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
Introduction to Long-Lived Assets
Plant Assets
Property, Plant, and Equipment
Expected to Benefit Future Periods
Actively Used in Operations
Tangible
Plant Assets
Issues Related to Plant Assets
Asset Service Potential
Acquisition DisposalUse in business operations
Time
Decline in future service benefits. Book Value
Accounting Issues
Measuring Cost
Recording Disposals
Allocating initial cost and subsequent
maintenance/repairs.
Acquisitioncost
Acquisition cost excludes financing charges and
cash discounts.
All expenditures
needed to prepare the asset for its intended use
Purchaseprice
Cost of Plant Assets
Land is not depreciable
Purchaseprice
Real estatecommissions
Title insurance premiumsDelinquent
taxes
Surveyingfees
Title search and transfer fees
Land
Purchaseprice
Architecturalfees
Cost ofpermits
Excavation andconstruction costs
Installationcosts
Transportationcosts
Buildings and Equipment
Depreciation – The Concept
A Theoretical View of Depreciation
$2; $3; $4; SV
$3; $4; SV
$4; SV
SV$1; $2; $3; $4;
SV
An application of the Matching Principle.
Time
Consumed as Depreciation Expense
Depreciation is a cost allocation process that systematically and rationally matches
acquisition costs of plant assets with periods benefited by their use.
Cost
Allocation
AcquisitionCost
(Unused)
Balance Sheet
(Used)
Income Statement
Expense
Depreciation
Income
StatementDepreciation
ExpenseDepreciation for
the current year
Balance
SheetAccumulatedDepreciation
Total depreciation to
date of balance sheet
Depreciation
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
2007 thru 2008 2008>
Could use any of four methods:
Straight-LineDeclining BalanceUnits-of-OutputSum-of-the-Years’ Digits
Methods of Depreciation
Straight-Line Method
Cost - Salvage Value
Useful life in years
Depreciation
Expense per Year=
Straight-Line Method
• Appropriate if an asset is expected to benefit all periods equally.
• 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.
Straight-Line Method
Depreciation Expense Per Year
=$50,000 - $5,000
5 Years
= $9,000
Depreciation Accumulated Accumulated UndepreciatedExpense Depreciation Depreciation Balance
Year (debit) (credit) Balance (book value)2001 50,000$ 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
Straight-Line Method
Dep
reci
atio
n
Exp
ense
Depreciation Expense is
reported on the Income
Statement.
Book Value is reported on the Balance
Sheet.
DepreciationPer Unit
= Cost - Salvage Value Total Units of Production
Step 1:
Step 2:
Depreciation Expense =
DepreciationPer Unit
×Number of
Units Producedin the Period
Exh. 8.9Units-of-Production
Method
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?
Step 2:Depreciation Expense = $.45 per unit × 22,000 units = $9,900
Step 1:Depreciation
Per Unit= $50,000 - $5,000
100,000 units = $.45 per unit
Units-of-Production Method
Accumulated UndepreciatedDepreciation Depreciation Balance
Year Units Expense Balance (book value)2001 50,000$ 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$
No depreciation expense if the equipment is idle.
Salvage Value
Units-of-Production Method
Depreciation RepairExpense Expense
Early Years High Low
Later Years Low High
Early years’ total expense approximates later years’ total expense.
Declining Balance Method
Repair Costs
Depreciation
Accelerated Depreciation
Step 2:Double-declining-
balance rate= 2 ×
Straight-linedepreciation rate
Exh. 8.11
Step 3:Depreciation
expense=
Double-declining-balance rate
×Beginning period
book value
Double-Declining-Balance Method
Step 1:Straight-line
depreciation rate=
100 % Useful life in periods
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
Step 2:Double-declining-
balance rate= 2 × 20% = 40%
Step 3:Depreciation
expense= 40% × $50,000 = $20,000 (2002)
Step 1:Straight-line
depreciation rate=
100 % 5 years
= 20%
Double-Declining-Balance Method
2002 Depreciation: 40% × $50,000 = $20,000
2003 Depreciation: 40% × ($50,000 - $20,000) = $12,000
Double-Declining-Balance Method
Depreciation Accumulated UndepreciatedExpense Depreciation Balance
Year (debit) Balance (book value)2001 50,000$ 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$
($50,000 – $43,520) × 40% = $2,592
Below salvage value
Double-Declining-Balance Method
Depreciation Accumulated UndepreciatedExpense Depreciation Balance
Year (debit) Balance (book value)2001 50,000$ 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 thelatter years to an amount that brings BV to salvage value.
Double-Declining-Balance Method
When a plant asset is acquiredduring the year, depreciation
is calculated for the fraction ofthe year the asset is owned.
When a plant asset is acquiredduring the year, depreciation
is calculated for the fraction ofthe year the asset is owned.
June 30
Partial Year Depreciation
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 = ($75,000 - $5,000) ÷ 10
= $7,000 for a full year
Depreciation = $7,000 × 6/12 = $3,500
Depreciation = ($75,000 - $5,000) ÷ 10
= $7,000 for a full year
Depreciation = $7,000 × 6/12 = $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.