Intermediate
Accounting 2
DEPRECIATION
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Depreciation – is defined as the systematic allocation of the depreciable amount of an asset over the useful life. It is a matter of cost
allocation in recognition of the exhaustion of the useful life of an item of PPE.
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Depreciation of an asset begins when it is available for use, meaning when the asset is in the location and condition necessary for it to be
capable of operating in the manner intended by management. Depreciation ceases when the asset is derecognized.
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Kinds of depreciation:
a. Physical depreciation – is related to depreciable asset’s wear and tear and deterioration over a period.
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b. Functional or economic depreciation – arises from inadequacy, supersession and obsolescence.
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Factors of depreciation:
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a. Depreciable amount – or depreciable cost is the cost of an asset or other amount substituted for cost, less the residual value.
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b. Residual value – is the estimated net amount currently obtainable if the asset is at the end of the useful life.
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c. Useful life – either the period over which an asset is expected to be available for use by the entity, or the number of production or similar
units expected to be obtained from the asset by the entity. Accordingly, the useful life of the asset is expressed as:
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a. Time periods as in years
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b. Units of output or production
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c. Service hours or working hours
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Service life is the period of time an asset shall be used by an entity. The service life is equivalent to useful life. Physical life refers to how
the asset shall last
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Depreciation method
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The depreciation method shall reflect the pattern in
which the future economic benefits from the asset are
expected to be consumed by the entity. The method
shall be changed if there is a significant change in the
expected pattern of future economic benefits and shall
be accounted for as change in accounting estimate.
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Methods of depreciation
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1. Straight line method – under this method, the annual
depreciation charge is calculated by allocating the
depreciable amount equally over the number of years of
estimated useful life.
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Formula: Annual depreciation = Cost - residual
value
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Useful life in years
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Cost minus residual value equals depreciable amount.
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Depreciable amount multiplied by the straight line
rate of depreciation also gives the amount of actual
depreciation, The straight line rate is determined by
dividing 100% by the life of the asset in years.
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Illustration: The following data relate to an equipment
acquired at the beginning of the first year:
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Equipment
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Residual value
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Useful life
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Required: How much should be the depreciation and
carrying amount of the equipment for the first year?
Journal entry?
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Depreciation = (105,000 – 5,000) / 5 years = 20,000
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Carrying amount = 105,000 – 20,000 = 85,000
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Note: At the end of useful of the asset, the carrying
amount should be equal the residual value. Adjusting
entry for depreciation is prepared at the end of every
accounting period.
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Journal entry:
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Depreciation
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Accumulated depreciation
105,000
5,000
5 years
20,000
20,000
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Composite and group method
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Illustration - Composite method
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Under the composite method, assets that are dissimilar in
nature or assets that have different physical characteristics and
vary widely in useful life, are grouped and treated as a single
unit.
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Shown below are items of PPE under a composite group
indicating the necessary computation in determining the
composite life and composite rate:
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Under the group method, all assets that are similar in nature
and in estimated useful life are grouped and treated as a single
unit.
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In other words, the average useful life and the composite or
group rate are computed, and the assets in the group are
depreciated on that basis.
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Accounting procedures
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a. Depreciation is reported in a single accumulated depreciation
account.
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Depreciable Useful life
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Asset
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Building
650,000
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Machinery 220,000
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Equipment 130,000
100,000
1,000,000
900,000
cost
amount
Annual
in years
Depreciation
600,000
15
40,000
200,000
8
25,000
4
25,000
90,000
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Total residual value is P100,000.
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Note: The composite life is determined by dividing the total
depreciable amount by total annual depreciation.
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Thus, P900,000 divided by P90,000 equals ten years. The
composite rate is determined by dividing the total annual
depreciation by the total cost. Thus, P90,000 divided by
P1,000,000 equals 9% composite rate.
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b. The composite or group rate is multiplied by the total
cost of the assets in the group to get the periodic
depreciation.
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Annual depreciation for the current year would be:
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Depreciation
c. When an asset in the group is retired, no gain or loss
is reported. The asset is credited for the cost of the
asset retired and the accumulated depreciation account
is debited for the cost minus salvage proceeds.
