Module 11
Noncurrent Assets: Depreciation and Exchange
Depreciation of Tangible Assets
Depreciation is the systematic and rational allocation of the cost of noncurrent, tangible,
fixed assets over their estimated useful lives. When a fixed asset is purchased, it is
recorded as an asset. The amount of the asset’s cost that is allocated to an expense
account in every period is called depreciation expense.
Depreciation does not do the following:
 Ensure that the book value of assets equals their market value
 Accumulate cash to replace noncurrent tangible assets.
Depreciation is recorded as follows:
Debit Depreciation Expense
Credit Accumulated Depreciation
The Accumulated Depreciation account is a contra-asset account and represents the
value of the asset allocated to depreciation from the time the asset was acquired, the
term accumulated depreciation refers to the amount in the Accumulated Depreciation
account.
The book value of an asset, at any time, is the original cost minus the amount in the
Accumulated Depreciation account up to that point in time.
In calculating the amount of depreciation per period, the following factors are relevant:
 Cost, which is the price at which the asset was purchased.
 Estimated useful life, which is the length of service the business expects from an
asset. For example, the useful life of a computer is the number of years it is expected
to be used.
 Salvage value, which is the expected cash value of the asset at the end of its useful
life. (The cost of the asset minus the salvage value is called depreciable cost.)
Many methods are used to for calculate depreciation expense:
 Straight-Line Method.
 Accelerated methods.
 Declining-Balance Method.
 Sum-of-the-Years’ Digits Method.
 Use Factor Methods.
 Service Hours.
 Units of Production.
 Group/Composite Methods.
Straight-Line Method
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The straight-line method allocates an equal amount of depreciation expense to each
period of the asset’s useful life. Depreciation expense each period is calculated as
follows:
Depreciation expense = Depreciable cost/Useful life = (Cost – Salvage value)/ Useful life
At the end of each period, the depreciation for that period is added to the current
Accumulated Depreciation account. Thus, the Accumulated Depreciation account
includes the total depreciation from the date the asset was purchased to the current
date. The difference between the cost and the accumulated depreciation amount is
called the book value of the asset as noted earlier.
Example:
Marks Company purchased a machine for $41,000 on January 1, 2002. The machine’s
salvage value is $5,000 and its useful life is 4 years. Calculate the depreciation expense,
accumulated depreciation at the end of the year, and the book value at the end of the
year for each year of the useful life of the asset.
Depreciation expense each year = ($41,000 – $5,000)/4 = $9,000 per year
Year ending
12/31/2002
12/31/2003
12/31/2004
12/31/2005
Book value at
Depreciation
Accumulated
Book value at
year beginning expense
depreciation
end of year
$ 41,000
$ 9,000
$ 9,000
$ 32,000
32,000
9,000
18,000
23,000
23,000
9,000
27,000
14,000
14,000
9,000
36,000
5,000
Accelerated Methods for Calculating Depreciation
Declining-Balance Method and Other Declining-Balance Methods
Accelerated Depreciation methods allocate larger amounts to depreciation expense in
the earlier periods of the assets’ useful life than in later periods. The declining-balance
method is an accelerated method.
We discuss the double-declining-balance method in detail. As noted later, the other
declining-balance method is substantially similar, they vary according to the
multiplication factor used to multiply the straight-line rate. In the double-decliningbalance method, depreciation expense is calculated as follows:
Step 1: Calculate the straight-line depreciation rate.
Straight-line depreciation rate = 1/Useful life
Step 2: Calculate the double-declining-balance (DDB) rate.
DDB rate = 2 x Straight-line rate
Step 3: Calculate depreciation expense.
Depreciation expense = DDB rate x Book value at the beginning of the period
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Note 1:
For the first period, the book value equals the cost of the asset. For each subsequent
period, the book value is the difference between the asset’s cost and the amount of
accumulated depreciation.
Note 2:
The asset must not be depreciated below its salvage value. If the amount of depreciation
expense for a year calculated using the preceding formula reduces the book value below
salvage, the amount of depreciation expense for that year is the amount needed to
reduce the asset's book value to its salvage value.
Example
Spencer Company purchased a machine for $25,000 on January 1, 2002. The
machine’s salvage value is $3,000, and its useful life is 4 years. Calculate the
depreciation expense, accumulated depreciation at the end of the year, and the book
value at the end of the year for each year of the asset’s useful life.
Step 1: Straight line rate = 1/Useful life = ¼ = 0.25
Step 2: DDB rate = 2 x Straight-line rate = 2 x 0.25 = 0.50
Year ending
Book value at
year beginning
B
$ 25,000
12,500
6,250
3,125
Depreciation
expense
C = B x 0.50
$ 12,500
6,250
3,125
125*
Accumulated
depreciation
D
$ 12,500
18,750
21,875
22,000
Book value at
end of year
E=B–C
$ 12,500
6,250
3,125
3,000
A
12/31/2002
12/31/2003
12/31/2004
12/31/2005
Note:
For the final year, depreciation expense is the “plug” number. Because salvage value is
given to be $3,000, the book value at the end of 2005 must equal $3,000. Because the
book value at the beginning of 2005 is $3,125, the depreciation expense for the year
must be $125 so that the book value becomes equal to $3,000.
