Depreciation

Long Term Assets

So far, we looked at adjustments for supplies, prepaid expenses such as insurance, late invoices and unearned revenue

Today, we look at adjustments for long term assets, referred to as depreciation

Can also be called long-lived assets, capital assets, Property, Plant and Equipment (PPE)

Depreciation

Process of allocating the cost of a long-term asset over its useful life, productive life

Process of cost allocation, not asset valuation

Applies to land improvements, buildings and equipment, not

land

These assets are income-producing. Therefore, the cost of

purchasing these long term assets should be spread out over

the length of time that they help to earn revenue.

It too has a balance sheet and income statement account for

adjustment

Aligns with the matching principle and time-period concept REMEMBERLand does not depreciate

because it does not wear out

Factors in Computing Depreciation

Cost Useful Life Salvage Value

Depreciation Methods

Management selects the method it believes best measures an asset’s contribution to revenue over its useful life

Straight-line method

Declining-balance method

Straight-Line Depreciation

Divides the net cost of the asset equally over the years of the asset’s life

Formula for Straight-line depreciation for one year:

Original cost – Estimated salvage

value________________________________________

Estimated Useful LifeREMEMBER

The denominator –estimated useful life may be different from the asset’s total useful

life for a business.

Example

Mama’s Pizza purchased a small delivery truck on January 1, 2012

Cost $13,000

Expected salvage value $1,000

Estimated useful life (in years) 5

Required Compute depreciation using Straight-Line Depreciation Method

Using Straight Line Method

What does the $2,400 mean?

Over the length of the truck’s estimated useful life, this is the amount of the truck’s cost that will be allocated to each fiscal year. The amount can also be regarded at the expense of using the truck for one year.

Original cost – Estimated salvage value

_________________________________________

Estimated Useful Life

$13,000 – 1,000

_______________ 5 years

= $2,400 depreciation

Expense per year

Adjusting Entry for Depreciation

The adjusting entry will do two things:

1. Reduces the value of the truck by $2,400 every year (Balance sheet side)*

2. Sets up the Depreciation Expense account for the same amount (Income sheet side)*

ADJUSTING ENTRY

Depreciation Expense………………………2,400

Accumulated Depreciation -Truck………………..2,400

* RULE OF THUMBAdjusting results in

debiting (increase) an expense account and a credit(decrease) to an

asset

CONTRA ASSET ACCOUNT

Depreciation Schedule - Straight Line Method for Mama’s Pizza

Year Book Value Year Start

Depreciation Expense

Accumulated Depreciation

Balance

Book Value Year End

2012 $13,000 $2,400 $2,400 $10,600

2013 10,600 2,400 4,800 8,200

2014 8,200 2,400 7,200 5,800

2015 5,800 2,400 9,600 3,400

2016 3,400 2,400 12,000 1,000

Reviewing

Y1 Y2 Y3 Y4 Revenue 90,000 92,000 84,000 87,000 Expenses 22,000 19,000 24,000 25,000 (Depr.-Truck) 7000 7000 7000 7000 Total Expenses 29000 26000 31000 32000 Net Income 61,000 66,000 53,000 55,000

Declining-Balance Method

Calculates the annual depreciation by multiplying the undepreciated cost of asset by a fixed percentage

Does not spread the cost of the asset evenly over its life like the straight-line method

These fixed % rates are set by the Canada Revenue Agency

Depreciation is referred to as Capital Cost Allowance(CCA)

Same adjusting entry as Straight-Line method

CCA Rates %List of CCA Rates and Classes

CLASS PROPERTY RATE

1 Buildings acquired after 1987

4%

3 Buildings acquired before 1988

5%

8 Office Furniture and equipment

20%

10 Automobiles and other Motor Vehicles

30%

12 Computer Software 100%

45 Data equipment and systems software

30%

50 Computer Equipment 55%For More Information on the CRA Class Rates, check out: http://www.cra-arc.gc.ca/tx/bsnss/tpcs/slprtnr/rprtng/cptl/dprcbl-eng.html

Back to our Example

Cost of Equipment $13,000

Expected salvage value $1,000

Estimated useful life (in years) 5

REQUIRED NOW compute depreciation using the Declining-Balance Method

Depreciation Schedule – Double-Declining Method

Year Book Value Year Start

CCA Rate Depreciation Expense

Accumulated Depreciation

Balance

Book Value Year End

2012 $13,000 30% 3,900 $3,900 $9,100

2013 9,100 30% 2,730 6,630 6,370

2014 6,370 30% 1,911 8,541 4,459

2015 4,459 30% 1,337.70 9,878.70 3,121.30

2016 3,121.30 30% 936.39 10,815 2,184.91

2017 2,184.91 30% 655.473 11,470 1,529

2018 1,529 30% 458.7 11,928 1,070

Comparing the Methods

Year Book Value Year Start

Depreciation Expense

Accumulated Depreciation

Book Value Year End

2012 $13,000 $2,400 $2,400 $10,600

2013 10,600 2,400 4,800 8,200

2014 8,200 2,400 7,200 5,800

2015 5,800 2,400 9,600 3,400

2016 3,400 2,400 12,000 1,000

TOTAL $12,000

Straight-Line

Declining-BalanceYear Book

Value Year Start

CCA Rate

Depreciation

Expense

Accumulated

Depreciation

Balance

Book Value

Year End

2012 $13,000

30% 3,900 $3,900 $9,100

2013 9,100 30% 2,730 6,630 6,370

2014 6,370 30% 1,911 8,541 4,459

2015 4,459 30% 1,337.70

9,878.70

3,121.30

2016 3,121.30

30% 936.39 10,815 2,184.91

2017 2,184.91

30% 655.473

11,470 1,529

2018 1,529 30% 458.7 11,928 1,070

Balance Sheet Presentation of DepreciationNotice that it is shown as cost of asset less accumulated depreciation = Net Book Value

Net Book Value