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CENTURY 21 ACCOUNTING © Thomson/South-Western
LESSON 8-4LESSON 8-4
Other Methods of Depreciation
CENTURY 21 ACCOUNTING © Thomson/South-Western
OTHER METHODS OF DEPRECIATIONOTHER METHODS OF DEPRECIATION
Many plant assets depreciate more in the early years of useful life than in the later years.
Charging more depreciation expense in the early years of a plant asset may be more accurate than caharging the same amount each year.
Multiplying the book value at the end of each fiscal period by a constant depreciation rate is called the declining-balance method of depreciation
Although the depreciation rate is the same each year, the annual depreciation expense declines from year to year
page 242
CENTURY 21 ACCOUNTING © Thomson/South-Western
DECLINING-BALANCE METHOD OF DECLINING-BALANCE METHOD OF DEPRECIATIONDEPRECIATION
The declining-balance depreciation rate is based on the straight-line rate. It is twice the straight-line rate (called the double declining-balance method)
This method does not use the estimated salvage value to compute annual depreciation
The estimated salvage value is used only to limit the last year’s depreciation expense A plant asset is never depreciated below its estimated
salvage value
page 242
CENTURY 21 ACCOUNTING © Thomson/South-Western
DECLINING-BALANCE METHOD OF DECLINING-BALANCE METHOD OF DEPRECIATIONDEPRECIATION
The annual depreciation expense is calculated using the beginning book value for each year (beginning book value is the same as the ending book value from the previous year)
Remember: Do not use salvage value in computing the book value
page 242
1. Calculate the declining-balance rate.Total Depreciation Expense 100%
Estimated Useful Life (years) 5= Straight-Line Rate 20% Double the Rate 2= Declining-Balance Rate 40%
Purchased a computer for $2,000 on January 1st. The computer has a useful life of 5 years and an estimated salvage value of $175
2. Calculate the annual depreciation for year 1.Beginning Book Value $2000
Depreciation Rate 40%= Annual Depreciation Expense $800
CENTURY 21 ACCOUNTING © Thomson/South-Western
5
LESSON 8-4
Plant asset: Computer
Depreciation method: Declining balance
Original cost: $2,000.00Estimated salvage value: $175.00Estimated useful life: 5 years
Year Beginning Book Value
Declining- Balance Rate
Annual Depreciation
Ending
Book Value
1
2
3
4
5
Total Depreciation
$2,000.00 1,200.00
720.00
432.00
259.20
40%
40%
40%
40%
40%
—
$ 800.00
480.00
288.00
172.80
84.20
$1,825.00
$1,200.00
720.00
432.00
259.20
175.00
—
1. Calculate the declining-balance rate.Total Depreciation Expense 100%
Estimated Useful Life (years) 5= Straight-Line Rate 20% Double the Rate 2= Declining-Balance Rate 40%
2. Calculate the annual depreciation for year 3.Beginning Book Value $720
Depreciation Rate 40%= Annual Depreciation Expense $288
DECLINING-BALANCE DECLINING-BALANCE METHOD OF DEPRECIATIONMETHOD OF DEPRECIATION page 242
1122
CENTURY 21 ACCOUNTING © Thomson/South-Western
SUM-OF-THE-YEARS’-DIGITS METHOD SUM-OF-THE-YEARS’-DIGITS METHOD OF DEPRECIATIONOF DEPRECIATION
Another method of calculating depreciation is based on a fraction derived from the years’ digist for the useful life of a plant asset
Using fractions based on the number of years of a plant asset’s useful life is called the sum-of-the-years’-digits method of depreciation
Like the straight-line method, the estimated salvage value is subtracted from the original cost to compute an estimated total depreciation expense
This results in a last year ending book value equal to the palnt asset’s salvage value
page 243
CENTURY 21 ACCOUNTING © Thomson/South-Western
SUM-OF-THE-YEARS’-DIGITS METHOD SUM-OF-THE-YEARS’-DIGITS METHOD OF DEPRECIATIONOF DEPRECIATION
The fractions are determined as follows: The years’ digits are added (1+2+3+4+5 = 15
Then, using the sum of the years’ digits, a fraction is created for each year with the years’ digits in reverse order
The sum-of-the-years’-digits method results in a last year ending book value equal to the plant asset’s salvage value
page 243
1. Calculate the fraction. Years’ Digits Fraction1 5/15
2 4/15
3 3/15
4 2/15
5 1/15
15
CENTURY 21 ACCOUNTING © Thomson/South-Western
8
LESSON 8-4
Plant asset: Computer