The approach for other declining-balance methods is very similar. The only difference is
in step 2. For the DDB method, step 2 is as follows:
DDB rate = 2 x Straight-line rate
If we use the 150% declining-balance (as opposed to DDB) method, step 2 is as follows:
150% declining-balance rate = 1.5 x Straight-line rate
If we use the 125% declining-balance (as opposed to DDB) method, step 2 is as follows:
125% declining balance rate = 1.25 x Straight-line rate
In other words, the only change is in the multiplication factor used to multiply the
straight-line rate, as noted earlier.
Sum-of-the- Years’-Digits Method
The sum-of-the-years’-digits method is another accelerated method. Under it, the
depreciation expense is calculated as follows. Assume that a machine has an estimated
useful life of 4 years. The sum-of-the-years’-digits equals 10 (1 + 2 + 3 + 4). In the first
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year, the depreciation expense is 4/10 of the total depreciable cost; in the second year,
the depreciation expense is 3/10 of the total depreciable cost, and so on. In the fourth
and final year, the depreciation expense is 1/10 of the depreciable cost.
Thus, under this method, the denominator equals the sum of the years involved. If an
asset has a useful life of N years, the denominator equals (1 + 2 + 3 . . . + N–1 + N).
The shortcut to calculate this is as follows:
1 + 2 + 3 . . . + N–1 + N = N x (N+1)/2
The numerator for the first year is N, for the second year is N–1, for the third year is N–2,
and so on; for the final year, the numerator is 1.
Use-Factor Methods
Under use-factor methods, depreciation is viewed as being related to the extent to which
an asset is used. Thus, the more an asset is used in a given period, the higher is its
depreciation expense for that period.
Example
Williams Company purchased a truck on January 1, 2002, for $35,000 and estimated
that the it would be driven for 200,000 miles after which it would be sold for $5,000. The
actual number of miles driven in the first three years of the truck’s life was as follows:
30,000 miles in 2002; 45,000 miles in 2003; 37,000 miles in 2004. What is the
depreciation expense in each of the first three years?
The total depreciable cost = $30,000 ($35,000 cost – $5,000 salvage value)
Total use factor = 200,000 miles
Depreciation per use-factor unit = $30,000/200,000 miles = $0.15 per mile
Thus, depreciation in each year is as follows:
Year
Use factor (miles)
Depreciation expense
2002
30,000
$4,500 (30,000 x 0.15)
2003
45,000
$6,750 (45,000 x 0.15)
2004
37,000
$5,550 (37,000 x 0.15)
In this, depreciation was calculated based on the input factor (miles driven). Other
examples of input factors used for calculating depreciation include machine hours,
service hours, and labor hours. In other situations, it may be more appropriate to
calculate depreciation based on the output factor, such as the number of units produced
or the number of customers served.
Note that when depreciation expense is calculated based on the output (for example,
when using the units-of-production method), depreciation is a variable expense in the
income statement. In contrast, when depreciation is calculated using the time-factor
methods (such as straight line, declining balance, or sum of the years’ digits), the
expense is fixed in the income statement.
Amortization of Intangible Assets
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Noncurrent intangible assets are amortized over their estimated useful lives, just as
noncurrent tangible assets are depreciated over their estimated useful lives. Thus,
amortization is similar to depreciation except that the word “amortization” is used only in
the context of intangible assets while depreciation is used for tangible assets. (A similar
word is depletion, which is used only in the context of natural resources, such as oil and
gas wells.)
Some differences exist between the amortization of intangible assets and the
depreciation of tangible assets. First, intangible assets are amortized by directly
crediting (that is, reducing the balance of) the intangible asset. Thus, intangible assets
have no Accumulated Amortization account. Second, intangible assets must be
amortized according to the straight-line method unless compelling reason exists to use
another method.
Change in Estimates Related to Depreciation
Depreciation calculations are based on estimates, such as the estimated salvage value,
estimated useful life or estimated output. Estimates are not precise and may change
over time. Any change in an estimate impacts the depreciation for only the current and
future periods; past periods’ depreciation remains unchanged (that is, companies do not
go back and correct prior periods’ depreciation).
Example
Cabrero Company bought a machine on January 1, 2002, for $24,000 and estimated its
useful life to be eight years. On January 1, 2005, the company revised the estimated
useful life to be only seven years. Calculate the depreciation expense for each year
using the straight-line method.
Depreciation expense for each of the years 2002, 2003, and 2004 equals $3,000 per
year ($24,000/8).
As of December 31, 2005, accumulated depreciation equals $9,000 ($3,000 multiplied
by 3).
Thus, as of January 1, 2006, the book value of the machine equals $15,000 ($24,000
minus $9,000).
Thus, the amount left to be depreciated as of January 1, 2006, equals $15,000.
This $15,000 must be depreciated over the next four years (because the revised
estimated useful life is seven years, and the machine has already been used for three
years).
Hence, the revised depreciation expense (for each of the years 2005 through 2008)
equals $3,750 per year ($15,000/4).
Impairment of Long-Lived Assets
Sometimes an asset may become impaired before the end of its estimated useful life.
