Long-term Assets

Study Guide

I. Tangible assets
A. Organizations recognize depreciation on fixed or long-term assets
purchased to spread the cost of the assets over the period they will
provide benefit to the organization. Depreciation calculations require
various judgments to be made by management.
1. The cost of the asset includes all costs of acquisition, shipping,
installation, or other costs associated with getting the asset ready
for its intended use.
2. Expected useful life of the asset, or the period over which the
asset is expected to provide benefit to the organization, must be
estimated.
3. Expected salvage value at the end of the asset's useful life must be
estimated. The amount depreciated for the asset should reflect the
estimated cost to the entity for use of the asset during its useful
life. The asset should not be depreciated below salvage value as it
is the amount the entity expects to receive for the asset upon
disposal and is, therefore, not a cost to the entity of using the
asset.
4. Depreciation method must be selected by management and should
reflect the usage pattern of the asset.
B. Organizations can select from a number of different depreciation
methods.
1. Straight-line depreciation recognizes an equal amount of
depreciation over the asset's useful life.
a. Illustration: An organization purchases a vehicle for
$25,000 and expects to sell the car for $5,000 at the end of
five years. The organization will depreciate $4,000 each
year [($25,000 − $5,000) ÷ 5] = $4,000. At the end of five
years, the net asset value ($25,000 less accumulated
depreciation) will be $5,000.
2. Sum of the year's digits (SOYD) depreciation assumes that an
asset is more productive and provides more benefit earlier in its
life than later in life. SOYD depreciation records more
depreciation in early years than in the later years of an asset's life
and is often called an accelerated depreciation method as a result.
 a. SOYD multiplies the depreciable amount (cost less salvage
value) by a unique fraction each year of the asset's life to
calculate the amount of depreciation to be recorded.
i. The numerator of the fraction is the number of years
remaining in the asset's life at the beginning of the
year for which the calculation is made.
ii. The denominator of the fraction is the sum of the
year's digits (hence the name) for the asset's useful
life.
b. Illustration: An organization purchases a vehicle for
$25,000 and expects to sell the car for $5,000 at the end of
four years. The depreciable amount is $20,000 (cost of
$25,000 less the salvage value of $5,000). For year 1, the
numerator in the unique fraction is 4 because there are four
years remaining in the asset's life at the beginning of that
year. The denominator is the sum of the year's digits, or 10
(1 + 2 + 3 + 4). Depreciation in the first year is $8,000
($20,000 × 4/10). Each year's depreciation is shown in the
table below.

*Note that after 4 years, the organization has recognized

the full depreciable amount of $20,000 for the car.

3. The double declining balance (DDB) method is another

accelerated depreciation method.
a. DDB calculates annual depreciation by multiplying the
book value of the asset (cost less accumulated depreciation)
by 2 ÷ n, where n = number of years in the asset's useful
life.
b. The calculation is repeated each year until the asset has
been depreciated down to its salvage value.
c. Illustration: An organization purchases a vehicle for
$25,000 and expects to sell the car for $5,000 at the end of
five years. The book value will be multiplied by 40% (2/5)
each year to find the depreciation expense for that year
 until the asset has been reduced to its salvage value. Each
year's depreciation is shown in the following table.

*Note that in Year 4, the asset would be depreciated below

its salvage value if the full percentage was applied. For this
reason, only the amount needed to reduce the asset to its
salvage value is expensed. In addition, no deprecation is
taken in Year 5 because DDB reduces the asset's book
value to its salvage value in Year 4.

4. Units of production (UOP) depreciation recognizes that some

assets have an expected number of units they will produce during
the expected life.
a. UOP calculates depreciation expense by spreading the
depreciable cost evenly over the number of units used up
during the asset's life.
b. Depreciable cost is divided by the total number of units
expected to be produced to find cost per unit.
c. Each year the cost per unit is multiplied by the number of
units produced that year to find depreciation expense.
d. The asset is not depreciated below its salvage value.
e. Illustration: An organization purchases a vehicle for
$25,000 and expects to sell the car for $5,000 at the end of
four years. At the date of purchase, the vehicle is expected
to be driven 100,000 miles in the four-year period of
operation. The resulting expected cost per mile is $0.20
[(25,000−5,000) ÷ 100,000]. Depreciation expense for each
year is shown in the table below, assuming the actual miles
driven each are as follows:
 *Note that in Year 4, depreciation expense is reduced from
the $0.20/mile estimate to ensure that the asset is not
depreciated below its salvage value.

