accounting for depreciation
DESCRIPTION
Here Depreciation has been discussed. Factors affecting Depreciation, its different methods, with the help of case studies have been discussedTRANSCRIPT
Accounting for Depreciation
M. Awais Yaqoob
2011-ch-32
(University of Engineering and Technology, Lahore)
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 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 costIts expected useful lifeIts 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 yearsAnnual depreciation expense =
Cost – Salvage valueLife
= $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 valueEstimated 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 3Depreciation rate per unit =
Cost – Salvage value
Estimated hour
= $24,000 - $2,000 = $2.20 10,000 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
Depreciati
on
Book value at
beginning of year
Rate Depreciation
Book value at end of year
1 $24,000 $24,000 40% $9,600 $14,400
2 24,000 9,600 14,400 40% 5,760 8,640
3 24,000 15,360 8,640 40% 3,456 5,184
4 24,000 18,816 5,184 40% 2,073.60 3,110.40
5 24,000 20,889.60 3110.40 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 7Depreciation expense=
= $130,000-$10,000
30
= $ 4,000.00 per year before changes
Accumulated Depreciation balance
=$4,000 X 10 years
= $40,000
Book value
= $130,000.00 – $40,000 = $90,000
Example 7
New depreciation expense =
Book value – new salvage
Remaining life
= ($90,000-$5,000)
25 = $ 3,400.00 per year for remaining years
Disposal of Fixed Assets
Discarding of Fixed AssetsWhen asset has no residual value and is
fully depreciated.
Example 8
Asset with a cost of $25,000 and fully depreciated is discarded
Account Debit Credit
Accumulated Depreciation $25,000
Fixed Asset $25,000
Selling of Fixed Assets
Three things can happenSale at book value
No gain or lossSale below book value
Loss is recognizedSale after book value
Gain is recognized
Selling at book value
Example 9: 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 recognizedExample 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