 # Accounting for Depreciation

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Accounting for Depreciation
Chapter 9 Part 2 of 4

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 - truck \$7,000

Depreciation Accumulated depreciation Depreciation expense
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 = \$ ,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 Accumulated Depreciation Book value at beginning of year Rate Book value at end of year 1 \$24,000 40% \$9,600 \$14,400 2 24,000 9,600 14,400 5,760 8,640 3 15,360 3,456 5,184 4 18,816 2,073.60 3,110.40 5 20,889.60 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 7 Depreciation expense= = \$130,000-\$10,000 30
= \$ 4, per year before changes Accumulated Depreciation balance =\$4,000 X 10 years = \$40,000 Book value = \$130, – \$40,000 = \$90,000

Example 7 New depreciation expense = Book value – new salvage
Remaining life = (\$90,000-\$5,000) 25 = \$ 3, 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 Account Debit Credit Accumulated Depreciation \$25,000
Asset with a cost of \$25,000 and fully depreciated is discarded Account Debit Credit Accumulated Depreciation \$25,000 Fixed Asset

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: Account Debit Credit Cash \$15,000
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 recognized Example 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