Chapter 6 Long Term Assets

Depreciation Expense The portion of the cost of a long-lived asset recorded as an expense in an accounting period. Depreciation in accounting is the spreading of the cost of a long-lived asset over its estimated useful life to the entity. It is an application of the matching rule.

Accumulated Depreciation Contra asset account. The balance in this account is the accumulated total of all the depreciation expense recognized to date on the related assets.

Other terminology To CAPITALIZE an expenditure means to record the expenditure as an asset. A long- lived asset that has been capitalized will be depreciated. To EXPENSE an expenditure means to record the expenditure as an expense. The difference between an asset’s cost and its accumulated depreciation is its net book value.

Recognition of depreciation does not affect cash. Net book value of an asset is not intended to reflect its value.

Example Asset purchased 1/1/98 for $22,000. Estimated life is 5 years. Estimated salvage value is $2,000. Machine will produce 200 units over useful life.

Straight Line Depreciation Cost - Salvage Value = Annual Estimated useful life Depreciation 22, ,000 = $4,000 5 years

Units of Production Cost - Salvage Value X #units produced Est. Total unitsthis period 22, ,000 X 36 units this period 200 units = $3,600 depreciation expense

Sum of the years’ digits (Cost - Salvage Value) X Remain. Life, Beg SOYD SOYD = n(n+1)/2 = 5*6/2 = 15 (22, ,000) * 5/15 = $6,667, Dep in yr 1 (22, ,000) * 4/15 = $5,333, Dep in yr 2

Declining Balance Deprec. (Cost - Acc. Dep) * 2 / Useful life OR Double straight line rate * NBV at Beg of Yr. (22, ) * 2/5 = 8,800, dep in yr 1 (22,000-8,800)*2/5 = 5,280, dep in yr 2.4 * 22,000 = 8,800, dep in yr 1.4 * (22,000-8,800), dep in yr 2

Present Value Money has value over time Amount to be received or paid in the future has a value today (present value) that is less than future value. Why? Because interest can be earned between the present and future.

Example Your boss says he’ll pay you a $4,000 bonus at the end of four years. What’s the present value (assume a discount rate of 8%). $4,000 *.7350 = $2,940 If you deposit $2,940 today at 8%, in 4 years you’ll have $4,000.

Capital leases vs. operating leases Capital lease is like a purchase of an asset Operating lease is like a rental agreement

Capital leases Long-term lease: a way of financing the acquisition of long-lived assets. The effect of the accounting for a leased asset should not be different from the accounting for a purchased asset

Capital Leases ‘Cost” of a leased asset is the present value of the lease obligations Depreciation expense is recorded based on this cost As annual lease payments are made, interest expense is recognized and the lease obligation is reduced.

Capital Lease Example 5 year lease. Annual lease payments are $20,000. (Assume discount rate of 8%). PV of lease payments is $79,854 Leased Asset79,854 Lease Liability79,854

Capital Lease Example (cont) To record first lease payment Interest Expense* 6,388 Lease Liability13,612 Cash20,000 *79,854 *.08 = 6,388

Capital Lease example (cont) To record Second lease payment Interest Expense* 5,299 Lease Liability14,701 Cash20,000 *(79, ,612) X.08 = 5,299

Terminology Fixed Assets: Depreciation Intangible Assets: Amortization Natural Resources: Depletion