C. Accumulated depreciation is a contra-asset account that reduces the

amount of fixed assets. Each asset is recorded on the financial records at
cost, and all depreciation is recorded in the Accumulated Depreciation
account. Organizations record depreciation expense with the following
general accounting entry:

D. Recognizing the impact of different depreciation methods.

1. Because depreciation is an expense, different depreciation
methods result in different effects on the balance sheet and net
income.
a. Accelerated depreciation methods, such as the double-
declining balance method, result in higher depreciation
expense earlier in the asset's life. Higher expenses reduce
net income and the value of the asset on the balance sheet
will decline more quickly under an accelerated depreciation
method.
b. Organizations looking to show higher net income during a
period of high investment will use the straight-line
depreciation method to show lower depreciation expenses
and higher net income in early years.
2. Organizations utilize different depreciation methods for book and
tax purposes, resulting in deferred tax assets and liabilities
[discussed in more detail in Part 1, Section A, Topic 2.3
Accounting for Income Taxes].
a. Organizations seeking to lower income tax payments may
want to use an accelerated depreciation method for tax
 purposes to maximize after-tax cash flow as early as
possible to invest in other projects.
i. Higher depreciation expenses will lower taxable
income, reducing tax payments early in the asset's
life.
ii. During later years, the organization will record
higher taxable income and pay more in income taxes
than it would using the straight-line method.
E. Impairment of tangible assets: Periodically, management will review
fixed assets for impairment losses. The process for calculating
impairment losses requires two steps.
1. Step 1 Recoverability test: The sum of the future undiscounted
cash flows expected to come from the asset is compared to the
book value (cost less accumulated depreciation) of the asset.
a. If the future cash flows exceed the book value of the asset,
the asset is considered recoverable and no impairment
exists. In this case, the second step need not be performed.
b. If the future cash flows are less than the book value of the
asset, the asset is considered unrecoverable and impairment
loss must be calculated and recognized. In this case, the
second step is required.
2. Step 2 Impairment loss: If the asset is unrecoverable, management
must estimate the fair value of the asset, which will be less than
the book value. The impairment loss to be recognized is the
difference between the book value of the asset and the fair value
of the asset.
a. Several methods for estimating fair value may be used.
i. Quoted market prices for similar assets, if available
ii. Outside appraisal
iii. Discounting the future cash flows used in step 1
iv. Internal appraisal based on expert knowledge of the
industry and the specific assets in question
b. The impairment loss is recorded in the period that the loss
is identified.
c. After an impairment loss is recognized, future annual
depreciation on the asset should be recalculated to reflect
the newly revised value and any updated estimates of
remaining useful life and salvage value.
3. Illustration: Company Z owns an aging factory with a book value
of $250,000 and expected future undiscounted cash flows of
$175,000. The fair value of the factory is estimated to be
 $160,000. Step 1: The future undiscounted cash flows are less
than the book value of the factory, so it fails the recoverability
test. Step 2: The impairment loss is $90,000 ($250,000 book value
less $160,000 fair value) and will be recorded with the following
entry:

F. Sales of tangible assets

1. When a fixed asset is sold, gains or losses will be recognized by
the organization.
a. Depreciation should be brought current before calculation
of any gain or loss on the sale of a long-term asset.
b. The historical cost of an asset as well as all related
accumulated depreciation should be removed from the
organization's records at the time of sale.
c. If the asset is sold for more than its book value at the time
of sale, a gain is recorded.
d. If the asset is sold for less than its book value at the time of
sale, a loss is recorded.
2. Illustration: An organization sells a vehicle with a historical cost
of $25,000 and accumulated depreciation of $20,000. The vehicle
is sold for $6,000 and depreciation is current at the time of sale.
The organization realizes a $1,000 gain on the sale of the vehicle,
calculated as the difference between the selling price of $6,000
and the book value of $5,000 (25,000 – 20,000).

Practice Question

Company Q purchases a widget maker for $120,000 and expects

to use it for the next 10 years when the salvage value of the
machine is expected to be $20,000. The company expects the
machine to produce 400,000 widgets in the 10 years it uses the
machine. Actual widgets produced in years 1, 2, and 3 are 30,000,
35,000, and 50,000. Calculate what depreciation expense for years
1, 2, and 3 would be using each of the following depreciation
methods:

a. Straight-line
b. Sum of the year's digits
 c. Double declining balance
d. Units of production

Answer

e. Straight-line depreciation is $10,000 each year [($120,000 

− $20,000) ÷ 10].
f. Sum of the year's digits denominator is 55 (10 + 9 + 8 + 7 + 
6 + 5 + 4 + 3 + 2 + 1). The depreciable amount is $100,000
(120,000 – 20,000). The following table shows the
calculation for depreciation expense using SOYD in years
1, 2, and 3.

g. Double declining balance percentage is 20% (2/10). The

following table shows the calculation for depreciation
expense using DDB in years 1, 2, and 3.

h. Units of production estimated cost per widget is

$0.25/widget [(120,000 – 20,000)/400,000]. The following
table shows the calculation for depreciation using UOP in
years 1, 2, and 3.

