Chapter 8! The Accounting Cycle Work Sheet and Adjusting Process Unit 4 Quest (chapter 8 and 10) will be on December 4 (Thursday) Youtube clip: “Episode 39: How to Calculate Depreciation” by Alanis Business Academy

 You must remember that adjusting entries and closing entries are different.  Last week, we learned 4 types of adjusting entries for office supplies, late arriving invoices, unearned revenue and prepaid insurance  You saw that these transactions affected one income statement account and one balance sheet account.  Now you will study the adjustments for long term assets, which is called Depreciation or Amortization. (similar to office supplies adjustment we learned) Adjusting for Depreciation

The Nature of Depreciation  There are two categories for assets: 1. Short Term Assets: These assets last only short term: E.g. Cash and AR 2. Long Term Assets : These assets last long term: E.g. Land, Building, Equipment, Computer, Car, Truck etc  Long Term assets are also called “Fixed Assets” or “Capital Assets” Adjusting for Depreciation

 Let’s say I own Pizza restaurant and I use my car to deliever pizza.  How long does my car last? In other words, how many years will my car help my business to generate income?  It lasts 15 years. After 15 years, my car will die. Its useful life is 15 years. My car will help my business to generate income for 15 years.  We recorded $15000, the original cost in Balance Sheet. Is it fair to the readers of balance sheet if I just do nothing to the balance of this car at the end of December ? (I paid $15000 for 2 year old, used Honda Civic on January ) Adjusting for Depreciation

 No it is not fair to the reader of the balance sheet because my car’s useful life is only 14 years left on December 31, The balance of my auto account is still 15000$ in Dec 31 if I do not make any adjusting entry.  Also it is not fair to the reader of the income statement because my car was used (during the last 12 months) to generate income of my business. Adjusting for Depreciation

 I must recognize the usage of this car as an expense and I must recognize that the value of this car is less on December 31.  Therefore, we have to make an adjusting entry to recognize the usage of my car at the end of December 31.  This adjusting entry must increase expense account and decrease auto account on December (similar to office supplies adjustment) Adjusting for Depreciation

 15000$ / 15 years = 1000 / year  On December 31 I must make an adjusting entry: Dr.Cr Depreciation Expense Auto1000 Accumulated Depreciation Auto1000 Recording depreciation for auto  Definition of Depreciation: Depreciation is a means of allocating the cost of a long term asset over its useful (productive) life. Adjusting for Depreciation

 The long term assets (like car, truck, computer and equipment) help the business’ producing income throughout the year.  Therefore, the cost of purchasing these assets must be spread out over the length of time that they help produce revenue.  By doing depreciation adjusting entry, we are honoring matching principle. Depreciation

 Accountants must estimate the useful life of the long term assets. = How long will this asset last?  The two most common methods of calculating depreciation are the straight line method and declining balance method. Depreciation

 SLMD for one year = Cost – Salvage Value Periods  Cost = original cost of the long term asset  Salvage value = how much you will receive when you sell it at the end of the useful life or selling price after you used it for many years.  Periods = How long you will use it before selling it or throwing away  The car example we used:  SLMD = = 1000 per year 15 years Straight Line Method

 Review Q #1, 3, 4, 5, 6, 7, 9 (P311)  P311 Ex 1A, 1B, 1C, 2A, 2C, 3, 4  I took up Ex 1A, 1B and 1C after 20 minutes. Homework