financial accounting mba depreciation)

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Depreciation . . . key terms Depreciation: the process of systematically allocating the cost of an asset over its useful life . Salvage value: The estimated value of an asset at the end of its useful life Depreciable cost: an asset’s acquisition cost less its salvage value Book value: an asset’s cost less its accumulated depreciation Three factors to consider when computing depreciation: cost, estimated useful life, and salvage value

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Page 1: Financial Accounting MBA Depreciation)

Depreciation . . . key terms• Depreciation:

the process of systematically allocating the cost of an asset over its useful life.

• Salvage value:

The estimated value of an asset at the end of its useful life

• Depreciable cost:

an asset’s acquisition cost less its salvage value• Book value:

an asset’s cost less its accumulated depreciation• Three factors to consider when computing

depreciation:

cost, estimated useful life, and salvage value

Page 2: Financial Accounting MBA Depreciation)

Fixed Assets

• Fixed assets are those assets:–that have a long life,–are used in the business for future generation

of income,–are not bought with the main purpose of resale.–Fixed assets are also called “Depreciable

Assets”

• No depreciation is charged on land.

Page 3: Financial Accounting MBA Depreciation)

Grouping of Fixed Assets

• Major groups of Fixed Assets:–Land–Building–Plant and Machinery–Furniture and Fixtures–Office Equipment–Vehicles

Page 4: Financial Accounting MBA Depreciation)

Recording• Depreciation

• Two different accounts are used–Depreciation Expense Account–Accumulated Depreciation Account

• Accumulated Depreciation Account – over the years the periodic depreciation is accumulated in this account.

• Debit Depreciation Expense Account

Credit Accumulated Account

Page 5: Financial Accounting MBA Depreciation)

Introduction to Long-Lived Assets

Plant Assets

Page 6: Financial Accounting MBA Depreciation)

Property, Plant, and Equipment

Expected to Benefit Future Periods

Actively Used in Operations

Tangible

Plant Assets

Page 7: Financial Accounting MBA Depreciation)

Issues Related to Plant Assets

Asset Service Potential

Acquisition DisposalUse in business operations

Time

Decline in future service benefits. Book Value

Accounting Issues

Measuring Cost

Recording Disposals

Allocating initial cost and subsequent

maintenance/repairs.

Page 8: Financial Accounting MBA Depreciation)

Acquisitioncost

Acquisition cost excludes financing charges and

cash discounts.

All expenditures

needed to prepare the asset for its intended use

Purchaseprice

Cost of Plant Assets

Page 9: Financial Accounting MBA Depreciation)

Land is not depreciable

Purchaseprice

Real estatecommissions

Title insurance premiumsDelinquent

taxes

Surveyingfees

Title search and transfer fees

Land

Page 10: Financial Accounting MBA Depreciation)

Purchaseprice

Architecturalfees

Cost ofpermits

Excavation andconstruction costs

Installationcosts

Transportationcosts

Buildings and Equipment

Page 11: Financial Accounting MBA Depreciation)

Depreciation – The Concept

Page 12: Financial Accounting MBA Depreciation)

A Theoretical View of Depreciation

$2; $3; $4; SV

$3; $4; SV

$4; SV

SV$1; $2; $3; $4;

SV

An application of the Matching Principle.

Time

Consumed as Depreciation Expense

Page 13: Financial Accounting MBA Depreciation)

Depreciation is a cost allocation process that systematically and rationally matches

acquisition costs of plant assets with periods benefited by their use.

Cost

Allocation

AcquisitionCost

(Unused)

Balance Sheet

(Used)

Income Statement

Expense

Depreciation

Page 14: Financial Accounting MBA Depreciation)

Income

StatementDepreciation

ExpenseDepreciation for

the current year

Balance

SheetAccumulatedDepreciation

Total depreciation to

date of balance sheet

Depreciation

Page 15: Financial Accounting MBA Depreciation)

Factors in Computing Depreciation

• The calculation of depreciation requires three amounts for each asset:

• Cost.