II. Intangible assets

A. Intangible assets with a finite life
1. Amortized in a manner similar to the depreciation of tangible
assets. Generally, straight line amortization is used and salvage
values are often zero.
2. Impairment of finite life intangible assets follows the same two-
step process as tangible asset impairment discussed above.
B. Intangible assets with an indefinite life
1. Not amortized.
2. Carried at cost and reviewed for impairment when circumstances
indicate a possible problem and at least annually.
3. Impairment test is one step: compare recorded value to fair value
and recognize impairment losses when fair value is lower.
C. Goodwill
1. Only recorded when a business is acquired for more than the fair
value of the net identifiable assets of the business.
2. Reviewed for impairment using a two-step process.
a. Step 1 Recoverability test: Compare the fair value of the
reporting unit to which goodwill belongs to the recorded
value of the reporting unit.
i. If the fair value of the reporting unit exceeds the
book value of the reporting unit, goodwill is not
impaired. In this case, the second step need not be
performed.
ii. If the fair value of the reporting unit is less than the
book value of the reporting unit, the goodwill is
impaired and the impairment loss must be calculated
and recognized. In this case, the second step is
required.
b. Step 2 Impairment loss: If the reporting unit is recorded at
an overall value that exceeds its fair value, then the
organization will measure the amount of implied goodwill
and compare that amount to recorded goodwill. The
difference is the impairment loss that will be recognized by
the organization.
i. All fair values of the identifiable assets and liabilities
within the reporting unit must be estimated.
ii. The amount by which the fair value of the reporting
unit exceeds the fair value of the net identifiable
assets of the reporting unit is implied goodwill.
iii. Recorded goodwill less implied goodwill is the
impairment loss.
 c. Illustration: Company P has a subsidiary, Company S with
a recorded value of $200,000, which includes goodwill of
$40,000. The fair value of Company S is $180,000.
Because the fair value of Company S is less than its
recorded value, Company P has determined that Company
S goodwill is impaired. The fair value of the underlying
identifiable net assets of Company S is estimated to be
$170,000. Therefore, implied goodwill of Company S is
$10,000 (180,000 – 170,000), and the impairment loss is
$30,000 (40,000 – 10,000). The company will make the
following entry to recognize the impairment loss:

Practice Question
Red Peppermint Co. purchases a customer list for $5,500,000 on 1/1/20X2. This
database has information such as names, contact history, and order history. Red
Peppermint Co. believes that this list will provide a benefit to them for four years. At
the end of the four years, it is expected that this database will have no salvage value.
Red Peppermint Co. uses the straight-line method to calculate amortization expense of
intangible assets. Provide the journal entries for 20X2 for:
a. The purchase of the customer list
b. Amortization Expense
Answer
a. The purchase of the customer list
This asset is initially recorded at the purchase price.
1/1/20X2
Customer 5,500,000  
List
   Cash   5,500,000
b. Amortization Expense
Amortization expense for intangible assets is calculated in a similar manner as
depreciation expense for tangible assets. The calculation of amortization expense
using the straight-line method is as follows:
(Purchase Price − Salvage Value) ÷ Years of Useful Life
The amortization expense for this example is calculated as:
($5,500,000 − 0) ÷ 4 years = $1,375,000/year
12/31/20X2
Amortization Expense 1,375,00  
0
   Accumulated Amortization–Customer Lists   1,375,000
Summary
Depreciation is used to spread the cost of long-term assets (less their salvage value)
over the expected useful life of the asset. There are several deprecation methods to
choose from, including straight-line, sum of the year's digits, double declining
balance, and units of production. The method of depreciation used will impact the
organization's financial statements and taxes. If a long-term asset becomes impaired,
an organization must record a loss and update depreciation estimates. When a long-
term asset is sold, gains or losses will be recognized and the asset and related
depreciation accounts will be removed from the financial records. Intangible assets
with a finite life are amortized similar to tangible assets. Intangible assets with an
infinite life and goodwill must be tested for impairment and losses recorded if
impairment occurs.
SLIDES
FLASHCARDS

What are some of the judgments or estimates that need to be

made by management when determining depreciation
calculations?
  The asset's expected useful life, or period over which the asset is expected to
provide benefit to the organization.
 The expected salvage value at the end of the asset's useful life. The asset should
not be depreciated below salvage value.
 The depreciation method must be selected and should reflect the asset's usage
pattern.

