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 Depreciation expense Accumulated depreciation truck Debit Credit 7 000 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 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 Depreciation expense Accumulated depreciation truck Debit Credit 4 400 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 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 Accumulat ed Depreciati on 1 24 000 2 24 000 3 Book value at beginning of year Rate Depreciati on Book value at end of year 24 000 40 9 600 14 400 9 600 14 400 40 5 760 8 640 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 7 Depreciation 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 Assets When 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 happen Sale No Sale at book value gain or loss below book value Loss Sale is recognized 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 Cash 15 000 Accumulated depreciation 10 000 Fixed Asset Credit 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 Cash Accumulated depreciation Fixed Asset Gain on disposal of asset Debit 20 000 10 000 Credit 25 000 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 Cash Accumulated Depreciation Loss on disposal of asset Fixed Asset Debit 12 000 10 000 3 000 Credit 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