Study Guide on Fixed Assets and Intangible Assets

Course: Intermediate Financial Accounting

Table of Contents
1. Introduction to Fixed Assets and Intangible Assets
2. Fixed Assets
o 2.1. Definition of Fixed Assets

o 2.2. Types of Fixed Assets

 2.2.1. Property, Plant, and Equipment (PP&E)

 2.2.2. Land
 2.2.3. Buildings and Machinery
o 2.3. Acquisition of Fixed Assets

o 2.4. Depreciation of Fixed Assets

 2.4.1. Methods of Depreciation

 2.4.2. Depreciation Calculation and Journal Entries
o 2.5. Impairment of Fixed Assets

o 2.6. Disposal of Fixed Assets

3. Intangible Assets
o 3.1. Definition of Intangible Assets

o 3.2. Types of Intangible Assets

 3.2.1. Patents
 3.2.2. Copyrights
 3.2.3. Trademarks
 3.2.4. Goodwill
o 3.3. Acquisition of Intangible Assets

o 3.4. Amortization of Intangible Assets

o 3.5. Impairment of Intangible Assets

4. Fixed and Intangible Assets in Financial Statements

o 4.1. Fixed Assets in the Balance Sheet

o 4.2. Intangible Assets in the Balance Sheet

 o 4.3. Income Statement Effects

5. Internal Controls over Fixed and Intangible Assets

o 5.1. Fixed Asset Internal Controls

o 5.2. Intangible Asset Internal Controls

6. Challenges and Considerations

o 6.1. Fixed Asset Management

o 6.2. Intangible Asset Management

7. Practice Problems
8. Conclusion

1. Introduction to Fixed Assets and Intangible Assets

Fixed assets and intangible assets are long-term resources that companies use to
conduct business and generate revenue. Fixed assets, such as land, buildings, and
equipment, are tangible, physical assets, while intangible assets include non-
physical resources like patents, trademarks, and goodwill. Both types of assets have
significant implications for a company's financial health and are subject to specific
accounting treatments, including amortization and depreciation.
This study guide provides an overview of both fixed and intangible assets, covering
their definitions, classifications, acquisition, valuation, and management, and how
they appear in financial statements.

2. Fixed Assets
2.1. Definition of Fixed Assets
Fixed assets (also known as Property, Plant, and Equipment or PP&E) are
tangible, long-term assets used in the operations of a business to produce goods or
services. These assets are expected to provide economic benefits over multiple
years.
 Example: A manufacturing company’s machinery, a retail store’s buildings,
or a delivery company’s fleet of trucks are all examples of fixed assets.
2.2. Types of Fixed Assets
2.2.1. Property, Plant, and Equipment (PP&E)
PP&E refers to the major, long-term assets used by a business in its daily
operations. These assets are not intended for sale, and they provide long-term
economic benefits.
  Example: Manufacturing equipment, office furniture, factory buildings, and
vehicles used for business purposes.
2.2.2. Land
 Definition: Land is a unique fixed asset because it is not subject to
depreciation. It has an indefinite useful life.
 Example: A company purchases land for future expansion.
2.2.3. Buildings and Machinery
 Definition: Buildings and machinery are physical assets used to carry out
the production or administrative functions of a business. These assets
typically depreciate over time due to wear and tear or obsolescence.
 Example: A factory building and its machinery used for manufacturing
products.
2.3. Acquisition of Fixed Assets
Fixed assets are initially recorded at their historical cost, which includes:
 The purchase price of the asset.
 Any costs necessary to bring the asset into working condition, such as
installation costs, legal fees, and delivery charges.
 Example: A company buys a piece of machinery for $100,000, with $5,000 in
delivery and installation costs. The total cost recorded is $105,000.
2.4. Depreciation of Fixed Assets
Depreciation refers to the systematic allocation of the cost of a fixed asset over its
useful life. Since fixed assets provide benefits over time, depreciation spreads the
cost across the asset's estimated life.
2.4.1. Methods of Depreciation
The most common depreciation methods are:
 Straight-Line Depreciation: The asset’s cost is spread equally over its
useful life.

 Declining Balance Depreciation: This method applies a fixed percentage

to the asset’s book value at the beginning of each period, resulting in higher
depreciation expenses in the earlier years.
 Units of Production Depreciation: Depreciation is based on the asset's
usage or production output. The formula is:
Depreciation per Unit=Cost of Asset−Residual ValueTotal Estimated Units\
 text{Depreciation per Unit} = \frac{\text{Cost of Asset} - \text{Residual
Value}}{\text{Total Estimated
Units}}Depreciation per Unit=Total Estimated UnitsCost of Asset−Residual Va
lue
2.4.2. Depreciation Calculation and Journal Entries
 Example (Straight-Line): A company purchases machinery for $100,000
with an estimated residual value of $10,000 and a useful life of 10 years. The
annual depreciation expense is:

 Journal Entry:
Debit: Depreciation Expense $9,000
Credit: Accumulated Depreciation $9,000
2.5. Impairment of Fixed Assets
An asset is considered impaired when its carrying value exceeds its recoverable
amount (the higher of its fair value less costs to sell or its value in use). If
impairment occurs, the asset must be written down to its recoverable amount.
 Example: A company’s machinery is no longer able to generate the
expected cash flows due to new technology. The carrying value of the
machinery is $80,000, but the recoverable amount is $50,000. The company
must record an impairment loss of $30,000.
2.6. Disposal of Fixed Assets
When a fixed asset is sold, scrapped, or retired, the company must remove the
asset from its balance sheet and recognize any gain or loss on disposal.
 Example: A company sells a truck with a book value of $10,000 for $12,000.
The gain on disposal is $2,000.

