Depreciation Techniques

Chapter

11

Chapter 11-1

Prepared by Coby Harmon, University of California, Santa Barbara

Section 1 Plant Assets

Plant assets include land, land improvements, buildings, and equipment (machinery, furniture, tools).

Major characteristics include:

Used in operations and not for resale. Long-term in nature and usually depreciated.

Possess physical substance.

Referred to as property, plant, and equipment; plant and equipment; and fixed assets.
Chapter 11-2

Determining the Cost of Plant Assets

Land
Includes all costs to acquire land and ready it for use.
Costs typically include: (1) the purchase price;

(2) closing costs, such as title and attorneys fees;

(3) real estate brokers commissions; (4) costs of grading, filling, draining, and clearing;

(5) assumption of any liens, mortgages, or encumbrances on the property.

Chapter 11-3

LO 1 Describe how the cost principle applies to plant assets.

Determining the Cost of Plant Assets

Buildings
Includes all costs related directly to purchase or construction.
Purchase costs:
Purchase price, closing costs (attorneys fees, title insurance, etc.) and real estate brokers commission. Remodeling and replacing or repairing the roof, floors, electrical wiring, and plumbing.

Construction costs:
Contract price plus payments for architects fees, building permits, and excavation costs.
Chapter 11-4

LO 1 Describe how the cost principle applies to plant assets.

Depreciation
Depreciation Methods
Objective is to select the method that best measures an assets contribution to revenue over its useful life. Examples include: (1) Straight-line method.
(2) Units-of-Activity method. (3) Declining-balance method.
Illustration 10-8 Use of depreciation methods in 600 large U.S. companies
Chapter 11-5

LO 3 Compute periodic depreciation using different methods.

Depreciation - Method of Cost Allocation

Depreciation is the accounting process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset.
Allocating costs of long-term assets:
Fixed assets = Depreciation expense Intangibles = Amortization expense Natural resources = Depletion expense

Chapter 11-6

LO 1 Explain the concept of depreciation.

Depreciation - Method of Cost Allocation

Methods of Depreciation
The profession requires the method employed be systematic and rational. Examples include:
(1) Units of Activity method (units of use or production). (2) Straight-line method. (3) Declining-balance method.

Chapter 11-7

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.

Depreciation - Method of Cost Allocation

Exercise (Depreciation ComputationsThree Methods)
Robert Parish Corporation purchased a new machine for its assembly process on September 30, 2007. The cost of this machine was $117,900. The company estimated that the machine would have a salvage value of $12,900 at the end of its service life. Its life is estimated at 5 years and its working hours are estimated at 1,000 hours. Year-end is December 31.
Instructions: Compute the depreciation expense under the following methods. (a) Straight-line depreciation. (b) Activity method. (c) Double-declining balance.
LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.

Chapter 11-8

Depreciation - Method of Cost Allocation

Exercise (Straight-line Method)
Year 2007 2008 2009 2010 2011 2012 Depreciable Base $ 105,000 105,000 105,000 105,000 105,000 105,000 / / / / / / Years 5 5 5 5 5 5 = = = = = = Annual Expense $ 21,000 21,000 21,000 21,000 21,000 21,000 x 9/12 = x Partial Year 3/12 = $ Current Year Expense 5,250 21,000 21,000 21,000 21,000 15,750 $ 105,000 Accum. Deprec. $ 5,250 26,250 47,250 68,250 89,250 105,000

Journal entry: 2007 Depreciation expense Accumultated depreciation 5,250 5,250

Chapter 11-9

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.

Depreciation - Method of Cost Allocation

Exercise (Activity Method)
($105,000 / 1,000 hours = $105 per hour)
Year 2007 2008 2009 2010 2011 (Given) Hours Used 200 150 250 300 100 1,000 Journal entry: 2007 Depreciation expense Accumultated depreciation
Chapter 11-10

Rate per Hours x x x x x $105 105 105 105 105 = = = = =

Annual Expense $ 21,000 15,750 26,250 31,500 10,500

Partial Year $

Current Year Expense 21,000 15,750 26,250 31,500 10,500 $ 105,000

Accum. Deprec. $ 21,000 36,750 63,000 94,500 105,000

21,000 21,000

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.

Depreciation - Method of Cost Allocation

Exercise (Double-Declining Balance Method)
Year 2007 2008 2009 2010 2011 2012 Depreciable Base $ 117,900 106,110 63,666 38,200 22,920 13,752 x x x x x x Rate per Year 40% 40% 40% 40% 40% 40% = = = = = = Annual Expense $ 47,160 x 42,444 25,466 15,280 9,168 5,501 Plug Partial Year 3/12 = $ Current Year Expense 11,790 42,444 25,466 15,280 9,168 852 $ 105,000 Accum. Deprec. $ 11,790 54,234 79,700 94,980 104,148 105,000

Journal entry: 2007 Depreciation expense Accumultated depreciation 11,790 11,790

Chapter 11-11

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.