SFAS No. 121 provides guidance on accounting for impairment of long-lived assets.
SFAS No. 121 allows an asset to be considered impaired when the undiscounted (that
is, without consideration of present value discounting) sum of estimated future cash
flows from the asset is less than the book value (that is, cost less accumulated
depreciation) of the asset.
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If the asset is considered impaired, another calculation is required to determine the
difference between the fair value of the asset and its book value. The fair value usually
equals the discounted present value of the estimated future cash flows from the asset.
Note that in the first step (to determine whether the asset is impaired), we use the
undiscounted future cash flows, but in the second step (to determine the amount of
impairment), we use the discounted future cash flows. The book value of the asset is
brought down to its fair value by reducing the original cost and amount of accumulated
depreciation and by recording a loss.
Example
Jones Company purchased a building for $500,000 on January 1, 2002. Its estimated
useful life was 20 years. On January 1, 2008, the company determined that the
undiscounted sum of future cash flows from the building (asset) was $340,000 but the
discounted sum of future cash flows from the asset was $210,000. Prepare the
necessary journal entries.
Depreciation per year on the building equals $25,000 ($500,000/20).
Accumulated depreciation as of January 1, 2008 equals $150,000 ($25,000 multiplied by
6 years).
Book value of the building as of January 1, 2008 equals $350,000 ($500,000 minus
$150,000).
Since the undiscounted sum of future cash flows ($340,000) is less than the building’s
book value ($350,000), the building is considered impaired.
The amount of impairment equals $140,000 ($350,000 minus $210,000).
(Note: To calculate the amount of impairment, we must use the discounted future cash
flow amount).
Journal entry
Debit Loss on Impairment (step 1)
$ 140,000
Debit Accumulated Depreciation (step 2)
150,000
Credit Building (step 3)
$ 290,000
Note:
After the journal entry, the new cost of the building is brought down to $210,000
($500,000 minus $290,000), which is its estimated fair value.
Disposal of Assets
Businesses dispose of plant assets after they cease to meet their needs. Businesses
may dispose of a plant asset by selling or exchanging it. If the asset cannot be sold or
exchanged, it may be discarded.
When a noncurrent asset is sold, a gain or loss may occur. If the price at which the asset
is sold is higher than its book value at the time of the sale, a gain is recognized. If the
price at which the asset is sold is less than its book value, a loss is recognized.
The journal entries for the disposal of an asset are as follows:
Step 1: Since the asset is no longer with the company, it must be removed from the
company’s books. This means that the previous asset account must be credited for the
(historical) cost of the asset.
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Step 2: Since the asset has been removed from the books, the accumulated
depreciation associated with the asset also must be removed. Hence, the Accumulated
Depreciation account is debited for the amount of accumulated depreciation associated
with the old asset.
Step 3: If the old asset is sold for cash, the Cash account is debited.
Step 4: Based on these three entries, if some amount is needed on the debit side to
make debits equal credits, a loss occurs; conversely, if some amount is needed on the
credit side to make debits equal credits a gain is recognized.
Example
David Company bought a machine on January 1, 2002, for $23,000. Its estimated useful
life was four years, and its estimated salvage value was $3,000. Assume that the
business uses the straight-line method for calculating depreciation. The company sold
the machine on January 1, 2005, for $6,000. Prepare the necessary journal entries for
the transaction.
Solution
At the time of the sale, the business has used the machine (asset) for three years (2002,
2003, and 2004). In each of these years, the depreciation expense was $5,000 per year
([$23,000 minus $3,000]/4). Thus at the time of the sale, the amount in the Accumulated
Depreciation account is $15,000, and the book value of the machine is $8,000 ($23,000
minus $15,000). The price at which the machine is sold ($6,000) is less than its book
value ($8,000). Thus, a loss of $2,000 is recognized. The journal entry for the sale
follows:
Debit Cash (step 3)
$ 6,000
Debit Accumulated Depreciation (step 2)
15,000
Debit Loss on Disposal (step 4)
2,000
Credit Machine (step 1)
$ 23,000
Nonmonetary Asset Exchanges
Nonmonetary asset exchanges involve exchanges of assets without paying the full
market price solely in the form of cash. For example, a company may exchange a
building for land, one machine for another, or a car for a truck. Such exchanges are
called nonmonetary because a company acquires the asset without paying the full
amount of its market price in the form of cash.
Nonmonetary asset exchanges may involve similar assets (such as one car for another,
or one building for another) or dissimilar assets (such as land for building, a truck for a
crane). In accounting for such exchanges, we assume that the exchanges are armslength transactions. This means that the fair market value (FMV) of the old asset(s)
given up must equal the FMV of the new asset(s) received. (Note: Total FMV of assets
being given up includes both the FMV of the asset being given up in the exchange plus
any cash paid; similarly, the total FMV of any assets received includes the FMV of the
asset being received in exchange plus any cash received.)
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When an exchange of nonmonetary assets occurs , the journal entries involve the
following
Step 1: Credit the book value of the asset being given up (because the comapnay no
longer owns it, the asset must be removed from the books).
Step 2: Debit the Accumulated Depreciation Account of the asset being given up (if the
asset is removed from the books, the amount of the accumulated depreciation related to
the asset also must be removed from the books).
