Accounting Practices 501 Chapter 9 Introduction to Depreciation Cathy Saenger, Senior Lecturer, Eastern Institute of Technology © Pearson 2011

Ch9A - Intro to Depreciation Definition of Depreciation The systematic allocation of the depreciable amount of an asset over its useful life Ch9A - Intro to Depreciation

How do we depreciate an asset? Identify the cost of the asset Determine the useful life of the asset Estimate a residual value Choose a method of depreciation allocation (we will use the following two methods) Straight-line method (SL) Diminishing value method (DV) Ch9A - Intro to Depreciation

Straight-line method (SL) The depreciable cost of the asset is spread evenly over its useful life $50,000 5 Accounting Periods $10,000 $10,000 $10,000 $10,000 $10,000 Ch9A - Intro to Depreciation

Straight-line method (SL) The Formula : Depreciation expense = Cost price – Residual value Estimated useful life Cost price includes all costs to get the fixed asset operational (Purchase price, insurance in transit, freight, modification costs, initial registration, installation costs, etc) Residual value is the expected value at the end of its estimated useful lifetime Ch9A - Intro to Depreciation

Diminishing Value method (DV) Assets are more efficient at the start of their lives and then taper off The costs to keep it operational will increase each year Depreciation charges are therefore higher in the earlier years Ch9A - Intro to Depreciation

Diminishing Value method (DV) The Formula : Depreciation expense = Book value x rate(%) Book value = Cost Price – Accumulated Depreciation Cost price includes all costs to get the fixed asset operational (Purchase price, insurance in transit, freight, modification costs, initial registration, installation costs, etc) Let’s look at an example of recording depreciation Ch9A - Intro to Depreciation

Ch9A - Intro to Depreciation General Journal Date Account Titles Ref no Debit Credit 1/4/X2 Vehicle at cost 16,000 GST Paid 2,400 Bank 18,400 Being entry required to record purchases of vehicle On 1 April 20X2: Purchased a vehicle for $18,400 cash General Ledger Date Details Ref no Dr Cr Balance Vehicle at cost 1/4/X2 Bank GJ1 16,000 16,000 Dr Ch9A - Intro to Depreciation

Ch9A - Intro to Depreciation General Ledger Date Details Ref no Dr Cr Balance Vehicle at cost 1/4/X2 Bank GJ1 16,000 16,000 Dr On 31 March 20X3: Depreciate the vehicle using the Straight-line method, estimated residual value $1,000 and estimated useful life is 5 years Depreciation expense (SL) = (16,000 – 1,000) / 5 years = $3,000 Let’s look at the General Journal entry for the depreciation amount Ch9A - Intro to Depreciation

Ch9A - Intro to Depreciation General Ledger Date Details Ref no Dr Cr Balance Vehicle at cost 1/4/X2 Bank GJ1 16,000 16,000 Dr On 31 March 20X3: Depreciate the vehicle using the Straight-line method, estimated residual value $1,000 and estimated useful life is 5 years Depreciation expense (SL) = (16,000 – 1,000) / 5 years = $3,000 General Journal Date Account Titles Ref no Debit Credit 31/3/X3 Depreciation expense 3,000 Accumulated depreciation (Vehicle) 3,000 Being entry required to record depreciation on vehicle on SL basis Ch9A - Intro to Depreciation

Ch9A - Intro to Depreciation General Ledger Date Details Ref no Dr Cr Balance Vehicle at cost 6/8/X2 Bank GJ1 16,000 16,000 Dr On 31 March 20X3: Depreciate the vehicle using the Straight-line method, estimated residual value $1,000 and estimated useful life is 5 years Depreciation exp (SL) = (16,000 – 1,000)/5 years x 8 mnths Depreciation exp (SL) = 3,000 x 8 /12 Depreciation exp (SL) = $2,000 What happens if the vehicle was purchased on 6 August 20X2? Ch9A - Intro to Depreciation