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Accumulated depreciation
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Retirement of asset in a group
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If the equipment is retired after four years ad sold for
P20,000, the journal entry is:
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Cash
20,000
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Accumulated depreciation
110,000
d. When the asset retired is replaced by a similar asset,
the replacement is recorded by debiting the asset
account and crediting cash or other appropriate
account. Subsequently, the composite or group rate is
multiplied by the balance of the asset account to get
the periodic depreciation.
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90,000
90,000
Equipment
130,000
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If there are no proceeds from the retirement of the
equipment, the journal entry is:
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Accumulated depreciation
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Equipment
130,000
130,000
After the retirement of the equipment, the remaining
cost of the asset in group is P870,000 (P1,000,000 –
P130,000). Consequently, the annual depreciation is
no longer P90,000.
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Variable charge or activity methods
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The variable or activity methods assumes that
depreciation is more a function use rather than
passage of time. The useful life of the asset is
considered in terms of the output it produces or
the number of hours it works.
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Thus, depreciation is related to estimated
production capacity of the asset and is
expressed in a rate per unit of output or per
hour of use. There are two variable methods
namely:
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a. Working hours method
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b. Output or production method
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The variable methods are adopted if the
principal cause of depreciation is usage.
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The variable methods are found to be
appropriate for assets such as machineries.
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The annual depreciation starting the fifth year
would be P78,300, computed by multiplying the
composite rate of 9% by the remaining cost of
P870,000.
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Retirement and replacement of asset
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Upon retirement of the equipment, the same is
replaced by a similar asset costing P160,000. Thus,
the total cost of the assets in the group is now
P1,030,000. Accordingly, the annual depreciation
starting the fifth year should be 9% times
P1,030,000 or P92,700.
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Note: Depreciation shall be discontinued when the
same would result to a carrying amount of the
assets in the group which is below the residual
value of the assets in the group.
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Illustration – Variable charge or activity methods
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Machinery, at cost
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Residual value
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Estimated useful life:
600,000
None
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Years
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Service hours
60,000 hours
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Output
150,000 unis
5 years
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Actual operation
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First year
14,000
34,000
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Second year
13,000
32,000
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Third year
10,000
25,000
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Fourth year
11,000
29,000
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Fifth year
12,000
30,000
60,000
150,000
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Service hours
Output
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Working hours method
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Output or production method
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Under this method, a depreciation rate per hour is
computed by dividing the depreciable amount by the
estimated useful life in terms of service hours. Thus,
the rate per hour is P10, computed by dividing P600,000
by 60,000 hours. The depreciation rate per hour is then
multiplied by the actual hours worked in one period to
get the depreciation for the period.
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Under this method, a depreciation rate per unit is
computed by dividing the depreciable amount by the
estimated useful life in terms of units of output.. Thus,
the rate per unit is P4, computed by dividing P600,000
by 150,000 units. The depreciation rate per unit is then
multiplied by the yearly output to get the annual
depreciation.
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Accu.
Year Particulars Depreciation
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depr.
Acquisition cost
Carrying
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amount
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600,000
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Year Particulars Depreciation
Accu.
Carrying
Depr.
Amount
Acquisition cost
600,000
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1
14,000 x 10
140,000
140,000
460,000
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1
34,000 x 4
136,000
136,000
464,000
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2
13,000 x 10
130,000
270,000
330,000
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2
32,000 x 4
128,000
264,000
336,000
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3
10,000 x 10
100,000
370,000
230,000
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3
25,000 x 4
100,000
364,000
236,000
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4
11,000 x 10
110,000
480,000
120,000
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4
29,000 x 4
116,000
480,000
120,000
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5
12,000 x 10
120,000
600,000
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5
30,000 x 4
120,000
600,000
-
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600,000
-
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600,000
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Decreasing charge or accelerated methods
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The decreasing charge or accelerated methods provide higher depreciation in the earlier years and
lower depreciation in the later years of the useful life of the asset. Thus, these methods result in a
decreasing depreciation charge over the useful life.
