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Depreciation . . .

key terms
• Depreciation:
the process of systematically allocating the cost of an
asset over its useful life.
• Salvage value:
The estimated value of an asset at the end of its useful
life
• Depreciable cost:
an asset’s acquisition cost less its salvage value
• Book value:
an asset’s cost less its accumulated depreciation
• Three factors to consider when computing
depreciation:
cost, estimated useful life, and salvage value
Fixed Assets
• Fixed assets are those assets:
– that have a long life,
– are used in the business for future generation of
income,
– are not bought with the main purpose of resale.
– Fixed assets are also called “Depreciable
Assets”
• No depreciation is charged on land.
Grouping of Fixed Assets
• Major groups of Fixed Assets:
– Land
– Building
– Plant and Machinery
– Furniture and Fixtures
– Office Equipment
– Vehicles
Recording
• Depreciation
• Two different accounts are used
– Depreciation Expense Account
– Accumulated Depreciation Account
• Accumulated Depreciation Account – over the
years the periodic depreciation is accumulated in
this account.
• Debit Depreciation Expense Account
Credit Accumulated Account
Plant Assets
Introduction to
Long-Lived Assets
Plant Assets

Tangible

Actively Used in Operations

Expected to Benefit Future Periods

Property, Plant, and Equipment


Issues Related to Plant Assets
Asset Service Potential
Use in business operations
Acquisition Disposal

Decli
ne
in fut
u
servic re
e ben
efits. Book Value
Time
Accounting Issues
Allocating initial cost and
Measuring Recording
subsequent
Cost Disposals
maintenance/repairs.
Cost of Plant Assets

Purchase All
price expenditures
needed to
prepare the
Acquisition asset for its
cost intended use

Acquisition cost excludes


financing charges and
cash discounts.
Land
Purchase Title insurance premiums
Delinquent
price
taxes

Real estate Surveying


commissions fees

Title search and transfer fees

Land is not depreciable


Buildings and Equipment

Purchase Installation
price costs

Architectural Transportation
fees costs

Cost of Excavation and


permits construction costs
Depreciation – The Concept
A Theoretical View of Depreciation

$1; $2; SV
$2; $3;
$3; $4;
$3; $4;
SV $4; SV
$4; SV SV

Time

Consumed as
Depreciation
Expense

An application of the Matching Principle.


Depreciation
Depreciation is a cost allocation process
that systematically and rationally matches
acquisition costs of plant assets with
periods benefited by their use.

Balance Sheet Income Statement


Acquisition Cost
Expense
Cost Allocation
(Unused) (Used)
Depreciation

Depreciation Depreciation for Income


Expense the current year Statement

Accumulated Total depreciation to Balance


Depreciation date of balance sheet Sheet
Factors in Computing
Depreciation
• The calculation of depreciation requires
three amounts for each asset:
• Cost.

• Salvage Value.

• Useful Life.
Depreciation Methods
• Straight-line

• Units-of-production

• Declining balance
• Sum-of-the-Years’ Digits
Depreciation
• If an asset is expected to benefit all
periods equally,

– a straight-line method of
depreciation would be
appropriate.
Depreciation
• If more benefits are expected early in
the life of an asset . . .

– an accelerated method of
depreciation would be
appropriate.
Depreciation
• If benefits are related to the output of
an asset . . .

– the units-of-production method of


depreciation would be
appropriate.
2007
thru
< 2007 2008 2008>

Could use any of four methods:


Straight-Line
Declining Balance
Units-of-Output
Sum-of-the-Years’ Digits
Methods of Depreciation
Straight-Line Method
Straight-Line Method

Depreciation Cost - Salvage Value


=
Expense per Year Useful life in years

• Appropriate if an asset is expected to


benefit all periods equally.
Straight-Line Method

• On December 31, 2001, equipment was


purchased for $50,000 cash. The
equipment has an estimated useful life of 5
years and an estimated residual value of
$5,000.
Depreciation = $50,000 - $5,000
Expense Per Year 5 Years

= $9,000
Straight-Line Method

Depreciation Accumulated Accumulated Undepreciated


Expense Depreciation Depreciation Balance
Year (debit) (credit) Balance (book value)
2001 $ 50,000
2002 $ 9,000 $ 9,000 $ 9,000 41,000
2003 9,000 9,000 18,000 32,000
2004 9,000 9,000 27,000 23,000
2005 9,000 9,000 36,000 14,000
2006 9,000 9,000 45,000 5,000
$ 45,000 $ 45,000

Salvage Value
Depreciation
Depreciation
Expense

Expense is
reported on the
Income
Statement.

Book Value is
reported on the
Balance Sheet.
Exh.

