Depreciation
Little Review…
• We looked at taking inventory…to figure out the cost of supplies used.
• We looked at prepaid insurance…to figure out the value of insurance used.
• We looked at unearned revenue…to figure out the value of services we owe.
• Now we are going to look at depreciation…to figure out the updated value
of LONG-TERM ASSETS.
What is Depreciation?
• Volkswagen Jetta Trendline+
$25,563
What is Depreciation?
• Depreciation is the loss of value over the life of an asset.
• Very few things we buy are worth the same amount we paid at the end of
their lives.
• Short term assets are things like pens, pencils, paper, nails, screws, etc. We
figured out how to account for these things using adjusting entries.
• Long term assets are popularly called PP&E assets
What is Depreciation?
• Long-term assets help produce revenue for many years.
• The cost of these assets should then be spread over the time that they help
make revenue.
• Depreciation is a way of spreading the cost of a long-term asset over its
useful, productive life.
Vehicle Depreciation
• Let’s pretend we buy a van for $24,000. After 5 years, we sell the van for
$1500.
• Over the 5 years that we have the van, the van cost the business $22,500.
(24000-1500)
• We have to think of that $22,500 as an expense at a yearly rate of $4500.
Vehicle Depreciation
Vehicle Depreciation
• Calculating depreciation is important for the matching principle and the
time period concept.
• This is fair recording of the revenues and expenses. Things would be
inaccurate if the accountant put the entire cost in the first year of its
purchase.
Calculating Depreciation
• We never know exactly how long an asset will last.
• We have to ESTIMATE the depreciation while we are using the asset. There
are two ways to do this:
• Straight-Line Depreciation and
• Declining-balance method.
Straight-Line Depreciation
• This is the easiest way to do it.
• We divide the cost of the asset EQUALLY over the years the asset is used.
Straight Line Depreciation
• Tip Top Trucking purchased a truck for $78,000 on January 1, 20-2. It
estimated that the truck would be used for six years, and at the end of that
time, could be sold for $7800. (The $7800 is the salvage value and is an
estimated amount.)
• Annual depreciation is $11,700.
Straight Line Depreciation
• Tip Top Trucking purchased $5120 of furniture on January 1, 20-2. The
company estimated that the furniture would be used for 10 years, at which
time it would have a value of $500.
• Annual depreciation is $462 a year.
Adjusting for Depreciation
• Adjusting entries for depreciation affects the income statement and balance
sheet.
Accumulated Depreciation Account
• Now…taking the value of the truck down by $11,700 is accurate and the
right thing to do. BUT…if we were to look at the balance sheet for Tip Top
Trucking, it would show $66,300 as the value of the truck.
• A better way of doing it is to show changes on the balance sheet.
Accumulated Depreciation Account
• INSTEAD of putting credit entries into the Truck account, we create an
account called Accumulated Depreciation – Truck #1--
Accumulated Depreciation Account
• The normal balance for Truck would have a debit balance.
• The Accumulated Depreciation Account – Truck has a credit balance.
Together…
Review of Depreciating Adjusting Entries
• 1. They record the depreciation for the period in a depreciation expense
account.
• 2. Increases the proper accumulated depreciation amount account for the
asset. This reduces the net book value of the asset.
• The basic entry is
Depreciation on the Financial Statements
Depreciation for Less Than a Year
• Sometimes assets do not last a whole year. Or…the fiscal period being
reported on is less than a year.
• We have to figure out depreciation for a PART of a year
• Imagine we buy a building on May 1, 2013, for $600,000. The building is
expected to be used for 30 years, and it will then be worth $150,000.
BUT…we are a large company and prepare quarterly financial statements.
Depreciation for Less Than a Year
• The annual depreciation would be ($600,000 - $150,000)/30 = $15,000.
• We have to figure out what it costs us per month then.
• $15,000/12 = $1250.
• So, the first statement after the building was purchased would be the end of June.
Two months had passed, so the depreciation for the period would be $2500.
Other Methods for Calculating Depreciation
• Declining-Balance
Depreciation uses a fixed
percentage to calculate annual
depreciation.
• These percentages are set by
the government.
Declining-Balance Depreciation
• We buy computers for $22,000 on January 1, 2015.
-$22,000 is the Capital Cost.
• Every year we have the computers, the value is going to drop by 55%.
Declining-Balance Depreciation
• If a business buys an asset halfway through a year, CRA still assumes that the
business used it for a year.
• The Half-Year Rule considers this and restricts the amount that an asset can
depreciate in the first year. They use 50% as the average. It looks like this.
Exercises
Exercises
Exercises