What are the four most common depreciation methods?

 Straight-line depreciation: Recognizes depreciation equally over the asset's
useful life.
 Sum of year's digits (SOYD): Records more depreciation in early years than
in the later years.
 Double declining balance (DDB): Calculates depreciation by multiplying the
asset's book value by 2 ÷ n (n = number of years in the asset's useful life).
 Units of production (UOP): Spreads the depreciable cost evenly over the
number of units produced during the asset's life.

What impact does using different depreciation methods have on

organizations?
Depreciation is an expense; therefore, different methods result in different effects on
the balance sheet and income statement:

 Accelerated depreciation methods (like double-declining balance and sum-of-

the-years' digits) result in higher depreciation expense earlier in the asset's life.
This will reduce net income and the asset's value on the balance sheet.
 Organizations looking for higher net income during a period of high investment
will likely use the straight-line method.

What is the process for calculating impairment losses on long-

term tangible assets?
 Step 1 Recoverability Test: Compare the book value of an asset to the sum of
the future undiscounted cash flows. If the FCF exceed the BV, the asset is
considered recoverable and no impairment exists. Otherwise, an impairment
loss must be calculated and recognized (Step 2).
 Step 2 Impairment Loss: Management must estimate the asset's fair value. A
loss will be recognized for the difference between BV and FV.
What are the different classifications of intangible assets and
how are they each carried on an organization's balance sheet?
 Intangible assets with a finite life: Amortized similar to depreciation of
tangible assets. Impairment follows the same two-step process as tangible asset
impairment.
 Intangible assets with an indefinite life: Carried at cost and reviewed for
impairment when circumstances indicate a possible problem and at least
annually.
 Goodwill: Recorded when a business is acquired for more than the fair value of
its net identifiable assets. There is a two-step process to review for impairment.

Question 1 
aq.lta.001_1802
When purchasing a machine for use in a company's manufacturing operations, a
company incurred costs for (1) transporting the machine to the production facility and
for (2) testing and preparation of the machine for use. Which of these costs,
respectively, should be capitalized?
Capitalized, Capitalized
Capitalized, Not capitalized
Not capitalized, Capitalized
Not capitalized, Not
capitalized
 This Answer is Correct
This answer is correct. The cost of machinery includes all expenditures incurred in
acquiring the asset and preparing it for use. Costs include the purchase price, freight
and handling charges, insurance on the machine while in transit, cost of special
foundations, and costs of assembling, installation, and testing. Therefore, both costs
given in this problem would be capitalized.
Question 2 
aq.lta.002_1802
Zulu Corp.’s (Zulu) comparative balance sheet at December 31, Year 6 and Year 5,
reported accumulated depreciation balances of $800,000 and $600,000, respectively.
Property with a cost of $50,000 and a carrying amount of $40,000 was the only
property sold in Year 6. How much depreciation was charged to Zulu's operations in
Year 6?
$190,000
$200,000
 $220,000
$210,000
 This Answer is Correct
This answer is correct. Accumulated depreciation began the year at $600,000. The
property with a $50,000 cost and $40,000 carrying amount must have had
accumulated depreciation of $10,000 ($50,000 − $40,000). When the property was
sold, the accumulated depreciation would have been reduced from $600,000 to
$590,000. Because accumulated depreciation ended the year at $800,000, depreciation
must have been recorded in the amount of $800,000 – $590,000 = $210,000.
Question 3 
aq.lta.003_1802
Assets are depreciated:
To determine the salvage value of the asset.
Because assets are always worthless after their useful life.
To spread the costs to the periods benefiting from the asset.
Because depreciation adds to the operating profit of a company.
 You Answered Correctly!
This answer is correct. Assets are depreciated to spread the cost of the asset over the
periods that the asset is used by the organization. An asset may have a salvage value
after its useful life.
Question 4 
aq.lta.004_1802
This information pertains to equipment owned by Brigade Company.

