Depreciation

Little Review…

• We looked at taking inventory…to figure out the cost of supplies used.

• We looked at prepaid insurance…to figure out the value of insurance used.

• We looked at unearned revenue…to figure out the value of services we owe.

• Now we are going to look at depreciation…to figure out the updated value of LONG-TERM ASSETS.

What is Depreciation?

• Volkswagen Jetta Trendline+$25,563

What is Depreciation?

• Depreciation is the loss of value over the life of an asset.

• Very few things we buy are worth the same amount we paid at the end of their lives.

• Short term assets are things like pens, pencils, paper, nails, screws, etc. We figured out how to account for these things using adjusting entries.

• Long term assets are popularly called PP&E assets

What is Depreciation?

• Long-term assets help produce revenue for many years.

• The cost of these assets should then be spread over the time that they help make revenue.

• Depreciation is a way of spreading the cost of a long-term asset over its useful, productive life.

Vehicle Depreciation

• Let’s pretend we buy a van for $24,000. After 5 years, we sell the van for $1500.

• Over the 5 years that we have the van, the van cost the business $22,500. (24000-1500)

• We have to think of that $22,500 as an expense at a yearly rate of $4500.

Vehicle Depreciation

Vehicle Depreciation

• Calculating depreciation is important for the matching principle and the time period concept.

• This is fair recording of the revenues and expenses. Things would be inaccurate if the accountant put the entire cost in the first year of its purchase.

Calculating Depreciation

• We never know exactly how long an asset will last.

• We have to ESTIMATE the depreciation while we are using the asset. There are two ways to do this:

• Straight-Line Depreciation and

• Declining-balance method.

Straight-Line Depreciation

• This is the easiest way to do it.

• We divide the cost of the asset EQUALLY over the years the asset is used.

Straight Line Depreciation

• Tip Top Trucking purchased a truck for $78,000 on January 1, 20-2. It estimated that the truck would be used for six years, and at the end of that time, could be sold for $7800. (The $7800 is the salvage value and is an estimated amount.)

• Annual depreciation is $11,700.

Straight Line Depreciation

• Tip Top Trucking purchased $5120 of furniture on January 1, 20-2. The company estimated that the furniture would be used for 10 years, at which time it would have a value of $500.

• Annual depreciation is $462 a year.

Adjusting for Depreciation

• Adjusting entries for depreciation affects the income statement and balance sheet.

Accumulated Depreciation Account

• Now…taking the value of the truck down by $11,700 is accurate and the right thing to do. BUT…if we were to look at the balance sheet for Tip Top Trucking, it would show $66,300 as the value of the truck.

• A better way of doing it is to show changes on the balance sheet.

Accumulated Depreciation Account

• INSTEAD of putting credit entries into the Truck account, we create an account called Accumulated Depreciation – Truck #1--

Accumulated Depreciation Account

• The normal balance for Truck would have a debit balance.

• The Accumulated Depreciation Account – Truck has a credit balance. Together…

Review of Depreciating Adjusting Entries

• 1. They record the depreciation for the period in a depreciation expense account.

• 2. Increases the proper accumulated depreciation amount account for the asset. This reduces the net book value of the asset.

• The basic entry is

Depreciation on the Financial Statements

Depreciation for Less Than a Year

• Sometimes assets do not last a whole year. Or…the fiscal period being reported on is less than a year.

• We have to figure out depreciation for a PART of a year

• Imagine we buy a building on May 1, 2013, for $600,000. The building is expected to be used for 30 years, and it will then be worth $150,000. BUT…we are a large company and prepare quarterly financial statements.

Depreciation for Less Than a Year

• The annual depreciation would be ($600,000 - $150,000)/30 = $15,000.

• We have to figure out what it costs us per month then.

• $15,000/12 = $1250.

• So, the first statement after the building was purchased would be the end of June. Two months had passed, so the depreciation for the period would be $2500.

Other Methods for Calculating Depreciation

• Declining-Balance Depreciation uses a fixed percentage to calculate annual depreciation.

• These percentages are set by the government.

Declining-Balance Depreciation

• We buy computers for $22,000 on January 1, 2015.-$22,000 is the Capital Cost.

• Every year we have the computers, the value is going to drop by 55%.

Declining-Balance Depreciation

• If a business buys an asset halfway through a year, CRA still assumes that the business used it for a year.

• The Half-Year Rule considers this and restricts the amount that an asset can depreciate in the first year. They use 50% as the average. It looks like this.

Exercises

Exercises

Exercises