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There are three decreasing charge methods, namely:
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a. Sum of years’ digits
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b. Declining balance
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c. Double declining balance
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Sum of years’ digits
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The sum of the years’ digits method provides for depreciation that is computed by multiplying the
depreciable amount by a series of fractions whose numerator is the digit in the useful life of the
asset and whose denominator is the sum of the digits in the useful life of the asset. The fractions are
developed by getting the sum of the digits in the useful life of the asset.
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For example, if the useful life is 4 years, the sum of years’ digits is 1 + 2 + 3 + 4 = 10. Thus, the
depreciation would be 4/10 for the first year, 3/10 for the second year, 2/10 for the third year and
1/10 for the last year.
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What if the useful life of the asset is 25 years? How then would the sum of the
years’ digits be computed?
SYD = Life (Life + 1) or: SYD = 25 (25 + 1) = 25 (13) = 325
2
2
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If the useful life of the asset is 2 ½ years, the procedure is to multiply the
useful life by 2 in order to get the useful life of the asset in half years. Thus
the useful life of the asset in half years would be 5 (2 ½ years x 2). The sum
of half years’ digit would then be 15 or 1 + 2 + 3 + 4 + 5
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First year: Two fractions 5/15 and 4/15 (each fraction pertaining to half year)
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Second year: Two fractions 3/15 and 2/15
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Third year: One fraction 1/15
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Illustration – sum of years’ digits
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Fractional depreciation – sum of years’ digits
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Machinery
430,000
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Cost of asset
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Residual value
30,000
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Residual value
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Estimated useful life
4 years
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Date of acquisition
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SYD = 4 (4 + 1) = 10
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Estimated useful life
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2
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SYD = 1 + 2 + 3 = 6
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Year Particulars Depreciation
300,000
None
April 1, 2020
3 years
Accu.
Carrying
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Computation of depreciation – calendar period
Depr.
amount
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2020: (3/6 x 300,000 x 9/12)
112,500
430,000
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2021: (3/6 x 300,000 x 3/12)
37,500
(2/6 x 300,000 x 9/12)
75,000
Acquisition cost
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1 4/10 x 400,000 160,000
160,000
270,000
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2 3/10 x 400,000 120,000
280,000
150,000
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3 2/10 x 400,000 80,000
360,000
70,000
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2022: (2/6 x 300,000 x 3/12)
25,000
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4 1/10 x 400,000 40,000
400,000
30,000
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(1/6 x 300,000 x 9/12)
37,500
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400,000
112,500
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62,500
2023: (1/6 x 300,000 x 3/12)
12,500
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Declining balance method
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Illustration – Double declining balance method
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Under the declining balance method, a fixed or uniform rate is
multiplied by the declining carrying amount of the asset in order
to arrive at the annual depreciation. The problem of this
method is the determination of the fixed rate to be applied
against the carrying amount. The formula cannot be used unless
there is a residual value. Under this method, the fixed rate is
determined following a mathematical formula.
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Cost of asset
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Date of acquisition
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Residual value
50,000
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Estimated useful life
5 years
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Double declining balance method
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Straight line rate (100%/5 years)
20%
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The common application of the declining balance method is the
double declining balance. This method is an approximation of
the declining balance method. The difference between the two
lies in the determination of the rate to be used.
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Double declining rate (200%/5 years)
40%
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Year Particulars Depreciation Accu. Depr. Carrying amt
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Under this method, a fixed rate is multiplied by the declining
carrying amount of the asset to arrive at the annual
depreciation. The straight line rate is simply doubled to get the
fixed rate. This method is also known as “200% declining
balance method”.
The residual value is ignored in the first year in the
computation of depreciation. The fixed rate is multiplied by
the total cost in the first year not by the depreciable amount.
The depreciation in the last year is simply the difference
between the carrying amount and the residual value.
500,000
January 1, 2020
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Acquisition cost
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2020 40% x 500,000
200,000
200,000
300,000
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2021 40% x 300,000
120,000
320,000
180,000
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2022 40% x 180,000
72,000
392,000
108,000
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2023 40% x 108,000
43,200
435,200
64,800
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2024 64,800 – 50,000
14,800
450,000
50,000
►
500,000
450,000
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150 % declining balance
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Inventory method
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Under the double declining balance, the fixed rate
is twice or 200% of the straight line rate. Under,
the 150% declining balance method, the fixed rate
is 150% of the straight line rate.