Units-of-Production Method 8.9

Step 1:
Depreciation Cost - Salvage Value
=
Per Unit Total Units of Production

Step 2:
Number of
Depreciation Depreciation
= × Units Produced
Expense Per Unit
in the Period
Units-of-Production Method

• On December 31, 2001, equipment was


purchased for $50,000 cash.
– The equipment is expected to produce
100,000 units during its useful life and has
an estimated salvage value of $5,000.

– If 22,000 units were produced in 2002, what


is the amount of depreciation expense?
Units-of-Production Method

Step 1:
Depreciation = $50,000 - $5,000
= $.45 per unit
Per Unit 100,000 units

Step 2:
Depreciation
Expense = $.45 per unit × 22,000 units = $9,900
Units-of-Production Method
Accumulated Undepreciated
Depreciation Depreciation Balance
Year Units Expense Balance (book value)
2001 $ 50,000
2002 22,000 $ 9,900 $ 9,900 40,100
2003 28,000 12,600 22,500 27,500
2004 - - 22,500 27,500
2005 32,000 14,400 36,900 13,100
2006 18,000 8,100 45,000 5,000
100,000 $ 45,000
Salvage Value

No depreciation expense if the equipment is idle.


Declining Balance Method

Depreciation Repair
Expense Expense
Early Years High Low
Later Years Low High

Early years’ total expense approximates


later years’ total expense.
Accelerated Depreciation

Repair
Costs

Depreciation
Exh.
8.11

Double-Declining-Balance Method
Step 1:
Straight-line 100 %
=
depreciation rate Useful life in periods

Step 2:
Double-declining- Straight-line
= 2 ×
balance rate depreciation rate

Step 3:
Depreciation Double-declining- Beginning period
= ×
expense balance rate book value
Ignores salvage value
Double-Declining-Balance
Method
• On December 31, 2001, equipment was
purchased for $50,000 cash.
• The equipment has an estimated useful
life of 5 years and an estimated residual
value of $5,000.
• Calculate the depreciation expense for
2002 and 2003
Double-Declining-Balance Method
Step 1:
Straight-line 100 %
= = 20%
depreciation rate 5 years

Step 2:
Double-declining-
= 2 × 20% = 40%
balance rate

Step 3:
Depreciation
= 40% × $50,000 = $20,000 (2002)
expense
Double-Declining-Balance
Method

2002
Depreciation:
40% × $50,000 = $20,000

2003
Depreciation:
40% × ($50,000 - $20,000) = $12,000
Double-Declining-Balance Method
Depreciation Accumulated Undepreciated
Expense Depreciation Balance
Year (debit) Balance (book value)
2001 $ 50,000
2002 $ 20,000 $ 20,000 30,000
2003 12,000 32,000 18,000
2004 7,200 39,200 10,800
2005 4,320 43,520 6,480
2006 2,592 46,112 3,888
$ 46,112 Below salvage value

($50,000 – $43,520) × 40% = $2,592


Double-Declining-Balance Method
Depreciation Accumulated Undepreciated
Expense Depreciation Balance
Year (debit) Balance (book value)
2001 $ 50,000
2002 $ 20,000 $ 20,000 30,000
2003 12,000 32,000 18,000
2004 7,200 39,200 10,800
2005 4,320 43,520 6,480
2006 1,480 45,000 5,000
$ 45,000

We usually have to force depreciation expense in the


latter years to an amount that brings BV to salvage value.
Partial Year Depreciation

When
When aa plant
plant asset
asset is is acquired
acquired
during
during the
the year,
year, depreciation
depreciation
is
is calculated
calculated for
for the
the fraction
fraction of
of
the
the year
year the
the asset
asset isis owned.
owned.

Ju n e
30
Partial Year Depreciation
• Calculate the straight-line depreciation on
December 31, 2003, for equipment
purchased on June 30, 2003.
• The equipment cost $75,000, has a useful
life of 10 years and an estimated salvage
value of $5,000.
Partial Year Depreciation

Depreciation
Depreciation == ($75,000
($75,000 -- $5,000)
$5,000) ÷÷ 1010
== $7,000
$7,000 for
for aa full
full year
year

66
Depreciation
Depreciation == $7,000 ×× //1122
$7,000
== $3,500
$3,500
Sum of the Year’s Digits (SOYD)
• Depreciation =
(cost-salvage value) * RL/ SOYD
Where
– RL = remaining years of useful life as of the
beginning of the year for which
depreciation is being computed.
– SOYD = sum of all the number from 1 through the
estimated useful life.
For example:
for a 5- year useful life, SOYD would
be1+2+3+4+5=15 and it would be 55 for
a 10 year useful life.
– Highest the first year and then declines by a
constant amount after.

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