3. Intangible Assets
3.1. Definition of Intangible Assets
Intangible assets are non-physical assets that provide long-term benefits to a
business. These assets are not tangible like fixed assets but can still contribute
significantly to the company’s operations.
 Example: Patents, trademarks, copyrights, and goodwill are all intangible
assets.
3.2. Types of Intangible Assets
3.2.1. Patents
 Definition: A patent gives the holder the exclusive right to produce, use, or
sell a product or process for a specified period (usually 20 years).
 Example: A company that invents a new type of drug patents the formula,
preventing others from making or selling it without permission.
3.2.2. Copyrights
 Definition: A copyright protects the creator’s rights to their literary, artistic,
musical, and other intellectual creations.
 Example: A company that produces software holds copyrights for its code.
3.2.3. Trademarks
 Definition: A trademark protects a company’s brand name, logo, or other
symbols that distinguish its products or services.
 Example: The “Nike Swoosh” is a registered trademark.
3.2.4. Goodwill
 Definition: Goodwill is the excess of the purchase price over the fair value of
the identifiable net assets acquired in a business combination.
 Example: If a company acquires another for $500,000, and the fair value of
net assets is $400,000, the goodwill is $100,000.
3.3. Acquisition of Intangible Assets
Intangible assets are typically acquired through purchase, but they can also be
developed internally. They are initially recognized at their acquisition cost or fair
value if purchased from another entity.
 Example: A company buys a patent for $50,000. This is recorded as an
intangible asset at the purchase cost.
3.4. Amortization of Intangible Assets
Intangible assets with a definite useful life are amortized over their estimated life,
similar to depreciation for fixed assets. The amortization expense is recorded on the
income statement each period.
 Example: A company acquires a patent for $60,000 with a useful life of 10
years. The annual amortization expense is:


  Journal Entry:
Debit: Amortization Expense $6,000
Credit: Accumulated Amortization $6,000
3.5. Impairment of Intangible Assets
Intangible assets are tested for impairment if there are indications that their
carrying value may not be recoverable. The asset is written down to its recoverable
amount if impaired.
 Example: A company’s patent has a carrying value of $20,000, but its
recoverable amount is only $12,000. The company must recognize an
impairment loss of $8,000.

4. Fixed and Intangible Assets in Financial Statements

4.1. Fixed Assets in the Balance Sheet
Fixed assets are listed under non-current assets on the balance sheet. They are
reported at cost, less accumulated depreciation (for tangible assets) or impairment
(for intangible assets).
4.2. Intangible Assets in the Balance Sheet
Intangible assets are reported under non-current assets as well. They are
presented at cost less accumulated amortization and any impairment.
4.3. Income Statement Effects
 Fixed Assets: Depreciation expense related to fixed assets is recorded on
the income statement.
 Intangible Assets: Amortization of intangible assets is recorded on the
income statement.

5. Internal Controls over Fixed and Intangible Assets

5.1. Fixed Asset Internal Controls
 Regular physical counts of assets to ensure accuracy.
 Segregation of duties to prevent asset misappropriation.
 Proper documentation for all acquisitions, disposals, and impairments.
5.2. Intangible Asset Internal Controls
 Ensuring proper legal protection for intangible assets, such as filing patents
and trademarks.
  Regular reviews of the useful life and impairment testing for intangible
assets.

6. Challenges and Considerations

6.1. Fixed Asset Management
 Accurate tracking and valuation of fixed assets is essential for financial
reporting and tax purposes.
 Ensuring proper maintenance and depreciation schedules to avoid
overstating asset values.
6.2. Intangible Asset Management
 Valuing intangible assets, especially goodwill, can be subjective and
challenging.
 Protecting intellectual property through patents, trademarks, and copyrights
is vital to prevent unauthorized use or loss of value.

7. Practice Problems
1. Fixed Asset Depreciation:
A company purchases equipment for $50,000 with an estimated residual
value of $5,000 and a useful life of 10 years. Using straight-line depreciation,
what is the annual depreciation expense?
Answer:

2. Intangible Asset Amortization:

A company purchases a patent for $20,000 with a useful life of 5 years. What
is the annual amortization?
Answer:

8. Conclusion
Understanding fixed and intangible assets is crucial for financial accounting and
management. Proper accounting for these assets ensures accurate financial
reporting and helps businesses manage their long-term investments effectively. By
mastering asset acquisition, depreciation, amortization, and impairment, businesses
can ensure they reflect the true value of their assets in their financial statements.