Step 3: Debit a cash account if cash is being received, or credit a cash account if cash is
being paid.
Step 4: Compare the book value of the old asset against its FMV.
If the FMV of the asset given up is less than its book value, a loss occurs.
Losses on exchanges are always recognized.
If the FMV of the asset given up is more than its book value, then a gain occurs.
Gains on exchanges are sometimes recognized, depending on the type of exchange.
The details are discussed later.
Step 5: If the exchange results in a loss as calculated earlier, first debit the new asset
received for its FMV and then debit the account Loss on Exchange.
If the exchange results in a gain, determine how much of the gain can be
recognized based on rules discussed later. First credit the account Gain on Exchange
and then debit the account for the new asset received (that is, the new asset account is
debited for the plug number that will make debits equal to credits).
Dissimilar Asset Exchanges, Different Lines of Business
Accounting for dissimilar asset exchanges are simple. In this case, the entire amount of
gain from the exchange can be recognized. (Remember that losses on exchange are
always recognized).
Example 1
Assume that a building with a book value of $50,000 (original cost $70,000) was
exchanged for land with a market value of $62,000. Because original cost of the building
was $70,000 but its book value is only $50,000, the mount of accumulated depreciation
on the building must be $20,000 ($70,000 minus $50,000). The journal entry for this
transaction follows:
Debit Land (step 3)
Debit Accumulated Depreciation (building) (step 2)
Credit Building (step 1)
Credit Gain on Exchange (step 4)
$ 62,000
20,000
$ 70,000
12,000
Example 2
Assume that a building with a book value of $30,000 (original cost $45,000) was
exchanged for land with a market value of $44,000. In addition, cash of $10,000 was
received in the exchange. The journal entry for this transaction follows:
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Debit Land (step 4)
Debit Cash (step 3)
Debit Accumulated Depreciation (building) (step 2)
Credit Building (step 1)
Credit Gain on Exchange (step 5)
$ 44,000
10,000
15,000
$ 45,000
24,000
Example 3
Assume that a building with a book value of $80,000 (original cost $90,000) was
exchanged for land with a market value of $78,000. In addition, cash of $12,000 was
paid in the exchange. The journal entry for this transaction follows:
Debit Land (step 4)
Debit Accumulated Depreciation (building) (step 2)
Debit Loss on Exchange (step 5)
Credit Building (step 1)
Credit Cash (step 3)
$ 78,000
10,000
14,000
$ 90,000
12,000
If the assets exchanged are considered similar, but are used in different lines of
business, they are accounted for as if they were dissimilar assets. That is, if two similar
machines used in different lines of business are exchanged, they are accounted for
exactly as noted here. Both gains and losses are fully recognized.
Similar Asset Exchanges, Same Line of Business
Accounting for exchanges of similar assets used in similar lines of business is different
than exchanges for different lines of business because gains on exchanges may not
always be fully recognized. (As before, losses on exchange are always fully
recognized.)
If it appears that gain on the exchange of similar assets may occur (that is, if the FMV of
assets being given up is higher than their book value), did the company receive any
cash during the exchange? (Note that the question asks only if cash was received, not
if it was paid. Of course, one company’s cash receipt must mean that the other company
paid cash, but accounting by the cash-receiving company is unrelated to accounting by
the cash-paying company).
If cash was not received, no gain is recognized on the exchange. In this case, the last
step is to record the new asset. The amount used is a plug number to make debits
equal credits. Note that this means the new asset is recorded for an amount less than
its FMV. (If no cash is or received, the new asset is recorded at the same value as the
book value of the old asset.)
If cash was received and if it received is at least 25% of the FMV of the assets received,
the entire gain can be recognized (that is, the accounting is just like that for dissimilar
assets). In this case, after recording the removal of the old asset and the receipt of
cash, a credit for the gain; the final step is recording a debit for the new asset (a plug
number to make debits equal credits must be recorded).
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If cash was received and is less than 25% of the FMV of the assets received, then a
partial gain is recognized. The amount of gain recognized is determined as follows:
(Cash received / Cash received + FMV of asset received) multiplied by Gain
In other words, the gain recognized is proportional to the cash portion of the overall
assets received by the company. In this case, after recording the removal of the old
asset and the receipt of cash, record a credit for the partial gain; the final step is a debit
for the new asset (a plug number to make debits equal credits).
Glossary
Accelerated depreciation methods allocate larger amounts to depreciation expense in
the earlier periods of the asset’s useful life than in later periods.
Accumulated Depreciation is a contra-asset account and represents the value of the
asset allocated to depreciation from the time the asset was acquired; accumulated
depreciation refers to the amount in the Accumulated Depreciation account.
Amortization is similar to depreciation but is used only in the context of intangible
assets.
Book value of an asset is the original cost minus the accumulated depreciation up to a
specific point in time.
Depreciation is the systematic and rational allocation of the cost of noncurrent assets
over their estimated useful lives.
Double-declining-balance method is an accelerated method of calculating
depreciation.
Estimated useful life is the length of service a business expects from an asset.
Nonmonetary asset exchanges involve exchanges of assets without paying the full
market price solely in the form of cash.
