&E, or Plant, Property and Equipment. For an item to be considered a fixed asset, it must first be a tangible asset. A tangible asset is one that has physical substance, such as a desk or a building.

Secondly, it must be a long term asset with over one year of use for the business. If the initial useful life of an item is less than a year, then it is simply an expense to the business. By being a long-term expense over a year, it becomes subject to depreciation. Land is the only fixed asset that does not get depreciated.

The final test is to ask "does this item serve a productive purpose, and is used by the business?" If you answer no, then the item is an investment. If, however, you can answer yes, then you have a fixed asset.

The cost for acquiring the fixed asset includes all monies that are spent to receive the asset and get it ready for use. For example, direct costs associated with constructing a building, and freight and installation costs for equipment would be added to the purchase price to determine the cost of the fixed asset. Direct costs associated with new construction, including labor and materials, should be debited to a "construction in progress" account until the work is completed. Once the work has been completed, then the amount in the construction in progress account can be credited to the account to clear it out, and the amount is then debited to the appropriate fixed asset account.

Only costs that are necessary for preparing a long-term asset for use should be included as a cost of the asset. Unnecessary costs that do not increase the usefulness of the asset are recorded as an expense. Examples of unnecessary costs are vandalism, mistakes in installation, uninsured theft, damage during installation and fines for not obtaining the proper permits.

Expenses will occur for the fixed asset once it is in place. Expenditures that only benefit the current period, such as general repairs and maintenance, are called revenue expenses. Expenditures that improve the asset for its useful life, such as adding a hydraulic lift to a delivery truck or overhauling the truck's engine to extend the useful life of it, are called capital expenses.

Leasing Fixed Assets

A lease is a contract for the use of an asset for a stated period of time. The two parties of a lease contract are the lessor and the lessee. The lessor is the party that owns the asset. the lessee is the party that is granted the right to use the asset by the lessor.

There are two basic types of leases. The first is an operating lease. This is a standard lease where the lessee records the payments by debiting rent expense and crediting cash. The second is a capital lease. With a capital lease, the item being leased is treated as if it were purchased by the lessor. This allows the lessor to write off the expense as an asset over the life of the lease.


Land has unlimited life, and can therefore provide unlimited services. Because of this, land cannot be depreciated. Other fixed assets such as buildings and equipment lose their ability to provide a useful service over time. As a result, the costs of equipment, buildings and land improvements should be transferred to an expense account over the expected useful life of the asset. This periodic transfer of the cost to expense is called depreciation.

The adjusting entry to record depreciation is usually made at the end of each month or year. The entry debits Depreciation Expense and credits the contra-asset account Accumulated Depreciation, or Allowance for Depreciation. The use of the contra-asset account allows the original cost to remain unchanged in the fixed asset account.

There are three factors in determining how much is to be depreciated. The first is the cost of the fixed asset. The second is the expected useful life of the asset. The final factor is the residual value of the asset. The residual value of an asset is the estimated value of an asset at the end of its useful life. If a fixed asset is expected to have little or no value at the end of its useful life, then the entire initial cost should be depreciated over its useful life. If it is expected to have a significant value, then this must be subtracted from the initial cost to find the asset's depreciable cost.

For example, equipment is purchased for a cost of $15,000. It is expected to be used for five years. At the end of the five years, it is expected that the equipment will be worth $2,000. The depreciable cost of the asset is $13,000, to be depreciated over five years.

There are three basic methods for determining depreciation. These are straight-line, units-of-production and double-declining-balance.

Straight-Line Method: With the straight line method, the same amount of depreciation expense is used for each year of the asset's useful life. With the example above, we have $15,000 cost, expected $2,000 residual value, and an expected useful life of 5 years. The formula would be ($15,000-$2,000)/5, which equals $2,600 per year depreciation. If an asset is used over only a portion of a year, then it would be prorated. The straight-line method is simple and the most widely used.

Another way to determine the straight-line amount is by a percentage by dividing 100 by the number of useful years. In the example above, with 5 years of useful service, this comes to (100 divided by 5) 20%. If you take the $13,000 in depreciable amount and multiply by 20%, the amount to be depreciated comes to $2,600.

Units-of-Production Method: If an asset's service is related to use rather than time, and the amount of use of the asset varies from year to year, then units-of-production method is more appropriate than the straight-line method. With this type of depreciation, the useful life of the asset is expressed in terms of units of productive capacity such as hours or miles. Using the above example, instead of having a useful life of 5 years, the item is a piece of equipment that is estimated to be useful up to 4,000 hours. The formula would be ($15,000-$2,000)/4,000, which equals $3.25 hourly depreciation. Assuming the item was in operation for 2,500 hours during a year, the depreciation for that year would be $3.25 times 2,500 hours, or $8,125.

Double-Declining-Balance Method: This method provides for a declining periodic expense over the estimated useful life of the asset. With this method, more depreciation is done at the beginning of the life of the asset than at the end. The double-declining-balance method uses the same method for determining percentage as in the straight-line method, but then doubles it, to get the depreciation percentage. In the example above, the percentage was determined at 20%. Therefore, the percentage to be depreciated is 40%.