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Illustration
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Cost of asset
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Residual value
The inventory method consists of merely
estimating the value of the asset at the end of the
period. The difference between the balance of the
asset account and the value at the end of the year
is then recognized as depreciation for the year. In
recording the depreciation, no accumulated
depreciation account is maintained. The
depreciation is credited directly the asset
account. Illustration:
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Date of acquisition
January 1, 2020
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Tools account, January 1
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Useful life
5 years
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Acquisition, at cost
90,000
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Straight line rate (100% / 5 years)
20%
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Sale of tools, at residual value
2,000
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Fixed rate (150% / 5 years)
30%
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Inventory of tools on Dec. 31, at cost
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Depreciation for 2020:
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1. To record the acquisition:
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(30% x 500,000)
500,000
50,000
150,000
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►
Tools
100,000
125,000
90,000
Cash
90,000
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Retirement and replacement method
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►
Under the retirement method of depreciation, no
depreciation is recorded until the asset is retired. The
amount of depreciation is equal to the original cost of
the asset retired minus salvage proceeds.
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Under the replacement method, no depreciation is
recorded until the asset is retired and replaced. The
amount of depreciation is equal to the replacement cost
of the asset retired, minus salvage proceeds. If the asset
is not replaced, the original cost of the asset retired but
not replaced is recognized as depreciation.
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Illustration: The following data relate to the tools
account of the current year.
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Balance-January1, 1,000 units at P50 per unit
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Acquisition-2,500 units at P70 per unit
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Retirement of tools-1,200 units
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Proceeds form retirement of tools
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Required: What are the journal entries to record the
acquisition and replacement of tools using retirement
method and
50,000
175,000
5,000
2. To record the sale of used tools at residual value:
Cash
►
►
►
2,000
Tools
3. To record the depreciation of tools:
Depreciation
►
Tools
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Retirement method
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1. To record the acquisition:
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Tools
►
►
2,000
63,000
63,000
175,000
Cash
175,000
2. To record the retirement:
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Cash
5,000
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Depreciation
59,000
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Tools (50,000 + 14,000)
64,000
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Change in useful life
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Illustration:
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The useful life of an item of PPE shall be reviewed at
least at each financial year-end and if expectations are
significantly different from previous estimate, the
change shall be accounted for as a change in
accounting estimate. Therefore, the depreciation
charge for the current and future periods shall be
adjusted.
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A depreciable asset costing P500,000 is originally
estimated to have a useful life of 5 years.
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At the beginning of the third year, the original useful
life is revised to 8 years. Thus, the asset has remaining
useful life of 6 years.
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Required: What is the annual starting the third year?
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Answer:
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Cost
500,000
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Accumulated depreciation (500,000 /5 x 2)
(200,000)
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Carrying amount –beginning of third year
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Annual depreciation starting the
►
Past depreciation is not corrected. The procedure is
simply to allocate the remaining carrying amount of the
asset over the remaining revised useful life in order to
get the subsequent annual depreciation.
►
►
third year (300,000 / 6)
300,000
50,000
Note: Revised annual depreciation = remaining carrying
amount / remaining revised useful life.
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Change in depreciation method
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Illustration:
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The depreciation method shall be reviewed at least at
each financial year-end and if there has been a
significant change in the expected pattern of economic
benefits embodied in the asset, the method shall be
changed to reflect the new pattern.
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An entity decided to change from SYD to the straight
line method of depreciation on January 1, 2020.
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The asset acquired on January 1, 2018 at a cost of
P1,000,000 and has an estimated useful life of 4 years.
When a change in depreciation method is necessary, the
change shall be accounted for as a change in accounting
estimate, and the depreciation charge for the current
and future periods shall be adjusted.
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Required: Compute the depreciation and prepare
journal entry for 2020.
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Answer:
The procedure is simply to allocate the remaining
carrying account over the remaining useful life using
the new depreciation method.
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Cost – January 1, 2018
►
Accumulated depreciation:
►
2018 (4/10 x 1,000,000)
400,000
►
2019 (3/10 x 1,000,000)
300,000
►
►
1,000,000
►
Carrying amount – January 1, 2020
►
Depreciation for 2020: (300,000 / 2)
►
Depreciation
►
Accumulated depreciation
700,000
300,000
150,000
150,000
150,000
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Problem 27-9
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Answers:
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Bitter Company acquired a machine on April 1, 2020.