Salvage value is the expected cash value of an asset at the end of its useful life.
Straight-line method of depreciation allocates an equal amount of depreciation
expense to each period of the asset’s useful life.
Sum-of-the-years’-digits method is an accelerated method of depreciation.
Use-factor methods assume that depreciation as being related to the extent to which
the asset is used.
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Demonstration Problem 1
Wexler Company
Wexler Company purchased a machine on January 1, 2002. Details about it are as
follows:
Cost
$120,000
Estimated salvage value
$20,000
Estimated useful life
5 years
Estimated service hours
8,000 hours
Estimated production
200,000 units
The company operated the machine for 1,500 hours and 2,000 hours during 2002 and
2003, respectively. The number of units produced is 30,000 and 50,000 during 2002
and 2003, respectively. Calculate the depreciation expense for 2002 and 2003 under
each of the following methods: (a) straight line, (b) double declining, (c) sum of years’
digits, (d) service hours, and (e) units of production.
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Solution to Demonstration Problem 1, Wexler Company
a. Straight-line method
Annual depreciation = (Cost minus Salvage value)/Estimated useful life
= ($120,000 – $20,000)/5
= $20,000.
b. Double-declining-balance method
Straight line rate
= 0.20 (1/5)
Double-declining rate = 0.40 (2 x 0.20)
Year ending
Book value at
Depreciation
year beginning
expense
A
B
C = B x 0.40
12/31/2002
$ 120,000
$ 48,000
12/31/2003
72,000
28,800
Accumulated
depreciation
D
$ 48,000
76,800
Book value at
end of year
E=B–C
$ 72,000
43,200
c. Sum-of-the-years’-digits method
Estimated useful life = 5 years
Sum-of-the -years’-digits = 15 (1 + 2 + 3 + 4 + 5)
Depreciation for 2002 = $100,000 x 5/15 = $33,333.33
Depreciation for 2003 = $100,000 x 4/15 = $26,666.67
Note: The depreciable cost (Cost – Salvage value) is $100,000.
d. Service hours method
Estimated total service hours = 8,000 hours
Thus, depreciation per service hour = $100,000/8,000 = $12.50 per hour
Depreciation for 2002 = $12.50 x 1,500 = $18,750.00
Depreciation for 2003 = $12.50 x 2,000 = $25,000.00
e. Units of production method
Estimated total production = 200,000 units
Thus, depreciation per unit produced = $100,000/200,000 = $0.50 per unit
Depreciation for 2002 = $0.50 x 30,000 = $15,000.00
Depreciation for 2003 = $0.50 x 50,000 = $25,000.00
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Demonstration Problem 2
Reid Company
Reid Company gave one of its machines to Grant Company and in return obtained a
building. In addition, Reid Company paid $15,000 cash to Grant Company. The cost,
book value, and market values of the two assets were as follows:
Asset owned by Asset given to
Cost
Book value
Fair market
value
Reid
Grant
$ 95,000
$ 75,000
$ 65,000
Grant
Reid
72,000
63,000
80,000
Record the transaction in Reid Company’s books.
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Solution to Demonstration Problem 2, Reid Company
Note: This is an exchange of dissimilar assets. Hence, all gains and losses on
exchange must be recognized.
Reid Company’s books
a. The market value of the machine given up is $65,000.
b. The book value of the machine given up is $75,000, so the loss on the exchange is
$10,000.
c. Accumulated depreciation of machine = Cost minus Book value
= $20,000 ($95,000 minus $75,000)
Journal entries for Reid Company
Account
New Asset (step 5)
Accumulated Depreciation–Old Asset (step 2)
Loss on Exchange (step 4)
Old Asset (step 1)
Cash (step 3)
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Debit
$ 80,000
20,000
10,000
Credit
$ 95,000
15,000
Demonstration Problem 3
Troy Company
Troy Company gave one of its machines to Drew Company and in return obtained
another. In addition, Drew Company paid $15,000 cash to Troy Company. The cost,
book value, and market values of the two machines were as follows:
Machine owned Machine given
Cost
Book value
Fair market
by
to
value
Troy
Drew
$ 105,000
$ 50,000
$ 75,000
Drew
Troy
90,000
70,000
60,000
Record the transaction in Troy Company’s books, assuming the two machines to be
similar and used in the same line of business.
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Solution to Demonstration Problem 3, Troy Company
Note: This is an exchange of similar assets used in the same line of business.
Troy Company’s books
a. The market value of assets given up by Troy Company is $75,000.
b. The book value of assets given up by Troy Company is $50,000, so this exchange
involves a gain for Troy Company. The initial calculation of the gain is $25,000 ($75,000
minus $50,000).
c. Troy Company receives cash, but it is less than 25% of the total assets received
($15,000/$75,000 is 20%), so only a partial gain can be recognized.
Gain recognized = (Cash received / [Cash received + FMV of asset received]) x Gain
= ($15,000 / [$15,000 + $60,000)] x $25,000
= $5,000
d. Accumulated depreciation of old machine of Troy Company = Cost minus Book value
= $55,000 ($105,000 minus $50,000).