After the first year, the declining book value of the asset is multiplied by the depreciation rate. With this method, both the book value and the amount depreciated are decreased over time. You'll notice that if you keep going, you'll end up with a book value that is less than the estimated residual value of the item. Because of this, the multiplier is not used at that point. Instead, the remaining balance to get to the residual value is depreciated.

Using the example above, the cost of the item is $15,000, the residual value is $2,000 and the useful life is 5 years. 100 divided by 5 is 20, times two is 40, so the depreciation percent is 40%. The depreciation would look as follows:

Depreciation for Taxes

The IRS specifies that the Modified Accelerated Cost Recovery System (MACRS) must be used for businesses in computing depreciation for tax purposes. With the MACRS method, there are eight classes of useful life and depreciation rates for each class. The two most common classes are the five year and seven year classes. In using MACRS, residual value is ignored and all fixed assets are assumed to be put in and taken out of service in the middle of the year.

Disposing of Fixed Assets

When fixed assets are no longer useful to the business and have no residual or market value, they are discarded. Discarded equipment is recorded as a debit to equipment. The credit is recorded against the accumulated depreciation-equipment account if it has been fully depreciated already. If it has not, then the amount that has been depreciated is debited to the accumulated depreciation account, and the remaining balance is debited to Loss on Disposal of Fixed Assets.

When a fixed asset is sold, it is journalized similar to when it is discarded, except that cash (or other assets) must be recorded. If the selling prices is more than the book value of the asset, then the transaction results in a gain. If it is less, then it results in a loss.

To illustrate selling a fixed asset, assume that an item costs $10,000 and is depreciated straight-line method over 10 years (10% per year, or $1,000 per year)). On October 1 of the 5th year, the item is sold. First, we must figure out how much has been, and still needs to be, depreciated. Since we've already depreciated four years, $4,000 has been depreciated. October 1 means that we have completed 9 of the 12 months of the fifth year. Therefore, we need to depreciate 9/12, or 75%, of the fifth year's depreciation. $1,000 times 75% is $750, so another $750 needs to be depreciated, giving a total depreciation of $4,750. After the current depreciation is recorded, the item has a book value of $10,000 minus $4,750, or $5,250 (the initial cost minus the amount depreciated).

Now let's look at the selling price. If the item were sold for $5,000, then we would have a loss of $250. We would debit cash $5,000, debit Accumulated Depreciation - Equipment $4,750, debit Loss on Disposal of Fixed Asset $250, and credit Equipment $10,000.

If the item were sold for $7,000, then we would have a gain of $1,750. We would debit cash $7,000, debit Accumulated Depreciation - Equipment $4,750, credit Equipment $10,000, and credit Gain on Disposal of Fixed Assets $1,750.

If the item were sold for $5,250, the book value after all depreciations, then there would not be a gain nor a loss. Cash would be debited $5,250, debit Accumulated Depreciation - Equipment $4,750, and credit Equipment $10,000.

Intangible Assets

Some assets of the company are items that do not have physical substance. Patents, copyrights, trademarks and goodwill are all long-term assets that are useful in the operations of the business. The basic principles of accounting for intangible assets are like those described for fixed assets. The main concerns of intangible assets are the initial cost and the amortization, or amount of cost to transfer to expense. Amortization results from passage of time or a decline in the usefulness of the intangible asset.

Patents: Patents are granted to companies as exclusive rights to produce and sell goods with one or more unique features. Rights granted under patents last for 20 years. The initial cost of the patent (including legal and filing fees) is debited to an asset account. This cost is amortized over the years of the patent's expected usefulness, which may be less than the legal life of the patent. The straight-line method is normally used for patents.

Copyrights and Trademarks: The exclusive right to publish and sell a literary, artistic or musical composition is called a copyright. These extend 70 years beyond the author's death. A trademark is a name, term, or symbol used to identify a business and its products. These are registered for 10 years, and then renewed every 10 years. Copyrights can be amortized over the estimated useful life of the asset. Trademarks, however, are not amortized. They are considered to have an indefinite useful life (such as land). Trademarks should be tested periodically for impaired value, and if found, written down and a loss recorded.

Goodwill: Goodwill refers to the intangible asset created from favorable factors such as location, product quality, reputation and managerial skill. GAAP allows for goodwill to be recorded in the accounts only if it is objectively determined by a transaction. An example of this is buying a business for more than its net assets (assets minus liabilities). If a business had a net asset of $1.5 billion, and were purchased for $2.5 billion, then the excess would be reported as goodwill. Goodwill is not amortized. However, a loss should be recorded if the business prospects of the acquired business become significantly impaired.

Reporting of Fixed and Intangible Assets

The amount of each major class of fixed assets should be disclosed on the balance sheet. If it is not, then it should be summarized on the balance sheet as Plant, Property and Equipment (net), and then discussed in detail in the notes for the balance sheet. These items are listed in the long term assets of the balance sheet. Intangible assets are usually detailed in the Other Assets category of the balance sheet.