CHAPTER F8
Challenging Issues Under
Accrual Accounting:
Long-lived Depreciable
Assets – A Closer Look
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Learning Objective 1:
Explain the process of
depreciating long-lived
assets as it pertains to
accrual accounting.
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Depreciation
Recall the basic definition of
depreciation (from Chapter 6):
 Depreciation is: a systematic
and rational allocation of the
cost of a long-lived item from
asset to expense.
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Depreciation
 Over time, the cost of using the
asset is transferred to the income
statement as an expense.
 As the cost of the asset is
transferred to the income
statement, the historical cost on
the balance sheet is reduced by
the accumulated depreciation.
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Learning Objective 2:
Determine depreciation
expense amounts using both
straight-line and doubledeclining-balance
depreciation methods.
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Effect of Estimates
Estimated useful life of the asset
and the estimated disposal value at
the end of that useful life each play
a large role in determining the
amount of depreciation to be
recognized in each year that we
use the long-lived asset.
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Discussion Questions
Think about your most recent purchase of a
long-lived asset. Maybe you bought a
computer, a car, or a TV.
 How long do you expect to keep it and use
it?
 What do you think it will be worth when
you are through with it?
 How certain are you of these answers?
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Effect of Estimates
Example: Assume that we buy a new
$6,000 computer system. We are
unsure whether to use a three-year
life or a five-year life, and some of
our “experts” think that it could be
worth as little as $0 after three years
or as much as $1,000 after five years.
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Effect of Estimates
Depr.
Year Expense
1
2
3
4
5
1,000
1,000
1,000
1,000
1,000
Book
Value
5,000
4,000
3,000
2,000
1,000
Using 5 years and
$1,000 disposal value,
you depreciate $1,000
each year.
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Year
1
2
3
Depr.
Book
Expense Value
2,000
2,000
2,000
4,000
2,000
0
Using 3 years and $0
disposal value, you
would depreciate
$2,000 each year.
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Effect of Different Methods
 When preparing the depreciation schedule
for a newly purchased long-lived asset, an
accountant has a choice of several different
depreciation methods.
 By choosing one method over another, the
accountant has an impact on the amount of
expense that will be reported in any given
year, and, therefore, also the net income.
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Straight-line Depreciation
 In Chapter 6, the straight-line method of
depreciation was illustrated. It is
probably the easiest method, and it is
definitely the most heavily used method
in the U.S.A.
 Approximately 95% of major corporations
in America use straight-line for some or
all of their long-lived assets.
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Straight-line Alternatives
 The straight-line method could be
calculated on the basis of time, with an
equal amount of depreciation being
allocated to each time period.
 Alternatively, the straight-line measure
could be units of production or some
other measure of usage, such as miles
driven for a vehicle or hours flown for an
airplane.
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Straight-line Based on Time
 The basic premise is that the same
amount of depreciation will be
recognized in each year of the useful
life of a long-lived asset.
 The computer system (5-year or 3-year)
depreciation schedules given
previously are examples of the straightline method based on the passage of
time.
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Straight-line Based
on Usage
 The other variation of the straight-line
method is often called the production
depreciation method.
 Instead of estimating the number of
years of useful life, we will instead
estimate the amount of usage that we
expect from the asset.
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Production
Depreciation Method
Assume that a pizza parlor buys a
delivery truck. Rather than drive the
truck into the ground, they decide that
they should sell it after it has 75,000
miles on it. The original cost is $20,000
and they estimate that the disposal
value will be $5,000 at that time.
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Production
Depreciation Method
 Step One: Calculate the depreciation charge
per mile driven:
Depreciable Base $15,000
Estimated Miles
75,000 = $.20/mile
 Step Two: Calculate depreciation each year
(or interim period) by multiplying actual miles
driven by the per mile depreciation:
Year 1: 30,000 miles X $.20 = $6,000
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Effect of Different
Methods
 Several other depreciation methods
are considered acceptable and are
used by some companies.
 Most of these other methods are
called accelerated depreciation
methods. They are accelerated in that
a larger amount of expense is taken in
the early years, and less in later years.
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Double-Declining-Balance
Method
 The most heavily used accelerated method
is the double-declining-balance method.
 The main features of this method are:
 (1) it depreciates at a rate (%) equal to
double the straight-line rate, and
 (2) you do not consider the estimated
disposal value during the early years of
depreciation.
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Double-Declining-Balance
Method
 First step: determine the DDB rate. The
DDB rate is equal to twice the annual
straight-line rate.
 For a five-year asset, the annual straight-line
rate is 1/5 or 20%. The DDB rate is 40%.
 For an three-year asset, the annual straightline rate is 1/3 or 33.3%. The DDB rate is
66.7%.
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Double-Declining-Balance
Method
 Second step: Multiply the DDB rate by the book
value at the beginning of the year.
 You will use the same rate (%) each year,
however, the amount of depreciation will
decrease each year because the beginning
book value also decreases each year.
 NOTE: Be careful in the later years, don’t
depreciate the asset below salvage value.
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Double-Declining-Balance
Method
 Let’s prepare double-declining-balance
depreciation schedules for the computer
system mentioned in an earlier slide.
 First, let’s assume a five-year life with
$1,000 disposal value, and
 Second, let’s assume a three-year life
with a $0 disposal value.
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DDB Schedule, 5-Year Asset
Year
Begin
Book
Value
40%
Depr.
Expense
Ending
Book
Value
1
2
3
4
5
6,000
3,600
2,160
1,296
1,000
2,400
1,440
864
296
0
3,600
2,160
1,296
1,000
1,000
Due to the accelerated amount of depreciation,
the asset is fully depreciated after four years.
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DDB Schedule, 3-Year Asset
Year
Begin
Book
Value
66.7%
Depr.
Expense
Ending
Book
Value
1
2
3
6,000
2,000
667
4,000
1,333
667
2,000
667
0
Using the 3-year life with zero disposal value, the amount of
depreciation for year 3 is equal to whatever amount remains.
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Learning Objective 3:
Describe in your own words
the effects on the income
statement and balance sheet
of using different methods of
depreciation.
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Understanding the Effects
The choice of straight-line or an accelerated
method affects all of the following:
 Depreciation expense in each year.
 Net income in each year (because of #1).
 Accumulated depreciation in each year
(except the last year when fully
depreciated).
 Net book value in each year (because of #3,
except the last year again).
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Understanding the Effects
However, the choice of method does NOT
affect the following:
 The amount of depreciation taken over the
entire useful life.
 The amount of net income reported over
the entire useful life.
 The book value at the end of the useful life
of the asset.
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Learning Objective 4:
Compare gains and losses
to revenues and expenses.
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Disposal of Assets
 At some point, a business will decide to
dispose of a long-lived asset. This could
happen at the end of the estimated useful
life, or it could just as easily happen
sooner or later than we originally
estimated.
 Each time we dispose of an asset, we need
to determine whether there is a gain or loss
on disposal.
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Gains and Losses
 A gain is a net inflow resulting from a
peripheral activity of the company, such as
selling a long-lived asset for an amount
greater than its net book value.
 A loss is a net outflow resulting from a
peripheral activity of the company, such as
selling a long-lived asset for an amount
less than its net book value.
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Gains and Losses
 Gains and losses are important
accounting elements. They are reported
on the income statement along with
revenues and expenses.
 Thus, the income statement equation is
now expanded to:
Net income =
Revenue + Gains - Expenses - Losses
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Learning Objective 5:
Calculate a gain or loss on
the disposal of a longlived depreciable asset.
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Determining Gains & Losses
 Consider these various examples of the
disposal of a depreciable asset:



1. A fully depreciated delivery truck (with 220,000
miles on it) is hauled off to the junk yard.
2. A delivery van with a net book value of $8,000
is traded in on a company car for the sales staff.
3. A one-year-old rental car with a net book value
of $15,000 is sold at auction to a car dealership.
Let’s explore this third example further.
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Calculating Gain
on Disposal
 A gain on disposal of a depreciable asset will
occur when the asset is sold for an amount in
excess of the ending book value.
 Example: The Car Rental Company sells a one-
year-old car to a car dealership. The company
has depreciated the asset to a book value of
$15,000. The dealership pays $16,500 to buy the
car. The Car Rental Company records a gain on
disposal of $1,500.
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Calculating Loss
on Disposal
 A loss on disposal of a depreciable asset will
occur when the asset is sold for an amount
less than the ending book value.
 Example: The same situation with the Car Rental
Company selling a car (book value of $15,000) to
a dealership. The car dealership pays $14,500 to
buy the car. The Car Rental Company records a
loss on disposal of $500.
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Disposal with No Gain or Loss
 There will be no gain or loss on the disposal of
a depreciable asset when the asset is sold (or
traded) for an amount equal to the recorded
book value.
 Example: The same situation with the Car Rental
Company selling a car (book value of $15,000) to
a dealership. The car dealership pays $15,000 to
buy the car. No gain or loss.
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Learning Objective 6:
Explain the effects on a
company’s financial
statements when
management disposes of a
depreciable asset.
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Effects of an Asset Disposal on
the Balance Sheet



The book value of the asset will be removed from
the balance sheet and decrease both the asset
account and accumulated depreciation account.
Cash will increase by the amount received for the
asset.
If cash exceeds book value, equity will increase
by the amount of the gain. If book value exceeds
the cash, equity will decrease by the amount of
the loss.
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Effects of an Asset Disposal on
the Income Statement
A gain on the disposal will increase
net income.
 A loss on the disposal will decrease
net income.

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Learning Objective 7:
Draw appropriate
conclusions when presented
with gains or losses on an
income statement.
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True Meaning of
Gains/Losses
 Net book value is the end result of the
depreciation amounts charged against
an asset.

Therefore, if book value does not equal the
disposal value of an asset, we simply took
too much or too little depreciation for the
asset.
 The gain or loss is just a depreciation
adjustment at the end of the process.
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True Meaning of
Gains/Losses
 Case #1: You bought an asset at a cost of
$9,000. You have been depreciating this
asset at a straight-line rate of $1,000 per
year for 4 years.
 The net book value at this time is $5,000
and you sell it for $4,000.
 You will record a loss on sale of $1,000.
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True Meaning of
Gains/Losses
 Case #2: Same asset, $9,000 original
cost and depreciated for the past four
years.
 If you had depreciated $1,250 each year
(total of $5,000), the book value would
have been equal to $4,000.
 When the asset was sold for $4,000,
there would be no gain or loss.
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True Meaning of
Gains/Losses
 In case #1, you have $4,000 depreciation
and a $1,000 loss on sale. This reduces net
income by $5,000 over the life of the asset.
 In case #2, you have $5,000 depreciation
and no gain or loss on sale. Again, net
income has been reduced by $5,000.
 Either way, total net income is the same
over the life of the asset.
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End of Chapter 8
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