Journal entries for Troy Company
Account
New Asset (plug number) (step 5)
Cash (step 3)
Accumulated Depreciation–Old Asset (step 2)
Old Asset (step 1)
Gain on exchange (step 4)
16
Debit
$ 40,000
15,000
55,000
Credit
$ 105,000
5,000
Demonstration Problem 4
Drew Company
Drew Company gave one of its machines to Troy Company and in return obtained a
machine. In addition, Drew Company paid $15,000 cash to Troy Company. The cost,
book value, and market values of the two machines were as follows:
Machine owned Machine given
Cost
Book value
Fair market
by
to
value
Troy
Drew
$ 105,000
$ 50,000
$ 75,000
Drew
Troy
90,000
70,000
60,000
Record the transaction in Drew Company‘s books, assuming the two machines to be
similar and used in the same line of business.
17
Solution to Demonstration Problem 4, Drew Company
Note: This is an exchange of similar assets used in the same line of business.
Drew Company’s books
a. The market value of the machine given up by Drew Company is $60,000.
b. The book value of the assets given up by Drew Company is $70,000, which creates a
loss for Drew Company. The loss on exchange is $10,000 ($70,000 – $60,000).
c. Accumulated depreciation of the old Drew Company machine = Cost – Book value
= $20,000 ($90,000 – $70,000)
Journal entries for Drew Company
Account
New Asset (step 4)
Accumulated Depreciation–Old Asset (step 2)
Loss on exchange (step 5)
Old Asset (step 1)
Cash (step 3)
18
Debit
$ 75,000
20,000
10,000
Credit
$ 90,000
15,000
Practice Problem 1
Moore Company
Moore Company purchased a machine on January 1, 2002. Details about it are as
follows:
Cost
$250,000
Estimated salvage value
$10,000
Estimated useful life
5 years
Estimated service hours
12,000 hours
Estimated production
500,000 units
The company operated the machine for 2,000 hours and 2,400 hours during 2002 and
2003, respectively. The number of units produced were 70,000 and 90,000 during 2002
and 2003, respectively. Calculate the depreciation expense for 2002 and 2003 under
each of the following methods: (a) straight line, (b) double declining, (c) sum of the
years’digits, (d) service hours, and (e) units of production.
19
Solution to Practice Problem 1, Moore Company
a. Straight-line method
Annual depreciation = (Cost – salvage value)/Estimated useful life
= ($250,000 – $10,000)/5
= $48,00
b. Double-declining balance method
Straight line rate
= 0.20 (1/5)
Double-declining rate = 0.40 (2 x 0.20)
Year ending
Book value at
Depreciation
year beginning
expense
A
B
C = B x 0.40
12/31/2002
$ 250,000
$ 100,000
12/31/2003
150,000
60,000
Accumulated
depreciation
D
$ 100,000
160,000
Book value at
end of year
E=B–C
$ 150,000
90,000
c. Sum-of-the-years’-digits method
Estimated useful life = 5 years
Sum-of-years’-digits = 15 (1 + 2 + 3 + 4 + 5)
Depreciation for 2002 = $240,000 x 5/15 = $80,000
Depreciation for 2003 = $240,000 x 4/15 = $64,000
Note: $240,000 is the depreciable cost (Cost – Salvage value).
d. Service hours method.
Estimated total service hours = 12,000 hours.
Thus, depreciation per service hour = $240,000/12,000 = $20 per hour.
Depreciation for 2002 = $20 x 2,000 = $40,000.
Depreciation for 2003 = $20 x 2,400 = $48,000.
e. Units of production method
Estimated total production = 500,000 units
Thus, depreciation per unit produced = $240,000/500,000 = $0.48 per unit
Depreciation for 2002 = $0.48 x 70,000 = $33,600
Depreciation for 2003 = $0.48 x 90,000 = $43,200
20
Practice Problem 2
Grant Company
Reid Company gave one of its machines to Grant Company and in return obtained a
building. In addition, Reid Company paid $15,000 cash to Grant Company. The cost,
book value, and market values of the two assets were as follows:
Asset owned by Asset given to
Cost
Book value
Market value
Reid
Grant
$ 95,000
$ 75,000
$ 65,000
Grant
Reid
74,000
63,000
80,000
Record the transaction in Grant Company’s books.
21
Solution to Practice Problem 2, Grant Company
Note: This is an exchange of dissimilar assets. Hence, all gains and losses on
exchange must be recognized.
Grant Company’s books
a. The market value of the building given up is $80,000.
b. The book value of the building given up is $63,000, so the gain on the exchange is
$17,000.
c. Accumulated depreciation of building = Cost – Book value
= $11,000 ($74,000 – $63,000)
Journal entries for Grant Company
Account
New Asset (step 5)
Accumulated depreciation–Old Asset (step 2)
Cash (step 3)
Old Asset (step 1)
Gain on Exchange (step 4)
22
Debit
$ 65,000
11,000
15,000
Credit
$ 74,000
17,000
Practice Problem 3
Pedro Company
Pedro Company gave one of its machines to Roger Company and in return obtained
another machine. In addition, Roger Company paid $5,000 cash to Pedro Company.
