©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones7 - 1 Chapter 7 Long-Lived Depreciable Assets – A Closer Look

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones7 - 2 Learning Objective 1 Explain the process of depreciating long-lived assets.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones7 - 3 Depreciation AccountingPeriod

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones7 - 4 Effect of Estimates on Depreciation Depreciable Annual Options BaseExpense Residual value: $4,000, Useful life: 4 years$16,000$4,000 Residual value: $4,000, Useful life: 5 years$16,000$3,200 Residual value: $3,000, Useful life: 4 years$17,000$4,250 Residual value: $3,000, Useful life: 5 years$17,000$3,400

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones7 - 5 Learning Objective 2 Determine depreciation expense using the straight-line and the double-declining-balance depreciation methods.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones7 - 6 The Effects of Different Depreciation Methods Amount of Depreciation Straight-line depreciation Accelerated depreciation

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones7 - 7 Depreciation Methods Used by 600 Companies, Year % Straight-line 4% Other

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones7 - 8 Straight-Line Depreciation Barlow Paving Corporation purchased a machine on January 2, 2002, for a total cost of $300,000. Cost includes: Invoice price Applicable taxes Installation costs Insurance in transit Shipping costs Personnel training costs Cost does not include: Repairs Maintenance MaintenanceInsurance (once the asset becomes productive)

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones7 - 9 Straight-Line Depreciation Data Amount Cost of machine$300,000 Less: Estimated residual value– 25,000 Depreciable base$275,000 Estimated useful life 5 years (Cost – Residual value) ÷ Estimated useful life ($300,000 – $25,000) ÷ 5 = $55,000 per year

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Barlow’ s Financial Statements Using Straight-Line Depreciation Income Statements Sales$755,000$755,000$755,000 Cost of goods sold 422, , ,000 Gross margin$333,000$333,000$333,000 Operating expenses other than depreciation–236,000–236,000–236,000 Depreciation expense– 55,000– 55,000– 55,000 Net income$ 42,000$ 42,000$ 42,000

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Barlow’ s Financial Statements Using Straight-Line Depreciation Balance Sheets Balance Sheets Assets: Cash$ 50,000$ 96,000$157,000 Accounts receivable 206, , ,000 Inventory 77,000 77,000 77,000 Machine 300, , ,000 Accumulated depreciation– 55,000–110,000–165,000 Total assets$578,000$620,000$662,000

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Barlow’ s Financial Statements Using Straight-Line Depreciation Balance Sheets Balance Sheets Liabilities and stockholders’ equity: stockholders’ equity: Accounts payable$206,000$206,000$206,000 Notes payable 170, , ,000 Common stock 100, , ,000 Paid-in capital 10,000 10,000 10,000 Retained earnings 92, , ,000 Total liabilities and stockholders’ equity$578,000$620,000$662,000 stockholders’ equity$578,000$620,000$662,000

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Barlow’ s Financial Statements Using Straight-Line Depreciation Partial Balance Sheet December 31, 2004 Plant assets: Machine$300,000 Less: Accumulated depreciation 165,000 $135,000 Book value

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Double-Declining-Balance Depreciation Straight-line rate per year: 100% ÷ 5 = 20% Book value of machine at the end of the first year: $300,000 × 40% = $120,000 $300,000 – $120,000 = $180,000 Double-declining balance: 2 times the straight-line rate = 40%

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Barlow’s Financial Statements Using Double-Declining Balance Income Statements Sales$755,000$755,000$755,000 Cost of goods sold 422, , ,000 Gross margin$333,000$333,000$333,000 Operating expenses other than depreciation–236,000–236,000–236,000 Depreciation expense–120,000– 72,000– 43,200 Net income$ 23,000$ 25,000$ 53,800

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Barlow’s Financial Statements Using Double-Declining Balance Balance Sheets Balance Sheets Assets: Cash$ 50,000$ 96,000$157,000 Accounts receivable 206, , ,000 Inventory 77,000 77,000 77,000 Machine 300, , ,000 Accumulated depreciation–120,000–192,000–235,200 Total assets$513,000$538,000$591,800