Depreciation - Method of Cost Allocation

Changes in Depreciation Rate

Accounted for in the period of change and future periods (Change in Estimate)

Chapter 11-12

LO 4 Explain special depreciation methods.

Change in Estimate Example

Arcadia HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight-line basis. In 2005 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of that time. Questions: What is the journal entry to correct the prior years depreciation? Calculate the depreciation expense for 2005.
Chapter 11-13

No Entry Required

LO 4 Explain special depreciation methods.

Change in Estimate Example

Equipment cost Salvage value Depreciable base Useful life (original) Annual depreciation

After 7 years

$510,000 First, establish - 10,000 NBV at date of change in estimate. 500,000 10 years $ 50,000 x 7 years = $350,000

Balance Sheet (Dec. 31, 2004) Fixed Assets: Equipment Accumulated depreciation Net book value (NBV)
Chapter 11-14

$510,000 350,000 $160,000

LO 4 Explain special depreciation methods.

Change in Estimate Example

Net book value Salvage value (new) Depreciable base Useful life remaining Annual depreciation $160,000 5,000 155,000 8 years $ 19,375

After 7 years
Depreciation Expense calculation for 2005.

Journal entry for 2005

Depreciation expense
Accumulated depreciation
Chapter 11-15

19,375
19,375

LO 4 Explain special depreciation methods.

Depletion
Natural resources, often called wasting assets, include petroleum, minerals, and timber. They have two main features:
1. complete removal (consumption) of the asset, and 2. replacement of the asset only by an act of nature. Depletion is the process of allocating the cost of natural resources.

Chapter 11-16

LO 6 Explain the accounting procedures for depletion of natural resources.

Depletion
Establishing a Depletion Base
Computation of the depletion base involves four factors: (1) Acquisition cost of the deposit, (2) Exploration costs, (3) Development costs, and (4) Restoration costs.

Chapter 11-17

LO 6 Explain the accounting procedures for depletion of natural resources.

Depletion
Write-off of Resource Cost
Normally, companies compute depletion on a units-ofproduction method (an activity approach). Thus, depletion is a function of the number of units extracted during the period. Calculation:
Total cost Salvage value

Total estimated units available

Units extracted x Cost per unit
Chapter 11-18

= Depletion cost per unit = Depletion

LO 6 Explain the accounting procedures for depletion of natural resources.

Plant Asset Disposals - Retirement

BE10-9 Prepare journal entries to record the following. (a) Gomez Company retires its delivery equipment, which cost $41,000. Accumulated depreciation is also $41,000 on this delivery equipment. No salvage value is received. (b) Assume the same information as (a), except that accumulated depreciation for Gomez Company is $39,000, instead of $41,000.

(a)

Accumulated depreciation Equipment

41,000 41,000

Chapter 11-19

LO 6 Explain how to account for the disposal of a plant asset.

Plant Asset Disposals - Retirement

BE10-9 Prepare journal entries to record the following. (a) Gomez Company retires its delivery equipment, which cost $41,000. Accumulated depreciation is also $41,000 on this delivery equipment. No salvage value is received. (b) Assume the same information as (a), except that accumulated depreciation for Gomez Company is $39,000, instead of $41,000.

(b)

Accumulated depreciation Equipment Loss on disposal

39,000 41,000 2,000

Chapter 11-20

LO 6 Explain how to account for the disposal of a plant asset.

Plant Asset Disposals

Sale of Plant Assets
Compare the book value of the asset with the proceeds received from the sale. If proceeds exceed the book value, a gain on disposal occurs. If proceeds are less than the book value, a loss on disposal occurs.

Chapter 11-21

LO 6 Explain how to account for the disposal of a plant asset.

Plant Asset Disposals - Sale

BE10-10 Chan Company sells office equipment on September 30, 2008, for $20,000 cash. The office equipment originally cost $72,000 and as of January 1, 2008, had accumulated depreciation of $42,000. Prepare the journal entries to (a) record the sale of the equipment.

Chapter 11-22

LO 6 Explain how to account for the disposal of a plant asset.

Plant Asset Disposals - Sale

BE10-10 Prepare the journal entries to (a) record the sale of the equipment. (a) Cash 20,000

Accumulated depreciation
Office equipment Loss on disposal

42,000
72,000 10,000

Chapter 11-23

LO 6 Explain how to account for the disposal of a plant asset.

Section 3 Intangible Assets

Intangible assets are rights, privileges, and competitive advantages that do not possess physical substance.
Normally classified as long-term asset.

Common types of intangibles:

Patents Copyrights Trademarks or trade names Goodwill

Franchises or licenses

Chapter 11-24