The cost, book value, and market values of the two machines were as follows:
Machine owned Machine given
Cost
Book value
Fair market
by
to
value
Pedro
Roger
$ 42,000
$ 30,000
$ 50,000
Roger
Pedro
64,000
55,000
45,000
Record the transaction in Pedro Company’s books, assuming the two machines to be
similar and used in the same line of business.
23
Solution to Practice Problem 3, Pedro Company
Pedro Company’s books
a. The market value of the assets given up by Pedro Company is $50,000.
b. The book value of the assets given up by Pedro Company is $30,000, so this
exchange involves a gain. The initial calculation of the gain is $20,000 ($50,000 –
$30,000).
c. Pedro Company receives Cash but it is less than 25% of the total assets received
($5,000/$50,000 is 10%), so only a partial gain can be recognized.
Gain recognized = (Cash received / [Cash received + FMV of asset received]) x Gain
= ($5,000 / [$5,000 + $45,000)] x $20,000
= $2,000
d. Accumulated depreciation of the old machine of Pedro Company = Cost – Book value
= $12,000 ($42,000 – $30,000)
Journal entries for Pedro Company
Account
New Asset (plug number) (step 5)
Cash (step 3)
Accumulated Depreciation–Old Asset (step 2)
Old Asset (step 1)
Gain on Exchange (step 4)
24
Debit
$ 27,000
5,000
12,000
Credit
$ 42,000
2,000
Practice Problem 4
Roger Company
Roger Company gave one of its machines to Pedro Company and in return obtained
another machine. In addition, Roger Company paid $5,000 cash to Pedro Company.
The cost, book value, and market values of the two machines were as follows:
Machine owned Machine given
Cost
Book value
Fair market
by
to
value
Pedro
Roger
$ 42,000
$ 30,000
$ 50,000
Roger
Pedro
64,000
55,000
45,000
Record the transaction in Roger Company ‘s books, assuming the two machines to be
similar and used in the same line of business.
25
Solution to Practice Problem 4, Roger Company
Note: This is an exchange of similar assets used in the same line of business.
Roger Company’s books
a. The market value of the machine given up by Roger Company is $45,000.
b. The book value of the machine given up by Roger Company is $55,000, so this
exchange involves a loss for Roger Company. Loss on the exchange is $10,000
($55,000 – $45,000).
c. Accumulated depreciation of the old machine of Roger Company = Cost – Book value
= $9,000 ($64,000 – $55,000)
Journal entries for Roger Company
Account
New Asset (step 4)
Accumulated Depreciation–Old Asset (step 2)
Loss on Exchange (step 5)
Old Asset (step 1)
Cash (step 3)
26
Debit
$ 50,000
9,000
10,000
Credit
$ 64,000
5,000
Homework Problem 1
Putin Company
Putin Company purchased a machine on January 1, 2002. Details about the machine
are as follows:
Cost
$500,000
Estimated salvage value
$50,000
Estimated useful life
5 years
Estimated service hours
15,000 hours
Estimated production
360,000 units
The company operated the machine for 2,500 hours and 3,000 hours during 2002 and
2003, respectively. The number of units produced is 65,000 and 80,000 during 2002
and 2003, respectively. Calculate the depreciation expense for 2002 and 2003 under
each of the following methods: (a) straight line, (b) double declining, (c) sum of the
years’ digits, (d) service hours, and (e) units of production.
27
Solution to Homework Problem 1, Putin Company
a. Straight-line method
Annual depreciation = (Cost – salvage value)/Estimated useful life
= ($500,000 – $50,000)/5
= $90,000.
b. Double-declining balance method
Straight-line rate
= 0.20 (1/5)
Double-declining rate = 0.40 (2 x 0.20)
Year ending
Book value at
Depreciation
year beginning
expense
A
B
C = B x 0.40
12/31/2002
$ 500,000
$ 200,000
12/31/2003
300,000
120,000
Accumulated
depreciation
D
$ 200,000
320,000
Book value at
end of year
E=B–C
$ 300,000
180,000
c. Sum-of-the-years’-digits method
Estimated useful life = 5 years
Sum-of-the-years’-digits method= 15 (1 + 2 + 3 + 4 + 5)
Depreciation for 2002 = $450,000 x 5/15 = $150,000
Depreciation for 2003 = $450,000 x 4/15 = $120,000
Note: $450,000 is the depreciable cost (cost – salvage value).
d. Service hours method
Estimated total service hours = 15,000 hours
Thus, depreciation per service hour = $450,000/15,000 = $30 per hour
Depreciation for 2002 = $30 x 2,500 = $75,000
Depreciation for 2003 = $30 x 3,000 = $90,000
e. Units of production method
Estimated total production = 360,000 units
Thus, depreciation per unit produced = $450,000/360,000 = $1.25 per unit
Depreciation for 2002 = $1.25 x 65,000 = $81,250
Depreciation for 2003 = $1.25 x 80,000 = $120,000
28
Homework Problem 2
Gorby Company
Yeltsin Company gave one of its machines to Gorby Company, and in return obtained a
building. In addition, Gorby Company paid $10,000 cash to Yeltsin Company. The
cost, book value, and market values of the two assets were as follows:
Asset owned by Asset given to
Cost
Book value
Market value
Yeltsin
Gorby
$ 45,000
$ 37,000
$ 40,000
Gorby
Yeltsin
42,000
34,000
30,000
Record the transaction in Gorby Company’s books.
