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 REMEMBER Land does not depreciate because it does not wear out

Factors in Computing Depreciation CostUseful LifeSalvage Value

Depreciation Methods Management selects the method it believes best measures an asset’s contribution to revenue over its useful life Straight-line methodDeclining-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 Life REMEMBER 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 THUMB Adjusting 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 YearBook Value Year Start Depreciation Expense Accumulated Depreciation Balance Book Value Year End 2012$13,000$2,400 $10, ,6002,4004,8008, ,2002,4007,2005, ,8002,4009,6003, ,4002,40012,0001,000

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) Total Expenses 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 CLASSPROPERTYRATE 1Buildings acquired after 19874% 3Buildings acquired before % 8Office Furniture and equipment 20% 10Automobiles and other Motor Vehicles 30% 12Computer Software100% 45Data equipment and systems software 30% 50Computer Equipment55% For More Information on the CRA Class Rates, check out: 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 YearBook Value Year Start CCA RateDepreciation Expense Accumulated Depreciation Balance Book Value Year End 2012$13,00030%3,900$3,900$9, ,10030%2,7306,6306, ,37030%1,9118,5414, ,45930%1, , , , % ,8152, , % ,4701, ,52930% ,9281,070

Comparing the Methods YearBook Value Year Start Depreciation Expense Accumulated Depreciation Book Value Year End 2012$13,000$2,400 $10, ,6002,4004,8008, ,2002,4007,2005, ,8002,4009,6003, ,4002,40012,0001,000 TOTAL$12,000 Straight-LineDeclining-Balance YearBook Value Year Start CCA Rate Depreci ation Expense Accumul ated Depreci ation Balance Book Value Year End 2012$13,00030%3,900$3,900$9, ,10030%2,7306,6306, ,37030%1,9118,5414, ,45930%1, , , , % ,8152, , % ,4701, ,52930% ,9281,070

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