16-1 PLANT ASSETS CHAPTER 16

16-2 Long-term assets Tangible assetsNatural resourcesIntangible assets e.g. plant, buildings, and equipment

16-3 Tangible assets Fixed assetsPlant assets Plant assets are remained for operations of business, not for resale. The useful life of plant assets is more than one year.

16-4 Depreciable asset The value of plant assets may decline due to general wear and tear. A decline in revenue-producing ability may also occur because of obsolescence.

16-5Depreciation Under the matching rule, the cost of plant assets must be allocated to all the periods over their useful life, and must be done in a "systematic and rational" manner. 1 year2 year

16-6Depreciation Before computing depreciation, it’s essential to determine The cost Residual value Depreciable cost Estimated useful life

16-7Cost Acquisition costThe cost of plant assetOriginal cost == It includes all expenditures reasonable and necessary to get the plant asset in place and available for use.

16-8Cost If a plant asset is acquired for cash, the acquisition cost consist of: the cash paid for the asset expenditures for packing freight insurance in transit installation testing value added tax other necessary related costs

16-9Cost If a plant asset is acquired by self-construction the acquisition cost consist of : Direct labor direct materials direct machinery equipment cost Other expenses incurred in the course of construction

16-10Cost If a plant asset is acquired from donation the acquisition value includes : fair value all the expenses incurred during the period when the donation is received Fair value refers to the amount which is agreed by two sides that are familiar with the transaction.

16-11Cost If a plant asset is purchased on credit the interests are not included in cost, but as expense for this period. However, if the assets are constructed, the interests during the construction should be calculated as part of cost of the asset.

16-12 Residual value The residual value of an asset is its estimated net scrap, salvage, or trade-in value as of the estimated date of disposal. Salvage value and disposal value are other terms used to stand for residual value.

16-13 Depreciable cost The cost of an asset － Residual value=Depreciable value For example, if furniture’s cost is $10,000 and its residual value is $4,000, its depreciable cost will be $6,000.

16-14 Estimated useful life Accounting considers estimated useful life as the depreciation years because deterioration and obsolescence are considered as well as wear and tear when a plant asset is depreciated. Estimated economic useful lifeEstimated useful life ＜ Physical useful life

16-15 Estimated useful life For example, a computer can be used for more than five years regardless to the out-of-dated. However, its estimated useful life may be only two years because the new type is put into use instead of the old one.

16-16 Methods of Computing Depreciation l Straight-line Method l Production Method l Accelerated Methods

16-17 Straight-line Method Method 1 Straight-lineMethod

16-18 Straight-line Method Under this method, an equal amount of depreciation expense is allocated to each period of the asset’s useful life. Straight-line method is also called average-years method.

16-19 Straight-line Method f = ax + b  x = (f – b)/a “x” stands for annual depreciation that we want to know. “f” refers to acquisition cost. “b” is salvage value. “a” is estimated useful life. In mathematics, the formula of a straight line is

16-20 Straight-line Method Formula Annual Depreciation= Acquisition Cost – Salvage Value Years of Useful life

16-21 Straight-line Method Now, let’s look at an example …

16-22 Straight-line Method On March 7, the George Ross Advertising Agency purchased art equipment and office equipment for$2,000 and $5,300 respectively. Suppose that the George Ross Advertising Agency estimates that the art equipment and office equipment will last for five years and the salvage will be worthless at the end of the useful life.

16-23 Straight-line Method The calculation is as follows: Annual Depreciation for Photocopy Equipment = ($2,000-0)/5 = $400 Annual Depreciation for Office Equipment = ($5, )/5 = $1,060

16-24 Straight-line Method Monthly Depreciation for Photocopy Equipment = $400/12 = $33.3 Monthly Depreciation for Office Equipment Monthly Depreciation = Annual Depreciation/12 = $1,060/12 =$88.3

16-25 Straight-line Method Shortcomings It pays more attention to the useful time than the useful Condition. And allocate equal amount to each period regardless to the level of wear and tear that the asset suffers.

16-26 Production Method Method 2 ProductionMethod

16-27 Production Method Production method allocates equal portion to the products. Formula Depreciation per Unit = Acquisition Cost – Salvage Value Estimated Production

16-28 Production Method Now, let’s look at an example …

16-29 Production Method A photocopier can copy about 100 thousand pieces of paper with a 5,000-dollar acquisition cost and 500-dollar salvage value. Depreciation per Unit = $5,000 - $ ,000 =$0.045

16-30 Production Method Different standards of workload should be applied to different plant assets. If the depreciated asset is a machine, the unit depreciation should be calculated on the basis of the estimated hours that the machine works for. If the depreciated asset is a vehicle, the unit depreciation should be calculated on the basis of the estimated mileage that the vehicle runs.

16-31 Accelerated Methods Method 3 AcceleratedMethods

16-32 Accelerated Methods Accelerated method has another name—descending depreciation expense method. Accelerated methods result in that relatively large amounts of depreciation will be recognized in the early years of use, while relatively small amounts of depreciation in the later years.

