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.