 Cost of equipment: $10,000

 Estimated residual value: $2,000
 Estimated useful life: 5 years
 Depreciation method: Straight-line

The accumulated depreciation at the end of year 3 is:

$4,800.
$1,600.
$6,000.
$5,200.
 This Answer is Correct
This answer is correct. Accumulated depreciation at the end of year 3 = [($10,000 − 
$2,000) ÷ 5] × 3 = $4,800.
Question 5 
aq.lta.005_1802
Which of the following statements comparing the straight-line depreciation method to
other depreciation methods is least accurate? Companies that use:
Accelerated depreciation methods will decrease the amount of taxes in early years.
Straight-line depreciation methods will have higher book values for the assets on the
balance sheet than companies that use accelerated depreciation.
Units of production and service hours methods to depreciate assets will result in higher
income during periods of low production.
Accelerated depreciation methods will increase the total amount of depreciation expense in
the latter years of the asset's life.
 This Answer is Correct
This answer is correct. Accelerated depreciation methods will increase the amount of
depreciation expense in the early years of the asset's life, but the depreciation expense
will be less in the latter years of the asset's life, so this statement is least accurate.
Question 6 
aq.lta.006_1802
The graph below depicts three depreciation expense patterns over time.

Which depreciation expense pattern corresponds to the sum of the years' digits method
and which corresponds to the double declining balance method?
I,
III
II,
III
II,
I
III,
II
 You Answered Correctly!
This answer is correct. The sum of the years' digits method is slightly less in the first
year and declines at a constant rate (II). The double declining balance method has the
highest depreciation in the first year (III). The straight-line method is represented by
(I).
Question 7 
aq.lta.007_1802
An analyst determined the following information concerning Franklin, Inc.’s stamping
machine:

 Acquired seven years ago for $22 million.

 Straight-line method used for depreciation.
 Useful life estimated to be 12 years.
 Salvage value originally estimated to be $4 million.
 The stamping machine is expected to generate $1,500,000 per year for five
more years and will then be sold for $1,000,000.

The stamping machine is:

Impaired because expected salvage value has declined.
Not impaired because annual expected revenue exceeds annual depreciation.
Impaired because its carrying value exceeds the sum of expected undiscounted cash flows.
Not impaired because it continues to produce material revenue.
 This Answer is Correct
This answer is correct. The carrying value of the stamping machine is its cost less
accumulated depreciation. Depreciation taken through 7 years was ($22,000,000 − 
$4,000,000) ÷ 12 × 7 = $10,500,000, so carrying value is $22,000,000 − $10,500,000 
= $11,500,000. Because the $11,500,000 carrying value is more than expected future
cash flows of (5 × $1,500,000) + $1,000,000 = $8,500,000, the stamping machine is
impaired.
Question 8 
aq.lta.008_1802
As part of a major restructuring of business units, General Security (an industrial
conglomerate operating solely in the United States and subject to U.S. GAAP)
recognizes significant impairment losses resulting in an overall net loss on the income
statement. The Investor Relations group is preparing an informational packet for
shareholders, employees, and the media. Which of the following statements
is most accurate?
During the year of the write-downs, retained earnings will increase.
In the future, net income, the return on assets ratio, and the return on equity ratio will
 decrease.
The write-downs are reported as a component of income from discontinued operations.
Write-downs taken on asset values cannot be reversed in later years if market conditions
improve.
 This Answer is Correct
This answer is correct. Impairments cannot be restored under U.S. GAAP.
Question 9 
aq.lta.009_1802
On January 1, Year 1, Renard Co. (Renard) purchased a machine for $800,000 and
established an annual depreciation charge of $100,000 over an 8-year life. Early in
Year 4, after issuing its Year 3 financial statements, Renard concluded:

 The machine suffered permanent impairment of its operational value.

 $200,000 is a reasonable estimate of the fair value of the amount expected to be
recovered through the use of the machine for the period January 1, Year 4,
through December 31, Year 8.
 The undiscounted cash flows are expected to total $300,000 for the remaining
life of the machine.

In Renard's December 31, Year 4, balance sheet, the machine should be reported at a
carrying amount of:
$0.
$160,000.
$100,000.
$400,000.
 This Answer is Correct
This answer is correct. As a result of the permanent impairment to the operational
value of the machine, the carrying value would be written down to $200,000 as of
1/1/Year 4. That amount would then be depreciated over the remaining 5-year useful
life from 1/1/Year 4 through 12/31/Year 8 at the rate of $40,000 (New carrying value
of $200,000 ÷ 5 years) per year. The carrying value at 12/31/Year 4 would be
$200,000 – $40,000, or $160,000.