16-33 Accelerated Methods This method comes along with the prudence principle. More depreciation will be allocated to the early years than to later years. It is along with matching rule that more expenses are allocated to more benefits or revenue.

16-34 Accelerated Methods Examples of accelerated methods Declining-balance method Double-declining-balance method Sum-of-the-years’-digits method Declining-depreciation-ratio method

16-35 Declining-balance method Under the declining-balance method, depreciation is computed by applying a fixed depreciation rate to the book value of the plant asset at the beginning of a year. This method will result in higher depreciation charges during the early years of useful life and lower depreciation charges during the later years of useful life.

16-36 Declining-balance method C----original cost/acquisition cost S carrying value at the end of the first year S carrying value at the end of the second year …… Sn----carrying value at the end of the n th year, namely salvage value

16-37 S1 = C-CR = C(1-R) S2 = C(1-R)-C(1-R)R = C(1-R)2 S n = C(1-R) n R = 1-√s/c S = C(1-R) n Declining-balance method Depreciation value per year =Carrying value at the beginning of the year × Rate

16-38 Declining-balance method Suppose the original value is $640,000, estimated useful life is 5 years; estimated salvage value is $20,000. Yearly Rate of depreciation =(1-5√20,000/640,000)× 100% = 50%

16-39 Declining-balance method Depreciation Schedule, Declining-Balance Method YearCalculation of depreciation Yearly depreciation Accumulated Depreciation Carrying value Date of purchase End of first year End of second year End of third year End of fourth year End of fifth year $640,000 *50% 320,000*50% 160,000*50% 80,000*50% 40,000*50% $320, ,000 80,000 40,000 20,000 $320, , , , ,000 $640, , ,000 80,000 40,000 20,000 Total620,000 Attention: If the salvage value is zero, when the rate of depreciation is calculated,we suppose that the salvage value is one dollar.

16-40 Double-declining-balance method Double-declining-balance method This method is based on the assumption that depreciation rate is twice the straight-line rate. Formula Yearly depreciation rate= Estimated useful life 2 ×100% Yearly depreciation= Carrying value at the beginning of the year × Yearly depreciation rate Yearly depreciation rate = 2 5 ×100%=40%

16-41 Double-declining-balance method The depreciation schedule for the double-declining-balance method YearCalculation of depreciation Yearly depreciation Accumulated Depreciation Carrying value Date of purchase End of first year End of second year End of third year End of fourth year End of fifth year $640,000*40% 384,000*40% 230,400*40% (138,240×20,000)/2 $256, ,600 92,160 59,120 $256, , , , ,000 $640, , , ,240 79,120 20,000 Total 620,000 Attention: In the fourth year and fifth year, the accelerated method isn’t applied to the calculation of depreciation because depreciation should be limited to amount necessary to reduce carrying value to residual value.

16-42 Sum-of-the - Years’-Digits Method Under this method, the years in the service life of an asset are added. Their sum becomes the denominator of a series of fractions that are applied in allocating the total depreciation over the estimated useful life. The numerators are the individual years in the estimated useful life of the asset in their reverse order.

16-43 Sum-of-the - Years’-Digits Method If a plant asset has an estimated five-year useful life, the denominator (or the sum of the years’ digits) is calculated as follows: = 15 The numerators are: 5, 4, 3, 2, 1. The fractions are: 5/15, 4/15, 3/15, 2/15, 1/15.

16-44 Sum-of-the - Years’-Digits Method Suppose the cost of a delivery truck is $10,000. The depreciation schedule for the sum-of-the-years’-digits method is as follows: YearCalculation of depreciation Yearly depreciation Accumulated Depreciation Carrying value Date of purchase End of first year End of second year End of third year End of fourth year End of fifth year (640,000-20,000) ×5/15 (640,000-20,000) × 4/15 (640,000-20,000) × 3/15 (640,000-20,000) × 2/15 (640,000-20,000) × 1/15 $206, , ,000 82,667 41,333 $206, , , , ,000 $640, , , ,000 61,333 20,000 Total 620,000

16-45 Accumulated depreciation The accumulated depreciation accounts are contra-asset accounts to summarize the depreciation expense on a specific fixed asset. Accumulated depreciation Accumulated depreciation Net amount shown as an asset The net amount is called carrying value or book value. As time passed

16-46 Accumulated depreciation Now, Let us adjust the transactions happen on March 7 …

16-47 Accumulated depreciation Decreases in assets are recorded by credits. Decreases in owner’s equity are recorded by debits. Owner’s equity is decreased by debits to Depreciation Expense, Art Equipment, and Depreciation Expense, Office Equipment. Assets are decreased by credits to contra-asset accounts Accumulated Depreciation, Art Equipment, and Accumulated Depreciation, Office Equipment.

16-48 Accumulated depreciation Depreciation Expense, Photocopy Equipment $33 Accumulated Depreciation, Photocopy Equipment $33 Depreciation Expense, Office Equipment $56 Accumulated Depreciation, Office Equipment $56

16-49 WE ARE SAILING RIGHT ALONG!!