AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 1 Property-Plant-Equipment: Module 3 Slide 1 Hi everyone. Now that we’ve gone through the first two accountable events in the lifecycle of PP&E, let’s spend a couple of minutes talking about the big one, which was the third accountable event dealing with depreciation.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 2 Slide 2 Let’s start with the basic definition of depreciation. Depreciation represents the systematic allocation of the cost of a plant asset to expense over its useful life. That is a textbook definition. Question is, well what does that mean? I think we should think of depreciation as simply representing the using up of our buildings and our equipment. Over time, the buildings and the equipment get used up. They don’t last forever. So as they get used up we record this thing called depreciation. So every year you’re gonna need to make an adjusting entry to record the amount of the asset, the building, or the equipment, that has been used up. And that adjusting entry is our depreciation entry.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 3 Slide 3 I’d like to go through a couple of critical, key points as it relates to depreciation. The most important thing. Kind of lets get this out of the way right now. Depreciation has absolutely nothing to do with the value of the asset. It is not recorded because the asset’s value has declined. Even though that’s what we commonly think of as depreciation. That’s not what it is. We do not depreciate an asset because its value is decreasing. We do depreciate buildings and equipment because of our friend the matching concept. And back in our previous course when we talked about adjusting entries and what adjustments were, we talked about the idea of the matching concept, recording the expense in the same period that the revenue is generated or the asset is used.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 4 Thus, because of our matching concept, the buildings and equipment are gonna get used for many years in the hopes of generating revenue. So our matching concept requires us to record some expense in each year the asset is used. The logic being in each of these years the asset will be used to generate revenue. So in each of those years some of the purchase price should become an expense as the asset is used up. Recording depreciation in this way allows for a proper matching of expenses with revenues. Do you notice that in the whole discussion of depreciation I’ve been limiting myself to buildings and equipment? The buildings and equipment get used up and the buildings and the equipment get depreciated.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 5 Slide 4 What about the land? And there’s this wonderful picture of a wonderful piece of land. What about the land? Why have I not included the land in the discussion of depreciation? The reason is, land is not depreciated. And it’s not because the land’s value goes up. Remember, depreciation has nothing to do at all with the value of the asset. The land is not depreciated because the land never gets used up. It’s never gonna go away. You come back in 5,000 years, more power to you if you do, this building Schoenbaum Hall is not going to be here and the equipment that’s inside of Schoenbaum Hall is not going to be there, but the land is gonna be there. The land has an infinite life. It will be around forever. The buildings and the equipment have finite lives; will only last for so many years. Because the land will never get used up the land is not depreciated.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 6 Slide 5 To record the depreciation expense, our basic adjusting entry. Now we’ve seen this once before when we learned adjusting entries back in our previous class work but here it is again. To record depreciation you will debit the depreciation expense and you will credit the account-accumulated depreciation. And there’s the basic adjusting entry there at the bottom of the slide.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 7 Slide 6 Let’s talk about both of those accounts. Depreciation expense. The name kind of gives it away. It’s classified as an expense account. It’s found on the income statement. And because it’s an expense it reduces our net income. And the depreciation expense, that account, or the balance in that account, represents the amount of the building or equipment that was used up in the current year. The accumulated depreciation account on the other hand, is classified as a contra asset account. That’s because it results in a decrease to our assets. Because it’s a contra asset resulting in a decrease to assets, the normal balance for the account is on the credit side. It’s the opposite of your asset normal balance. And it’s a contra asset. That means it’s found on your balance sheet directly underneath the asset being depreciated. And because it’s found on the balance sheet the balance in this account is theAMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 8 accumulation, hence the name, it’s the accumulation of all depreciation recorded on the asset. So the balance in the accumulated depreciation represents the total amount of the building or equipment that has been used up since it was acquired by the company. Used up here is simply another way of saying depreciated.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 9 Slide 7 Now we already talked about, we’ve seen it a couple of times, the accumulated depreciation, is a contra asset account. And it is a contra asset account because it results in a decrease to assets on the balance sheet. So here’s how it’s going to appear on your balance sheet. Here’s a partial balance sheet, the P, P, and E section. There’s your land, capitalized cost of 200,000. Remember the land doesn’t depreciate, so underneath that will be the building, capitalized cost of 300,000. Right underneath the building would be its accumulated depreciation. So in my little example, $80,000 of the cost of the building has been turned into an expense, has been used up. The equipment, capitalized cost of