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

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, 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, 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, $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