ACCT 240 004 11 1 Notes Chapter 8 Depreciation Reporting and Interpreting Property Plant and Equipment Natural Resources and Intangibles Insufficient capacity of assets results in lost sales Costly excess capacity reduces profits Classifying Long Lived Assets Actively used in operations Expected to benefit future periods Tangible Physical Substance Intangibles No physical Substance Fixed asset Turnover Rate Net sales revenue Average net fixed assets Net fixed assets Original cost of inventory depreciation Measuring and recording acquisition cost Acquisitions cost includes the purchase price and al expenditures needed to prepare the asset for its intended use This does not include financing charges and cash discounts Buildings Purchase price Renovation and repair costs Legal and realty fees Title fees Capitalized Costs Equipment Purchase price Installation costs Modification to building needed to install equipment Transportation Costs Land Purchase price Real estate commissions Title insurance premiums Delinquent taxes surveying fees Title search and transfer fees Does not depreciate Measuring and recording acquisition costs Acquisition for cash Flight Equipment 75 mil Cash 75 mil Flight Equipment 75 Cash 1 Notes payable 74 Acquisition by construction Asset cost includes All materials and labor traceable to the construction A reasonable amount of overhead Interest on debt related to construction Ordinary repairs and maintnence revenue 1 Maintains normal operating condition 2 Does not increase productivity 3 Does not extend life beyond original estimate 4 Recurring in nature and involve mall amounts of money at each occurrence Additions and improvements capital 1 Major overhaels or partial replacements 2 Usually occur infrequently 3 Increase efficiency 4 may extend life 5 involve larger amounts of money Depreciation Concepts Depreciation is a cost allocation process that systematically and rationally matches acquisition costs of operational assets with periods benefited by their use Deporeciation Concepts The calculation of depreciation requires three amounts for wach asset 1 Acquisition cost 2 Estimated useful life 3 Estimated residual value Alternative depreciation methods Straight Line method Depreciation expense per year Cost Residual Value Useful life in years Units of production Method Step 1 Depreciation rate Cost Residual Value Life in units of production Step 2 Depreciation Expense Depreciation Rate x Number of Units Produced for the year M8 6 Computing Book Value Units of Production Depreciation LO3 Calculate the book value of a three year old machine that has a cost of 21 000 has an estimated residual value of 1 000 and an estimated useful life of 40 000 machine hours The company uses units of production depreciation and ran the machine 3 200 hours in year 1 7 050 hours in year 2 and 7 500 hours in year 3 21k 20k 20k 40k hours 5 Machine Hour Year one 3200 hours 1600 dep expense net value 19 4 Year two 7050 hours 3525 dep expense net value 15 875 Year three 7500 3750 dep expense net value 12 125 Double Declining Balance Method Accelerated Depreciation Accelerated depreciation matches higher depreciation expense with higher revenues in the early years of the assets useful life when the asset is more efficient Annual Depreciation Expense Net book value x 2 Useful life in year Year 1 Depreciation For 3 year livig 62 500 2500 thing 62 5 x 2 3 years 41 667 Year 2 62 5 41 667 x 2 3 years 6944 In final year of life you need to make the undepreciated book value the residual value and the final year s deprecation is simply the difference between last year s value and that M8 5 Depreciation y1 45 000 x 2 4 22 5 Dep y2 22 5 x 2 4 11 25 Dep y3 5 625 Dep y4 625