►
1. 4/01/20 – 3/31/21 (1,080,000 x 8/36)
240,000
►
Cost
1,200,000
►
4/01/21 – 3/31/22 (1,080,000 x 7/36)
210,000
►
Residual value
120,000
►
Depreciation for 2020 (240,000 x 9/12)
180,000
►
Estimated useful life
8 years
►
►
Required:
►
4/01/21 – 12/31/21 (210,000 x 9/12)
►
1. What is the depreciation for 2020 using sum of years’ digits?
►
Depreciation for 2021
►
2. What is the depreciation for 2021 using sum of years’ digits?
►
►
3. What is the depreciation for 2020 using double declining
balance?
►
►
4. What is the depreciation for 2021 using double declining
balance?
►
5. What is the carrying amount of the machine on December 31,
2021 using double declining balance?
►
►
►
►
2. 1/01/21 – 3/31/21 (240,000 x 3/12)
3. Fixed rate (100% / 8 = 12.5% x 2)
60,000
157,500
217,500
25%
Depreciation for 2020:
(1,200,000 x 25% x 9 / 12)
225,000
4. Depreciation for 2021:
(1,200,000 – 225,000 = 975,000 x 25%)
5. Cost of the machine
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Less: Accumulated depr. (225,000 + 243,750)
►
Carrying amount – 12/31/21
243,750
1,200,000
468,750
731,250
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Problem 27-23
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Answers:
►
Patterson Company provided the following information on
January 1, 2020:
►
1. Depreciation for 2022:
►
Vehicle cost
►
Useful life in years
5
►
Useful life in miles
100,000
►
Residual value
►
Actual miles driven
►
5,000,000
1,000,000
►
2020
30,000
►
2021
20,000
►
2022
15,000
►
Required:
►
1. What is the depreciation for 2022 using the SYD method?
►
2. What is the accumulated depreciation on December 31, 2021
using the double declining balance method?
►
3. What is the accumulated depreciation on December 31, 2022
using the miles driven?
►
3/15 (5,000,000 – 1,000,000) =
800,000
2. Accumulated depreciation on December 31, 2021:
►
Straight line rate (100% / 5)
20%
►
Double declining rate (200% /5)
40%
►
12/31/2020: (40% x 5,000,000)
2,000,000
►
12/31/2021: (40% x 3,000,000)
1,200,000
►
Accumulated depreciation – 12/31/2021
3,200,000
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3. Accumulated depreciation on 12/31/2022:
►
Depreciable amount (5,000,000 – 1,000,000)
►
Rate per mile (4,000,000 / 100,000 miles)
►
Miles driven (30,000 + 20,000 +15,000)
►
Accumulated depreciation (65,000 x P40) 2,600,000
4,000,000
40 / mile
65,000 miles
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Problem 27-17
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Answer:
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Tarnish Company purchased equipment on January 1, 2020 for
P5,000,000. The equipment had an estimated life 5-year useful
life. The accounting policy for 5-year assets is to use the 200%
double declining balance method for the first two years of the
asset’s life and then switch to straight line depreciation.
►
Double declining rate (200% / 5 years)
►
Depreciation using double declining method:
►
12/31/2020 (5,000,000 x 40%)
2,000,000
Required: What amount should be reported as accumulated
depreciation on December 31, 2022?
►
12/31/2021 (3,000,000 x 40%)
1,200,000
►
Accumulated depreciation – 12/31/21
3,200,000
►
Equipment, at cost
5,000,000
►
Less: Accumulated depreciation
3,200,000
►
Carrying amount – 12/31/2021
1,800,000
►
Remaining life of equipment (5 – 2)
►
Depreciation using straight line method:
►
12/31/2022 (1,800,000 / 3 years)
►
Total accumulated depreciation – 12/31/2022
►
Note: Depreciation using straight line method is computed by
dividing carrying amount of P1,800,000 by the asset’s remaining
life of 3 years.
►
40%
3 years
600,000
3,800,000