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Accounting for Depreciation
Chapter 2
Alex. Socratous
Accounting for Depreciation
Fixed assets other than land lose their ability over time to provide services
Costs of equipment, buildings, and land improvements should be transferred to expense accounts in a systematic manner during their expected useful lives. DEPRECIATION
Adjusting entry to record depreciation is usually made at the end of each month or at the end of the year Fixed assets other than land lose their ability over time to provide services
Adjusting Entry
Account Debit Credit
Depreciation expense $7,000
Accumulated depreciation (Provision) – truck $7,000
Depreciation
Accumulated depreciation(Provision for dep.) Shows the amount that the asset has lost in value since its
purchase
Depreciation expense Shows the amount that the asset has lost in value this
period.
Factors that cause a decline the ability of a fixed asset to provide services may be identified as Physical depreciation
Occurs from the wear and tear while in use and from the action of the weather
Functional depreciation Occurs when a fixed asset is no longer able to provide services
at the level for which it was intended.
Factors in Computing
Depreciation Expense
The fixed asset’s initial cost
Its expected useful life
Its estimated value at the end of
its useful life.
Depreciation Methods
Straight line
Declining balance
Units of production
Straight line Method
Provides for the same amount of
depreciation expense for each year of
the asset’s useful life
Annual depreciation expense =
Cost – Salvage value
Life
Example 1
A machine had a cost of $24,000, salvage value of $2,000 and useful life of 5 years
Annual depreciation expense =
Cost – Salvage value
Life
= $24,000 - $2,000
5 years
= $4,400 annual depreciation
Adjusting entry
Account Debit Credit
Depreciation expense $4,400
Accumulated depreciation - truck $4,400
Example 2
A machine had a cost of $30,000,
salvage of $5,000 and useful life of 6
years. Compute depreciation under the
straight line method?
What is depreciation expense in year 3?
Units of Production
This method provides for the same
amount of depreciation expense for
each unit produced or each unit of
capacity used by the asset
Units of Production
Depreciation rate per unit =
Cost – Salvage value
Estimated units
Depreciation Expense =
Depreciation rate x annual units
Example 3
A machine had a cost of $24,000,
salvage value of $2,000, estimated total
hours of production of 10,000 and
annual hours used of 2,100 hours.
Compute depreciation for the period
under the units of production method.
Example 3
Depreciation rate per unit =
Cost – Salvage value
Estimated hour
= $24,000 - $2,000 = $2.20
10,000 hours
Annual depreciation expense =
Hourly depreciation rate x annual hours
= $2.20 x 10,000 hours = $2,200
Example 4
A machine had a cost of $30,000,
salvage value of $5,000, estimated total
hours in production of 5,000 and annual
hours used of 900 hours. Compute the
depreciation expense for the period
using the units of production method
Declining Balance Method
Provides for a declining periodic
expense over the estimated useful life
of the asset.
Book value
= Cost – Accumulated depreciation
Declining Balance Method
Steps Compute the DB rate = 100/Life of asset
For double declining balance
Multiply rate time 2
Depreciation expense =
Beg. book value X Rate
Rule: the book value may never by less than the salvage value of the asset
Example 5: A machine had a cost of $24,000, salvage value of $2,000,
estimated life of five year. Compute depreciation
Year Cost Accumula
ted
Depreciati
on
Book
value at
beginning
of year
Rate Depreciati
on
Book
value at
end of
year
1 $24,000 $24,000 40% $9,600 $14,400
2 24,000 9,600 14,400 40% 5,760 8,640
3 24,000 15,360 8,640 40% 3,456 5,184
4 24,000 18,816 5,184 40% 2,073.60 3,110.40
5 24,000 20,889.60 3110.40 1,110.40 2,000
Example 6
Example 6: A machine had a cost of $30,000, salvage value of
$5,000, estimated life of 6 years. Compute depreciation
using the double declining balance method.
Revision of Depreciation
Revising the estimates of the residual
value and the useful life is normal
Used to determine depreciation
expense in future periods
Example 7
Assumed a fixed asset purchased for $130,000 was originally estimated to have a useful life of 30 years and a residual value of $10,000. The asset has been depreciated for 10 years by the straight line method.
At the end of ten years, the asset’s book value of $90,000. During 11th year, it is estimated that the remaining useful life is 25 years and that the residual value is $5,000.
Compute depreciation expense for the 11th
year using the new information provided.
Example 7Depreciation expense=
= $130,000-$10,000
30
= $ 4,000.00 per year before changes
Accumulated Depreciation balance
=$4,000 X 10 years
= $40,000
Book value
= $130,000.00 – $40,000 = $90,000
Example 7
New depreciation expense =
Book value – new salvage
Remaining life
= ($90,000-$5,000)
25
= $ 3,400.00 per year for remaining years
Disposal of Fixed Assets
Discarding of Fixed Assets
When asset has no residual value and is
fully depreciated.
Example 8
Asset with a cost of $25,000 and fully
depreciated is discarded
Account Debit Credit
Accumulated Depreciation $25,000
Fixed Asset $25,000
Selling of Fixed Assets
Three things can happen
Sale at book value
No gain or loss
Sale below book value
Loss is recognized
Sale after book value
Gain is recognized
Selling at book value
Example 9:
Asset with cost of $25,000 and Accumulated
Depreciation of $10,000 is sold for $15,000 cash.
Account Debit Credit
Cash $15,000
Accumulated depreciation $10,000
Fixed Asset $25,000
Selling price above book value
Gain is recognized
Example 10:
Asset with cost $25,000, Accumulated
Depreciation of $10,000 is sold for $20,000 cash.
Account Debit Credit
Cash $20,000
Accumulated depreciation $10,000
Fixed Asset $25,000
Gain on disposal of asset $5,000
Selling price below book value
Loss is recognizedExample 11: Asset with cost of $25,000, Accumulated
Depreciation of $10,000 is sold for $12,000 cash.
Account Debit Credit
Cash $12,000
Accumulated Depreciation $10,000
Loss on disposal of asset $3,000
Fixed Asset $25,000
Exchanging Similar Assets
Old equipment is often traded in for new
equipment having a similar use.
The seller allows the buyer an amount for
the old equipment traded in called TRADE
IN ALLOWANCE.
The remaining balance – the amount owed
is either paid in cash or recorded as a
liability – called BOOT
Gain on exchanges
Not recognized for financial reporting
purposes.
When trade-in allowance exceeds the book
value of an asset traded in and no gain is
recognized, the cost recorded for the new
asset can be determined in either of two
ways: Cost of new asset = List price + Unrecognized gain
Cost of new asset = Cash given + book value of oldNot
recognized for financial reporting purposes.
Example 12
New equipment is purchased with a list price
of $5,000, trade in allowance of old is $1,100,
cost of old equipment is $4,000, accumulated
depreciation $3,200. Record the entry. New
equipment is purchased with a list price of
$5,000, trade in allowance of old is $1,100,
cost of old equipment is $4,000, accumulated
depreciation $3,200. Record the entry.
Example 12
Account Debit Credit
Fixed Asset – new $800
Accumulated Depreciation $3,200
Fixed Asset – old $4,000
Losses on Exchange
For financial reporting purposes, losses are
recognized on exchanges of similar fixed
assets.
If trade in is less than the book value of
the old equipment, there is a loss
Example 14
New equipment is purchased with a list price
of $5,000, trade in allowance of old is $700,
cost of old equipment is $4,000, accumulated
depreciation $3,200. Record the entry.
Account Debit Credit
Fixed Asset – new $700
Accumulated Depreciation $3,200
Loss on exchange of asset $100
Fixed Asset – old $4,000