EN.662.611 Chap.4 Capital Assets, Depreciation and Intangibles
Capital Assets, Depreciation and Intangibles
Three kinds of long-lived asset
Week 4 separates capital assets into property, plant and equipment, which is depreciated; intangibles, which are amortized when their life is definite and tested for impairment when it is not; and natural resources, whose depletion flows into cost of goods sold.
Each asset has a life cycle: acquisition, when its cost is capitalized on the balance sheet; use, when depreciation moves that cost to the income statement; and disposal, when it is removed and any gain or loss recognized.
Land is not depreciated.
What gets capitalized
The capitalized cost includes every reasonable and necessary cost to acquire the asset and place it into operation: price, sales tax, shipping, import duties, installation and trial runs. Costs after the place-in-service date are expensed.
Getting this boundary right matters because it decides whether a cost reduces this year's income or is spread over many years.
Depreciation methods and why they differ
Straight-line depreciation divides cost less residual value evenly over the useful life and is the usual choice for financial reporting.
Declining balance applies a multiple of the straight-line rate to the opening net book value, with a final-year plug so that book value never falls below residual. MACRS is the IRS schedule, a more aggressive form of double declining balance on the full cost with a half-year convention.
Unlike inventory, companies may use one method for their books and another for tax, and accelerated tax depreciation saves cash earlier.
Disposals and intangibles
On disposal, compute net book value, compare it with the proceeds, and record the gain or loss as a non-operating item. Definite-life intangibles such as patents are amortized straight-line over the lesser of legal and economic life.
Goodwill arises only when a whole business is acquired, as the excess of price over the fair value of identifiable net assets, and it is written down when an impairment test shows the business is worth less than was paid.
Why depreciation choices show up in analysis
Depreciation is a non-cash expense, yet it matters twice to an analyst.
It reduces taxable income, so a faster tax schedule leaves more cash in the business early in an asset's life. It also sets net book value, which is the denominator of fixed asset turnover: net sales divided by average fixed assets at book value. An old, heavily depreciated asset base can therefore make turnover look strong even when the company is simply not reinvesting.
What this chapter covers
- 01
Categories of capital assets
- 02
Capitalized cost and the place-in-service date
- 03
Straight-line, declining balance and MACRS
- 04
Book versus tax depreciation
- 05
Disposal, gains and losses
- 06
Fixed asset turnover
- 07
Amortization, goodwill and impairment
Worked example · free
Depreciate a van two ways
- 2Straight-line: ($48,000 less $8,000) divided by 4 is $10,000; book value $38,000.
- 2Double declining: $48,000 times 2 divided by 4 is $24,000; book value $24,000.
Key terms
- Capitalized Cost
- All reasonable and necessary costs to acquire an asset and place it into operation.
- Net Book Value
- Historical cost less accumulated depreciation, the part of an asset's cost not yet expensed.
- MACRS
- The IRS depreciation system for tax returns, using table rates on full cost with a half-year convention.
- Goodwill
- The excess of an acquisition price over the fair value of the identifiable net assets acquired.
Capital Assets, Depreciation and Intangibles FAQ
Is a repair after installation capitalized?
Usually not. Once the asset is in service, routine repairs and maintenance are expensed as incurred. Only costs needed to acquire the asset and get it working are added to its capitalized cost.
Why can a company use different depreciation for books and tax?
The rules allow it for fixed assets, unlike inventory where LIFO conformity applies. Straight-line keeps reported earnings smooth, while an accelerated tax method defers tax and improves cash flow.
Where does a loss on selling equipment appear?
Below operating income, as a non-operating item, because selling used equipment is not part of the company's core activity of delivering its goods or services.
Exam move
Take one asset through its whole life: capitalize it, build straight-line and declining-balance schedules side by side, sell it part way through, and record the entry. Then repeat the exercise for a patent with a legal life longer than its economic life.
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