Sec. 8.4 – Adjusting for Depreciation

 Long-term assets must be adjusted for depreciation  This adjustment is similar to the others we learned in the previous section and it has both a balance sheet and income statement component

Long-term assets  Historically called “fixed assets”, long-term assets can be called; long-lived assets, capital assets, plant and equipment, and property, plant, and equipment (PP&E).  Depreciation is a means of allocating the cost of a long-term asset over its useful, productive life.  Depreciation meets the requirements of the matching principle and the time period concept  Net income is reported fairly

Straight-Line Depreciation  The simplest way, it divides the net cost of the asset equally over the years of the asset’s life  The estimated salvage value is subtracted from the original cost and divided by the estimated number of period in the life of the asset

Adjusting for Depreciation  The adjusting entry for depreciation affects the income statement and blance sheet, just like the other adjusting entries you have learned. (see page 303, bottom of page)  Without the depreciation expense, net income would be overstated

Accumulated Depreciation Account  To provide the data on our balance sheet for depreciation, a business would need to created an account called Accumulated Depreciation  Therefore, the asset account is not credited, Accumulated Depreciation account would be credited  The accumulated depreciation account is known as a valuation account or a contra account  It is a permanent account, it is not closed at the end of the year  As time goes on, the contra account will increase in value

Depreciation on the Financial Statements  Would not show up on the regular trial balance and must be added near the bottom of the Accounts column  Would show up on the Worksheet  Depreciation would come after items such as Supplies Expense and Insurance Expense (see p. 306)  Shows up on both the Income Statement and the Balance Sheet

Depreciation for Part Year  Depreciation may be calculated on a monthly basis

Declining-Balance Depreciation  Calculates the annual depreciation by multiplying the undepreciated cost of the asset by a fixed percentage. Canada Revenue Agency set these rates (see p. 308)  The declining-balance method typically produces depreciation figures that are larger in the early years and smaller in the later years. The estimated final salvage value of the asset is ignored when using this method  Higher expenses mean lower net income figures, which mean lower taxes—at least in the early years  This helps ease the financial burden of buying assets for a business

Half-Year Rule  Relates to the first year in which a long-term asset is purchased  CRA is unconcerned about the number of months the asset was owned  CRA allows only 50% of an asset’s cost to be eligible for depreciation in its first year of use.  The half-year rule affects the calculation of depreciation expense in the early years of an asset’s life, but the impact evens out with time  When compared to the declining balance method, after five years, the totals are very similar