Accounting for Fixed Assets and Depreciation Chapter 24

Buying and Recording Fixed Assets A fixed asset is recorded at its cost. Examples of fixed assets are equipment, land, and building. A business buys fixed assets to use in earning revenue. However, all fixed assets, except land, will go down in value as they are used.

Effects of Depreciation on Fixed Assets A piece of equipment will go down in value as you use it. Think of a car you want to own. You may buy it for $14 000 but after you drive it for 4 years you want to sell it and get a new one. Will you get $14 000 for that car? Why?

Effects of Depreciation on Fixed Assets The same applies to fixed assets of a company. We will use equipment as an example. Each year or month that the company uses a piece of equipment to earn revenue it is becoming less valuable to the company (as it gets older).

Effects of Depreciation on Fixed Assets We can’t have our assets reflecting a higher number than what we actually have so we need to make an adjustment for accumulated depreciation each fiscal period just like we do for supplies and prepaid insurance.

Effects of Depreciation on Fixed Assets Depreciation is when a portion of the fixed assets cost is transferred to an expense account in each fiscal period that a fixed asset is used to earn revenue (PRINCIPLE: Matching Expenses with Revenue).

Effects of Depreciation on Fixed Assets Example: ABC company paid $13 000 for a new delivery truck in 2005. A portion of the new delivery trucks cost will be recorded as depreciation expense each fiscal period during the estimated useful life of the truck.

Figuring Depreciation Expense Three factors affect the amount of depreciation expense for a fixed asset. The original cost of a fixed asset. The estimated salvage value of a fixed asset The estimated useful life of a fixed asset.

Original Cost The original cost is how much the company paid for the fixed asset. This includes delivery and installation costs if applicable. In our example ABC Company paid $13 000 total for their delivery truck.

Estimated Salvage Value This is the amount the company estimates they will be able to get for the asset when it is no longer of use to the company (what they can sell it for once they are done with it). In our example ABC Company believes they will be able to get $1 000 for the delivery truck at the end of its useful life.

Estimated Useful Life The total amount of depreciation expense is distributed over the estimated useful life of a fixed asset. This must be estimated when the fixed asset is purchased. In our example ABC Company believes they will be able to get 5 years out of the delivery truck.

Figuring Depreciation Expense Straight-line depreciation is what we will use and it is calculated as shown below: Original – Estimated = Total amount cost salvage value subject to depreciation $13 000.00 - $1 000.00 = $12 000.00

Figuring Depreciation Expense Cont. The annual depreciation expense for the delivery truck is shown below: Total amount / Years of = Annual subject to estimated depreciation depreciation useful life expense $12 000.00 / 5 = $2 400.00

Figuring Depreciation Expense Cont. The monthly depreciation expense for the delivery truck is shown below: Annual / Months in = Monthly depreciation a year depreciation expense $2 400.00 / 12 = $200.00

Accounts Affected by Fixed Assets There are 3 account affected by fixed assets. An asset account is used to record the original purchase price Accumulated depreciation account record the total amount of depreciation to date Expense account is used to record the amount of depreciation expense.

Asset Accounts An asset account is used to record the original amount of the asset. In our example ABC Company would have debited delivery equipment or automobile and credited cash or accounts payable (depending on how they paid). No more entries will go into this account in relation with depreciation. The fixed asset accounts will continue to record the original purchase price until they are sold.

Accumulated Depreciation Accounts Depreciation is credited to a contra asset account (that means it will bring down the overall value of the assets) called accumulated depreciation. The name of what you are depreciating will follow the title. In our example it would be: accumulated depreciation - delivery equipment

Depreciation Expense Accounts Depreciation expense is an expense of a business. In our example it would be: depreciation expense – delivery equipment

Recording Depreciation Expense Adjustments on a Work Sheet This is the same type of entry as we did for supplies and prepaid insurance. Debit to the depreciation expense account (ex. depreciation expense – delivery equipment) Credit to the accumulated depreciation account (ex. accumulated depreciation - delivery equipment)

Journalizing Adjusting Entries for Depreciation Expense You will then record the entries made in the worksheet in the adjustments column the same way as they appear on the worksheet. This is the same procedure as you did for the adjustments for supplies and prepaid insurance. Record the entries to the general journal and then to then post them to the general ledgers.

For Our Example You Should Record: Debit to the depreciation expense – delivery equipment for $200.00 Credit to accumulated depreciation - delivery equipment for $200.00 In the general journal and general ledger Remember: leave the asset account delivery truck account alone – do not add or subtract anything from this account at this time.

Disposing of a Fixed Asset When no longer used, a fixed asset may be sold or discarded. After 5 years ABC Company sells the delivery truck. They get $1 000.00 for the truck. We need to record the $1 000.00 we received in cash as well as get the delivery equipment account off of our books (since we do not have it anymore) and close the accumulated depreciation – delivery equipment account (make it zero).

To Dispose of the Fixed Asset in Our Example We: Debit cash $1 000.00 Debit Accumulated depreciation – delivery equipment $12 000.00 Credit Delivery equipment $13 000.00