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Barlow’s Financial Statements Using Double-Declining Balance Balance Sheets Balance Sheets Liabilities and stockholders’ equity: stockholders’ equity: Accounts payable$206,000$206,000$206,000 Notes payable 170, , ,000 Common stock 100, , ,000 Paid-in capital 10,000 10,000 10,000 Retained earnings 27,000 52, ,800 Total liabilities and stockholders’ equity$513,000$538,000$591,800 stockholders’ equity$513,000$538,000$591,800

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Learning Objective 3 Describe how the use of different depreciation methods affects the income statement and the balance sheet.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Straight-Line versus Double-Declining-Balance DepreciationNet Book DepreciationNet Book Year Expense Income Value 2002$ 55,000$ 42,000$245, $ 55,000$ 42,000$190, $ 55,000$ 42,000$135, $ 55,000$ 42,000$ 80, $ 55,000$ 42,000$ 25,000 Total$275,000$210,000 Straight-Line

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Straight-Line versus Double-Declining-Balance DepreciationNet Book DepreciationNet Book Year Expense Income Value 2002$120,000$–23,000$180, $ 72,000$ 25,000$108, $ 43,200$ 53,800$ 64, $ 25,920$ 71,080$ 38, $ 13,880$ 83,120$ 25,000 Total$275,000$210,000 Double-Declining-Balance

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Learning Objective 4 Compare and contrast gains and losses with revenues and expenses.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Disposal of Depreciable Assets Disposing of depreciable assets is usually not associated with the company’s ongoing major or central activity. This type of transaction is most often incidental or peripheral to the day-to-day operation of the business.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Gains and Losses Gains are increases in equity from peripheral or incidental transactions of an entity except those that result from revenues or investments by owners. Losses are decreases in equity from peripheral or incidental transactions of an entity except those that result from expenses or distributions to owners.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Learning Objective 5 Calculate gains and losses on the disposal of depreciable assets.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Gain on Disposal: Example Barlow sells the machine, which cost $300,000, on January 7, 2002, for $32,000. The book value of the machine is $25,000. What is the gain?

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Loss on Disposal: Example Assume that Barlow sells the machine for $19,000 on January 2, What is the loss?

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Barlow Paving Corporation Income Statements Sales$755,000$941,000 Cost of goods sold 422, ,000 Gross margin$333,000$416,000 Operating expenses other than depreciation–236,000–319,000 other than depreciation–236,000–319,000 Depreciation expense– 55,000 0 Operating income$ 42,000$ 97,000 Loss on sale of machine 0 – 6,000 Net Income$ 42,000$ 91,000

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Barlow Paving Corporation Income Statements Assets: Cash$289,000$212,000 Accounts receivable 355, ,000 Inventory 77, ,000 Machine 300,000 0 Less: Accumulated depreciation–275,000 0 Total assets$746,000$697,000

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Barlow Paving Corporation Income Statements Liabilities and stockholders’ equity: stockholders’ equity: Accounts payable$206,000$216,000 Notes payable 170,000 20,000 Common stock 100, ,000 Paid-in capital 10,000 1,0000 Retained earnings 260, ,000 Total liabilities and stockholders’ equity$746,000$697,000 stockholders’ equity$746,000$697,000

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Learning Objective 6 Describe the true meaning of gains and losses on the disposal of depreciable assets.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Understanding the True Meaning of Gains and Losses 1. Straight-Line Movers and Accelerated Movers have identical business activities. 2. On January 2, 2002, each company purchased a fleet of trucks for $228, Estimated useful life is 4 years. 4. Estimated residual value is $92,000.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Straight-Line and Accelerated Movers Financial Statements Income Statements For the Year Ending December 31, 2002 Sales$769,000$769,000 Cost of goods sold 295, ,500 Gross margin$473,500$473,500 Wages expense 67,500 67,500 Utilities expense 31,000 31,000 Depreciation expense 34, ,000 Operating income$341,000$261,000 Other revenues and expenses: Interest expense 120, ,000 Net income$221,000$141,000 Straight-Line Accelerated