• Salvage Value.

• Useful Life.

Page 16: Financial Accounting MBA Depreciation)

Depreciation Methods

• Straight-line

• Units-of-production

• Declining balance

• Sum-of-the-Years’ Digits

Page 17: Financial Accounting MBA Depreciation)

Depreciation• If an asset is expected to benefit all

periods equally,

– a straight-line method of depreciation would be appropriate.

Page 18: Financial Accounting MBA Depreciation)

Depreciation• If more benefits are expected early in

the life of an asset . . .

– an accelerated method of depreciation would be appropriate.

Page 19: Financial Accounting MBA Depreciation)

Depreciation• If benefits are related to the output of

an asset . . .

– the units-of-production method of depreciation would be appropriate.

Page 20: Financial Accounting MBA Depreciation)

< 2007

2007 thru 2008 2008>

Could use any of four methods:

Straight-LineDeclining BalanceUnits-of-OutputSum-of-the-Years’ Digits

Page 21: Financial Accounting MBA Depreciation)

Methods of Depreciation

Straight-Line Method

Page 22: Financial Accounting MBA Depreciation)

Cost - Salvage Value

Useful life in years

Depreciation

Expense per Year=

Straight-Line Method

• Appropriate if an asset is expected to benefit all periods equally.

Page 23: Financial Accounting MBA Depreciation)

• On December 31, 2001, equipment was purchased for $50,000 cash. The equipment has an estimated useful life of 5 years and an estimated residual value of $5,000.

Straight-Line Method

Depreciation Expense Per Year

=$50,000 - $5,000

5 Years

= $9,000

Page 24: Financial Accounting MBA Depreciation)

Depreciation Accumulated Accumulated UndepreciatedExpense Depreciation Depreciation Balance

Year (debit) (credit) Balance (book value)2001 50,000$ 2002 9,000$ 9,000$ 9,000$ 41,000 2003 9,000 9,000 18,000 32,000 2004 9,000 9,000 27,000 23,000 2005 9,000 9,000 36,000 14,000 2006 9,000 9,000 45,000 5,000

45,000$ 45,000$

Salvage Value

Straight-Line Method

Page 25: Financial Accounting MBA Depreciation)

Dep

reci

atio

n

Exp

ense

Depreciation Expense is

reported on the Income

Statement.

Book Value is reported on the Balance

Sheet.

Page 26: Financial Accounting MBA Depreciation)

DepreciationPer Unit

= Cost - Salvage Value Total Units of Production

Step 1:

Step 2:

Depreciation Expense =

DepreciationPer Unit

×Number of

Units Producedin the Period

Exh. 8.9Units-of-Production

Method

Page 27: Financial Accounting MBA Depreciation)

Units-of-Production Method

• On December 31, 2001, equipment was purchased for $50,000 cash.

– The equipment is expected to produce 100,000 units during its useful life and has an estimated salvage value of $5,000.

– If 22,000 units were produced in 2002, what is the amount of depreciation expense?

Page 28: Financial Accounting MBA Depreciation)

Step 2:Depreciation Expense = $.45 per unit × 22,000 units = $9,900

Step 1:Depreciation

Per Unit= $50,000 - $5,000

100,000 units = $.45 per unit

Units-of-Production Method

Page 29: Financial Accounting MBA Depreciation)

Accumulated UndepreciatedDepreciation Depreciation Balance

Year Units Expense Balance (book value)2001 50,000$ 2002 22,000 9,900$ 9,900$ 40,100 2003 28,000 12,600 22,500 27,500 2004 - - 22,500 27,500 2005 32,000 14,400 36,900 13,100 2006 18,000 8,100 45,000 5,000

100,000 45,000$

No depreciation expense if the equipment is idle.

Salvage Value

Units-of-Production Method

Page 30: Financial Accounting MBA Depreciation)

Depreciation RepairExpense Expense

Early Years High Low

Later Years Low High

Early years’ total expense approximates later years’ total expense.

