Chapter 7

 The cost of a fixed asset includes all reasonable and necessary costs to get the asset in place and ready for its intended use

Costs that do not increase the asset’s usefulness are treated as expenses

 Depreciation is a process of allocation, not valuation

Purpose is to allocate the cost of the asset over the periods in which it will provide benefits

No attempt is made to adjust the asset’s cost to approximate its current value
 Depreciation expense is based on estimates of the asset’s useful life and salvage value

Only the original cost is known with certainty

 Various methods of calculating depreciation are acceptable

Straight line method
 (Cost – salvage value) / useful life

Units of output method
 (Cost
– salvage value) / total expected output * current output

Accelerated methods


Declining balance method
Sum of the years’ digits method

 Double declining balance method

Straight line rate is calculated by dividing 100% by the useful life and doubling that rate

The rate is multiplied by the book value each year to determine the depreciation expense

Depreciation stops when the salvage value is reached

 Example
An asset with a cost of $24,000 and an estimated salvage value of $2,000 is expected to have a useful life of 8 years
100% / 8 years * 2 = 25%
8
9
6
7
Year Book value
1 $ 24,000
2
3
4
5
18,000
13,500
10,125
7,594
5,695
4,271
3,204
2,403
Rate
25%
25%
25%
25%
25%
25%
25%
25%
Expense
$ 6,000
4,500
3,375
2,531
1,898
1,424
1,068
801
403
Accumulated depreciation Book value
$ 6,000
10,500
$ 18,000
13,500
13,875
16,406
18,305
10,125
7,594
5,695
19,729
20,796
21,597
22,000
4,271
3,204
2,403
2,000

 Various types of expenditures are made after a fixed asset has been acquired

Revenue expenditure


Normal maintenance to keep the asset operating as designed
Does not add to the asset’s value, improve its functionality, or extend its life
 Treat as an expense


Capital Expenditure

Increase the asset’s life, improve its capacity, or increase its value
 Replacement of major components or addition of new components
 Treat as an additional cost of the asset
 Capitalize and depreciate
 If a replacement of an existing component, write off the remaining value of the component being replaced as depreciation expense

 Steps in accounting for the disposal

Update depreciation to the date of the disposal

Compare book value to selling price (if any) to determine any gain or loss

Remove the asset’s original cost and its accumulated depreciation from the books, and record the cash received and any gain or loss

 Provide future benefits but have no physical substance

Usually some sort of legal right
 Patents, copyrights, trademarks, franchise fees, leaseholds, goodwill, etc.

Recorded at original cost

Amortized using the straight line method


No salvage value
No accumulated amortization account
 Asset account is reduced directly

 Property, plant and equipment

Show at cost, less accumulated depreciation
 Intangibles

Show at depreciated cost