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Assets: Cash$226,000$226,000 Accounts receivable 198, ,000 Inventory 223, ,000 Trucks, net of depreciation 194, ,000 2 Total assets$841,000$761,000 1 $228,000 – $34,000 2 $228,000 – $114,000 Straight-Line and Accelerated Movers Financial Statements Straight-LineAccelerated Balance Sheets December 31, 2002

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Liabilities: Accounts payable$ 22,000$ 22,000 Notes payable 61,000 61,000 Total liabilities$ 83,000$ 83,000 Shareholders’ equity: Common stock$200,000$200,000 Paid-in capital 194, ,000 Retained earnings 364, ,000 Total shareholders’ equity$758,000$678,000 Total liabilities and shareholders’ equity$841,000$761,000 shareholders’ equity$841,000$761,000 Straight-Line and Accelerated Movers Financial Statements Straight-LineAccelerated

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Straight-Line and Accelerated Movers Financial Statements Income Statements For the Year Ending December 31, 2003 Sales$769,000$769,000 Cost of goods sold 295, ,500 Gross margin$473,500$473,500 Wages expense 67,500 67,500 Utilities expense 31,000 31,000 Depreciation expense 34,000 22,000 Operating income$341,000$353,000 Other revenues and expenses: Interest expense 120, ,000 Net income$221,000$233,000 Straight-Line Accelerated

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Assets: Cash$ 426,000$426,000 Accounts receivable 253, ,000 Inventory 223, ,000 Trucks, net of depreciation 160, ,000 2 Total assets$1,062,000$994,000 1 $228,000 – $68,000 2 $228,000 – $136,000 Straight-Line and Accelerated Movers Financial Statements Straight-LineAccelerated Balance Sheets December 31, 2003

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Liabilities: Accounts payable$ 22,000$ 22,000 Notes payable 61,000 61,000 Total liabilities$ 83,000$ 83,000 Shareholders’ equity: Common stock$ 200,000$200,000 Paid-in capital 194, ,000 Retained earnings 585, ,000 Total shareholders’ equity$ 979,000$911,000 Total liabilities and shareholders’ equity$1,062,000$994,000 shareholders’ equity$1,062,000$994,000 Straight-Line and Accelerated Movers Financial Statements Straight-LineAccelerated

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Sale of Trucks: Example On December 31, 2003, the companies sold the trucks for $150,000. Straight-Line incurred a loss. $160,000 – $150,000 = $10,000 loss Accelerated had a gain. $150,000 – $92,000 = $58,000 gain

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Other Depreciation Methods Units of Production (or Activity) Method ($125,000 – $25,000) ÷ 400,000 = $.25/mile On January 2, 2003, Rodriguez Trucking purchased a truck for $125,000. Estimated residual value is $25,000. It is estimated that the truck would be used for 400,000 miles.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Other Depreciation Methods Under the Modified Accelerated Cost Recovery System (MACRS), companies must use IRS mandated service lives regardless of how long the company feels its assets will last.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Learning Objective 7 Prepare journal entries associated with long-lived depreciable assets.

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Journal Entries On January 2, 2002, Barlow Corporation purchased a paving machine for $300,000 cash Jan 2 Machine300,000 Cash300,000 On December 31, 2002, Barlow Corporation records straight-line depreciation for $55, Dec 31 Depreciation Expense 55,000 Accumulated Depreciation 55,000

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones Journal Entries On January 2, 2007, Barlow Corporation sold its paving machine for $32,000 cash resulting in a gain of $7, Jan 2 Cash 32,000 Accumulated Depreciation275,000 Machine300,000 Gain on Disposal of Assets 7,000

©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones End of Chapter 7