AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 1 Property-Plant-Equipment: Module 8 Slide 1 Hi everyone. Welcome back. Now that we have seen all three depreciation methods, let’s talk about a situation that often arises when we are calculating depreciation on assets.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 2 Slide 2 Now as a reminder, depreciation is based on estimates. We have to estimate the residual value. And we have to estimate the useful life of the asset. What happens whenever one of those estimates are changed over time? Let’s say new information comes to light a few years into depreciating an asset and this new information results in a revision to one or both of these estimates. How do we handle that? How does that affect the depreciation of the asset?AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 3 Slide 3 Well whenever there’s a change in estimate that happens, whenever a change in estimate is made, first thing to make note of, no changes are made to the prior year’s depreciation. You do not go back in time and change the amounts recorded as depreciation in those previous years. So no change made to any previous year calculations. What we do change would be the depreciation in the year of change to estimate and we incorporate those changes into all future year calculations. So the change in estimate will affect the current year and all future years. It does not affect the calculations made in all previous years. In order to determine the new depreciation expense once there’s been a change in estimate, and we incorporate that change into the current and future years, to calculate the new depreciation expense, what you do is you depreciate the remaining book value. And we know we’ve seen it enoughAMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 4 times now, the book value is the cost minus the accumulated depreciation. So we will depreciate the remaining book value of the asset as of the date of change and we depreciate that based on the number of years that are remaining in the useful life. So we’ll depreciate the remaining book value based on the number of years left in the life to depreciate. Let’s see if we can get a little bit of practice on that.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 5 Slide 4 Take a look at example number four from our website problems. And here’s what it says. On January 1st of 1992, Betty DeRose, Inc. purchased a piece of equipment that cost $80,000. The equipment was assigned a $5,000 residual value, a 10-year life, and was being depreciated using the straight-line method. On January 1st of 1998, Betty DeRose decided the life of the equipment needed to be revised from 10 years to 14 years. Calculate the depreciation reported on the equipment for 1998, the year of change. All right, we remember that we have to depreciate the remaining book value based on the number of years left in the life. In order to get the remaining book value as of the date of change, we have to figure out how much depreciation had been recorded in the previous years. So the depreciation for years leading up to the date of change, that would be 1992 through 1997, well the asset had an $80,000 cost, a $5,000 residual, and a 10-year life. So we were depreciating a $7,500 per year. In the years 1992 through 1997,AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 6 count on your fingers so we don’t make any mistakes—92, 93, 94, 95, 96, 97. That’s six years. Six years were depreciated at 7,500 per year, so as of the date of change to our estimated life, the total depreciation recorded was $45,000, which means the book value of the equipment at January 1st of 1998—the date we had a change in estimate—was 35,000. Eighty thousand dollar cost minus the 45,000 of accumulated depreciation.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 7 Slide 5 And then in 1998 we had a change in life. We changed the life from 10 years to 14 years. And the rule is to depreciate the remaining book value, which we just calculated on the previous slide to be 35,000. So we’ll take the remaining book value of 35,000 minus of course the residual value, this is the straight-line depreciation. So we’ll subtract the 5,000 residual and we divide that by the number of years left in the life. Now the life was changed to 14, but we have already depreciated six of those years. Six years have already been depreciated up to the point of change. So the number of years that are left in the life amount to eight. So we’ll take the new book value minus the residual divided by the eight remaining years. And the depreciation expense for 1998, 3,750. And in fact, because this is straight-line, the depreciation will be 3,750 every year for the remaining eight years of the asset’s life.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 8 That’s how to incorporate a change in estimate into the depreciation calculation.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 9 Slide 6 Another type of change in estimate deals with an expenditure that happens in the middle of the asset’s life. Now we’ve already talked a little bit about these types of expenditures. Any expenditure that occurs once the asset is in use is classified as either a capital expenditure or a revenue expenditure. And as a refresher, we’ve again already seen this; a capital expenditure is classified as such if the expenditure substantially adds value to the asset. Typically that means the asset’s life has increased. For a capital expenditure because it adds value to the life of the or to the asset, that cost should be capitalized, meaning it becomes part of the cost of the asset reported on the balance sheet. A revenue expenditure on the other hand, is a cost that’s incurred simply to maintain the asset in its current condition. All revenue expenditures and they’re fairly easy to pick out; revenue expenditures do not increase the life of the asset. Those things are not capitalized. They are expensed. That meansAMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 10 they are recorded on the income statement as an expense rather than on the balance