I.

Depreciation
a. The allocation of the cost of a PPE asset to expense in the periods in which
services are received from the asset.
b. Basic purpose of depreciating is to offset the revenue of an accounting period
with the cost of the goods and services being consumed in the effort to generate
that revenue.
c. You make a purchase debit an asset account as you use the asset
depreciate to allocate its cost to the revenue its helping to generate debit dep
ex. Credit acc. dep.
d. Accumulated depreciation:
i. the sum of all the past depreciation expenses in the past periods
ii. symbolizes the part of the asset that is already transferred to expense
iii. a contra-asset so you subtract from PPE balance in SFP
iv. usually companies maintain separate asset and acc. dep. Accounts to help
distinguish different activities
e. Dep. Is not a way of valuating your asset. It is a process of cost allocation
i. BV =/= FV
f. It is a non-cash expense in the sense that you do not shell out money when you
incur it. You shelled out the money when you bought the PPE
g. Causes
i. Physical deterioration: from use and exposure to the elements. Cant
prevent it even through repairs
ii. Obsolescence: becoming out of date. More efficient and effective PPE are
now available
h. Definitions
i. Accumulated depreciation:
1. the sum of all the past depreciation expenses in the past periods
2. symbolizes the part of the asset that is already transferred to
expense
3. a contra-asset so you subtract from PPE balance in SFP
4. usually companies maintain separate asset and acc. dep. Accounts
to help distinguish different activities
ii. residual value: estimated amount that an entity would currently obtain
from disposal of an asset after deducting the estimated cost of disposal
1. Amount currently obtainable if asset is at the end of its useful life
iii. 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
1. Also means service life but not equal to physical life
2. Determined by
a. Expected usage
b. Expected physical wear and tear
c. Technical or commercial obsolescence
d. Legal limits
II. Methods of depreciation
a. When to begin?
 i. When it is available for use, meaning when the asset is in the condition
and location necessary for it to be capable of operating in the manner
intended by management
ii. It stops when the asset is derecognized
b. Which one to use?
i. GAAP requires only that a depreciation method result in a rational and
systematic allocation of cost over the assets useful life
c. Straight-line method
i. Most commonly used
ii. Allocates equal portion of dep. Expense to each period of the assets
useful life
iii. Formula: (cost-residual value) called the depreciable amount/ years of
useful life
iv. Make example on the spot
v. At the end of the depreciation, the BV should equal to the residual value
(so that means the total depreciation should equal the cost residual
value)
d. Composite and group methods (discuss tomorrow!)
i. Depreciating multiple assets as if they were a single asset (usually for big
companies)
ii. Composite
1. 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
iii. Group
1. All assets that are similar in nature and in estimated useful life are
grouped and treated as a single unit
iv. Just look at the book
e. Declining balance method
i. higher dep in earlier years and lower dep on later years
ii. assumes the philosophy that new assets are generally capable of producing
more revenue in the earlier years than in the later years
iii. computed as a specified percentage of the straight line depreciation rate
1. i.e. if 5 years useful life = 20 % per year
2. you multiply that 20 % to a number to get the declining rate
3. most common is double declining method (i.e. 20% x 2)
iv. formula: dep. Ex = remaining BV x the rate
v. note: in SL, depreciation is constant per year. In Declining, depreciation
decreases per year (ergo, declining method)
1. highest dep. Ex. Is on the earlier years of the asset
vi. Make example on the spot
1. Use table
Year Particular Dep Acc.dep. Carrying
(CA x rate) amount
 2. Note that you do not consider the Residual value in getting the
depreciable amount. But consider residual value in getting the last
year of depreciation (last year dep is just the diff bet the dep ex
according to the computation residual value)
3. Again, at the end of the period, BV = residual value
f. Units of output method / working hours method
i. Based on some measure of output / input rather than the passage of time
ii. Which means more depreciation is recognized in the periods in which the
assets are most heavily used.
iii. Formula: (Cost residual value) / estimated units of output
iv. Make example on the spot
v. Provide excellent matching of expense with revenue
vi. But should only be used when the total units of output can be estimated
with reasonable accuracy (appropriate for assets such as machineries)
g. SYD
i. Multiply 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
ii. Fractions are developed by getting the sum of the digits in the useful life
of the asset
iii. Make example on the spot
iv. SYD = life x (life + 1)/2
h. Sum of half years digit
i. Make example (organize per year! Use calendar method)
i. Decelerated methods
i. Methods which recognize less expense in early years and more in the later
years
ii. Assets which become increasingly productive over time
III. Depreciation for fractional periods
i. much like interest, you just apply the fraction to the depreciation expense
ii. half-year convention: you recognize year depreciation at the 1st yr and
last yr.
1. used to average out any purchases of similar assets made during
the year
2. usually in the problems it would say this. No need to remember
IV. Which depreciation methods do businesses use?
a. No specific one is required as long as it results in a rational and systematic
allocation of cost
b. Note
i. SL: increasing profit
ii. Declining methods: decreasing profit
V. Differences in depreciation methods? Are they real?
a. NO. Just an estimate. No effect on the financial strength of the business
b. Tax implications are the most concrete result
VI. Financial statement disclosures
a. Must disclose in notes to financial statements the methods used to depreciate
 b. Estimates of useful life and Residual value are just estimates and ultimately up to
management (not the job of the auditor)
i. Usually based on the companys past experience with similar assets
ii. Also reflect the companys current circumstances and managements
future plans
iii. Auditors job: to make sure these estimates are reasonable
c. Principle of consistency:
i. Apply a method of dep the same way within a group of assets
ii. Dont change year to year unless there is a good reason
d. Revision of estimated useful life
i. It is a prospective change, meaning the dep of past periods will not be
changed
ii. Make example on the spot
1. Note the wording (5 year left or extended to 5 yrs since date of
acquisition)
VII. Impairment
a. Results because of obsolescence, etc.
b. If the carrying amount of an asset cannot be recovered through future use or sale,
the asset should be written down to its fair value. The offsetting debit is to an
impairment loss account
VIII. Disposal
a. Before you dispose, you need to recognize the dep for the year the asset is
disposed (or part of a year)
b. To dispose: dr. acc. dep cr. PPE
c. Note: when an asset is fully depreciated, it is not necessary to dispose
i. But do not record dep anymore (although you can still
ii. Acc. dep. should never exceed total cost of asset
iii. Asset and acc. dep. Accounts just remain in the SFP until asset is disposed
d. Gains and losses on the disposal of PPE
i. Compare BV to the amount received from sale (gain/loss is shown in the
I/S as other income or expense)
ii. Journal entry
Cash
Acc dep
loss
Machinery
gain