Declining Balance Method

Page 31: Financial Accounting MBA Depreciation)

Repair Costs

Depreciation

Accelerated Depreciation

Page 32: Financial Accounting MBA Depreciation)

Step 2:Double-declining-

balance rate= 2 ×

Straight-linedepreciation rate

Exh. 8.11

Step 3:Depreciation

expense=

Double-declining-balance rate

×Beginning period

book value

Double-Declining-Balance Method

Step 1:Straight-line

depreciation rate=

100 % Useful life in periods

Ignores salvage value

Page 33: Financial Accounting MBA Depreciation)

Double-Declining-Balance Method

• On December 31, 2001, equipment was purchased for $50,000 cash.

• The equipment has an estimated useful life of 5 years and an estimated residual value of $5,000.

• Calculate the depreciation expense for 2002 and 2003

Page 34: Financial Accounting MBA Depreciation)

Step 2:Double-declining-

balance rate= 2 × 20% = 40%

Step 3:Depreciation

expense= 40% × $50,000 = $20,000 (2002)

Step 1:Straight-line

depreciation rate=

100 % 5 years

= 20%

Double-Declining-Balance Method

Page 35: Financial Accounting MBA Depreciation)

2002 Depreciation: 40% × $50,000 = $20,000

2003 Depreciation: 40% × ($50,000 - $20,000) = $12,000

Double-Declining-Balance Method

Page 36: Financial Accounting MBA Depreciation)

Depreciation Accumulated UndepreciatedExpense Depreciation Balance

Year (debit) Balance (book value)2001 50,000$ 2002 20,000$ 20,000$ 30,000 2003 12,000 32,000 18,000 2004 7,200 39,200 10,800 2005 4,320 43,520 6,480 2006 2,592 46,112 3,888

46,112$

($50,000 – $43,520) × 40% = $2,592

Below salvage value

Double-Declining-Balance Method

Page 37: Financial Accounting MBA Depreciation)

Depreciation Accumulated UndepreciatedExpense Depreciation Balance

Year (debit) Balance (book value)2001 50,000$ 2002 20,000$ 20,000$ 30,000 2003 12,000 32,000 18,000 2004 7,200 39,200 10,800 2005 4,320 43,520 6,480 2006 1,480 45,000 5,000

45,000$

We usually have to force depreciation expense in thelatter years to an amount that brings BV to salvage value.

Double-Declining-Balance Method

Page 38: Financial Accounting MBA Depreciation)

When a plant asset is acquiredduring the year, depreciation

is calculated for the fraction ofthe year the asset is owned.

When a plant asset is acquiredduring the year, depreciation

is calculated for the fraction ofthe year the asset is owned.

June 30

Partial Year Depreciation

Page 39: Financial Accounting MBA Depreciation)

Partial Year Depreciation

• Calculate the straight-line depreciation on December 31, 2003, for equipment purchased on June 30, 2003.

• The equipment cost $75,000, has a useful life of 10 years and an estimated salvage value of $5,000.

Page 40: Financial Accounting MBA Depreciation)

Partial Year Depreciation

Depreciation = ($75,000 - $5,000) ÷ 10

= $7,000 for a full year

Depreciation = $7,000 × 6/12 = $3,500

Depreciation = ($75,000 - $5,000) ÷ 10

= $7,000 for a full year

Depreciation = $7,000 × 6/12 = $3,500

Page 41: Financial Accounting MBA Depreciation)

Sum of the Year’s Digits (SOYD)• Depreciation =

(cost-salvage value) * RL/ SOYD

Where– RL = remaining years of useful life as of the

beginning of the year for which depreciation is being computed.

– SOYD = sum of all the number from 1 through the estimated useful life.

For example:

for a 5- year useful life, SOYD would be1+2+3+4+5=15 and it would be 55 for a 10 year useful life.

– Highest the first year and then declines by a constant amount after.