Depreciation method: Sum-of-the-years-digits
Original cost: $2,000.00
Estimated salvage value: $175.00
Estimated useful life: 5 years
YearBeginning Book
Value FractionTotal
Depreciation Annual Depreciation
Ending
Book Value
1
2
3
4
5
Total
$2,000.00
1,391.67
905.00
540.00
296.67
5/15
4/15
3/15
2/15
1/15
$1,825.00
$1,825.00
$1,825.00
$1,825.00
$1,825.00
$608.33
486.67
365.00
243.33
121.67
$1,825.00
$1,391.67
905.00
540.00
296.67
175.00
2. Calculate the annual depreciation for year 1.Original Cost
$2,000.00Estimated Salvage Value
– 175.00Estimated Total Depreciation
$1,825.00Year’s Fraction
5/15Annual Depreciation
$608.33
SUM-OF-THE-YEARS-DIGITS SUM-OF-THE-YEARS-DIGITS METHOD OF DEPRECIATIONMETHOD OF DEPRECIATION page 243
11 22
1. Calculate the fraction. Years’ Digits Fraction1 5/15
2 4/15
3 3/15
4 2/15
5 1/15
15
CENTURY 21 ACCOUNTING © Thomson/South-Western
9
LESSON 8-4
COMPARISON OF THREE COMPARISON OF THREE METHODS OF DEPRECIATIONMETHODS OF DEPRECIATION page 244
Plant asset: Computer
Depreciation method: Comparison
Original cost: $2,000.00
Estimated salvage value: $175.00
Estimated useful life: 5 years
YearStraight-Line
Method
Double Declining-Balance Method
Sum-of-the-Years-Digits
Method
1
2
3
4
5
Total Depreciation
$365.00
365.00
365.00
365.00
365.00
$1,825.00
$ 800.00
480.00
288.00
172.80
84.20
$1,825.00
$608.33
486.67
365.00
243.33
121.67
$1,825.00
Regardless of the depreciation method used, the total depreciation expense over the useful life of an asset is the same
Double declining balance method & sum-of-the-years’-digits are known as accelerated depreciation methods
CENTURY 21 ACCOUNTING © Thomson/South-Western
PRODUCTION-UNIT METHOD OF PRODUCTION-UNIT METHOD OF DEPRECIATIONDEPRECIATION
Sometimes the useful life of a plant asset depends on how much the asset is used
Ex. Automobile will wear out faster if it is driven 80,000 miles a year rather than 60,000 miles.
Calculating estimated annual depreciation expense based on the amount of production expected from a plant asset is called the production-unit method of depreciation
The depreciation rate for the asset is calculated by dividing the estimated total depreciation expense by the estimated useful life
page 245
1. Calculate the depreciation rate.Original Cost
$18,200– Estimated Salvage Value
– 2,000= Est. Total Depreciation Expense
$16,200 Estimated Useful Life (miles)
90,000= Depreciation Rate
$0.18/mile
CENTURY 21 ACCOUNTING © Thomson/South-Western
11
LESSON 8-4
Plant asset: Truck Depreciation method: Production-unitOriginal cost: $18,200.00Estimated salvage value: $2,000.00
Estimated total depreciation: $16,200.00Estimated useful life: 90,000 milesDepreciation rate: $0.18 per mile driven
Year Beginning Book Value
Miles Driven Annual Depreciation EndingBook Value
12345
Totals
$18,200.0016,580.0012,440.00
7,940.003,980.20
9,00023,00025,00022,000
8,00087,000
$ 1,620.004,140.004,500.003,960.001,440.00
$15,600.00
$16,580.0012,440.00
7,940.003,980.202,540.00
1. Calculate the depreciation rate.Original Cost $18,200
– Estimated Salvage Value – 2,000= Est. Total Depreciation Expense $16,200 Estimated Useful Life (miles) 90,000= Depreciation Rate $0.18/mile
2. Calculate annual depreciation for year 1.Total Miles Driven 9,000
Depreciation Rate $0.18= Annual Depreciation Exp. $1,620.00
PRODUCTION-UNIT METHOD PRODUCTION-UNIT METHOD OF DEPRECIATIONOF DEPRECIATION page 245
11
22
CENTURY 21 ACCOUNTING © Thomson/South-Western
CALCULATING DEPRECIATION EXP. CALCULATING DEPRECIATION EXP. FOR INCOME TAX PURPOSESFOR INCOME TAX PURPOSES
Modified Accelerated Cost Recovery System is a depreciation method required by the Internal Revenue Service to be used for income tax calculation purposes for most plant assets placed in service after 1986.
This method is generally referred to as MACRS.
MACRS has prescribed periods for nine classes of useful life for plant assets.
An asset is assigned to a specific class based on its characteristics and general life expectancy.
page 246
CENTURY 21 ACCOUNTING © Thomson/South-Western
15
LESSON 8-4
TERMS REVIEWTERMS REVIEW
declining-balance method of depreciation sum-of-the-years’-digits method of depreciation production-unit method of depreciation Modified Accelerated Cost Recovery System
page 248