29
Solution to Homework Problem 2, Gorby Company
Note: This is an exchange of dissimilar assets. Hence, all gains and losses on
exchange must be recognized.
Gorby Company’s books:
a. The market value of the building given up is $30,000.
b. The book value of the building given up is $34,000, so the loss on the exchange is
$4,000.
c. Accumulated depreciation of building = Cost – Book value
= $8,000 ($42,000 – $34,000)
Journal entries for Gorby Company
Account
New Asset (step 5)
Accumulated Depreciation–old asset (step 2)
Loss on Exchange (step 4)
Old Asset (step 1)
Cash (step 3)
30
Debit
$ 40,000
8,000
4,000
Credit
$ 42,000
10,000
Homework Problem 3
Hayes Company
Hayes Company gave one of its machines to Patel Company and in return obtained a
machine. In addition, Patel Company paid $14,000 cash to Hayes Company. The cost,
book value, and market values of the two machines were as follows:
Machine owned Machine given
Cost
Book value
Market value
by
to
Hayes
Patel
$ 85,000
$ 60,000
$ 70,000
Patel
Hayes
75,000
55,000
56,000
Record the transaction in Hayes Company’s books, assuming the two machines to be
similar and used in the same line of business.
31
Solution to Homework Problem 3, Hayes Company
Hayes Company’s books
a. The market value of the machine given up by Hayes Company is $70,000.
b. The book value of the machine given up by Hayes Company is $60,000 so this
exchange involves a gain for Hayes Company. The initial calculation of the gain is
$10,000 ($70,000 – $60,000).
c. Hayes Company receives Cash but it is less than 25% of the total assets received
($14,000/$70,000 is 20%), so only a partial gain can be recognized.
Gain recognized = (Cash received / [Cash received + FMV of asset received]) x Gain
= ($14,000 / [$14,000 + $56,000)] x $10,000
= $2,000
d. Accumulated depreciation of old machine of Hayes Company = Cost – Book value
= $25,000 ($85,000 – $60,000)
Journal entries for Hayes Company.
Account
New Asset (plug number) (step 5)
Cash (step 3)
Accumulated Depreciation–Old Asset (step 2)
Old Asset (step 1)
Gain on Exchange (step 4)
32
Debit
$ 48,000
14,000
25,000
Credit
$ 85,000
2,000
Homework Problem 4
1. Depreciation is a variable expense in the income statement when using the
a. sum-of-the-years’-digits method.
b. units of production method.
c. straight-line method.
d. double-declining-balance method.
2. Salvage value is ignored in calculating annual depreciation when using the
a. sum-of-the-years’-digits method.
b. units of production method.
c. straight-line method.
d. double-declining-balance method.
3. Intangible assets are normally amortized using the
a. sum-of-the-years’-digits method.
b. units of production method.
c. straight-line method.
d. double-declining-balance method.
4. Rehnquist Company purchased a machine for $30,000 on January 1, 2002. Its
estimated useful life is four years, and it has no salvage value. If the sum-of-the-years’digits method is used, depreciation expense for the year ending December 31, 2003, is
a. $3,000.
b. $9,000.
c. $7,500.
d. $12,000.
5. Ginsberg Company purchased a machine for $30,000 on January 1, 2002. Its
estimated useful life is four years, and it has no salvage value. If the double-declining
balance method is used, depreciation expense for the year ending December 31, 2002,
is
a. $7,500.
b. $9,000.
c. $15,000.
d. $12,000.
6. Jackson Company purchased a building for $400,000 on January 1, 2002. Its
estimated useful life is 20 years, and it is depreciated using the straight-line method. On
January 1, 2007, the company determines that the undiscounted sum of future cash
flows from the asset was $280,000 but the discounted sum of future cash flows from the
asset was $170,000. As of January 1, 2007,
a. there has been no impairment in the value of the building.
b. the impairment in the value of the building is $130,000.
33
c. the impairment in the value of the building is $110,000.
d. the impairment in the value of the building is $20,000.
7. Scalia Company acquired Thomas Company and recorded goodwill on the purchase.
When the goodwill is amortized, the journal entry
a. debits Amortization expense and credits Goodwill.
b. debits Goodwill and credits Amortization Expense.
c. debits Amortization Expense and credits Accumulated Amortization.
d. debits Accumulated Amortization and credits Amortization Expense.
8. Souter Company sold a machine and recorded a loss on the transaction. This means
that the machine was sold for
a. less than fair market value.
b. less than book value.
c. less than the original cost.
d. more than book value
9. Kennedy Company sold a machine to Breyer Company for $25,000. The machine
had been bought six years earlier for $40,000, and the accumulated depreciation on it
was $18,000. In recording the sale, Kennedy Company recognizes a:
a. gain of $7,000.
b. loss of $7,000.
c. loss of $3,000.
d. gain of $3,000.
10. In a nonmonetary exchange, gain cannot be recognized when the exchange involves
a. dissimilar assets in the same line of business.
b. dissimilar assets in different lines of business.
c. similar assets in the same line of business.
d. similar assets in different lines of business.
34