2. Plant Assets - Depreciation

What id depreciation?

the process of allocating the cost of a plant asset to expense while it is in use.

What does depreciation not measure?

Decline in the asset's market or its physical deterioration.

What are the 3 factors that determine depreciation?

1. Cost

2. Salvage value

3. Useful life

What does the cost of a plant asset consist of?

All necessary and reasonable expenditure to acquire it and to prepare it for its intended use.

What is salvage value?

An estimate of the asset's value at the end of its useful life. This is the amount the owner expects to receive from disposing of the asset at the end of its useful life.

What are other names for salvage value?

Residual value or scrap value

If the asset is expected to be traded in on a new asset, what is its salvage value?

the expected trade-in value.

If we expect disposal costs, what is the salvage value?

The salvage value equals the expected amount received from disposal less any disposal costs.

What is useful life?

The length of time the plant asset is used in a company's operation. Useful life, or service life, might not be as long as the asset's total productive life.

Review

For example, the productive life of a computer can be eight years or more. Some companies, however, trade in old computers for new ones every two years. In this case, these computers have a two-year useful life.

What is the useful life of a plant asset impacted by?

Inadequacy and obsolescence.

What is inadequacy?

The inability of a plant asset to meet its demands.

What is obsolescence?

The process of becoming outdated and no longer used.

Review

Useful life and salvage value are estimates.

What are the 3 depreciation methods we learn?

1. Straight-Line method

2. Units of Production method

3. Declining-Balance method

What are depreciation methods used to do?

To allocate a plant asset’s cost over its useful life.

What is the most frequently used depreciation method?

The straight-line method. Though the units-of -production and double-declining method are also commonly used.

What is the straight-line method?

Charges the same amount to each period of the asset's useful life

What is the first step in the two step process for straight-line depreciation?

Compute the depreciable cost of the asset, also called cost to be depreciated.

How do we compute the depreciable cost of the asset?

It is computed as plant asset total cost - salvage value.

What is the second step in the two step process for straight-line depreciation?

Depreciable cost is divided by the number of accounting periods in the asset's useful life.

What is the straight-line depreciation formula?

(cost - salvage value) / useful life in periods

What is the end of period adjusting entry that we make at the end of each year of the asset’s useful life?

debit Depreciation expense for amount calculated with straight-line formula, credit Accumulated Depreciation - Accuont name for same amount

Which statement is depreciation expense reported on?

The income statement

What type of account is Accumulated Depreciation?

A contra asset account to the plant asset account (for example Machinery)

What statement does Accumulated Depreciation account go on?

The balance sheet

Is accumulated depreciation a normal debit or credit account?

Credit.

Review Example under straight-line method starting under exhibit 10.6

What is the net balance sheet amount?

The asset book value or book value.

What is book value?

asset’s total cost - accumulated depreciation

Review example under figure 10.7 in straight-line method.

How do we compute the straight-line depreciation rate?

100% / number of periods in the asset’s useful life

What does the straight-line depreciation schedule show?

1. Straight-line depreciation is the same in each period.

2. Accumulated depreciation is the total of current and prior period's depreciation expense.

3. Book value declines each period until it equals salvage value - at that point, we stop depreciating the asset.

Review straight-line depreciation schedule figure.

When is it best to use the units-of-production method?

The use of some plant assets varies greatly from one period to the next. When equipment varies form period to period, the units-of-production depreciation method can better match expenses with revenues.

What is an example of use of plant assets varying?

For example, a builder might use a piece of equipment for a month and then not use it again for several months.

How does units-of-production depreciation work?

Charges a varying amount for each period depending on an asset's usage.

What is the first step in the two step process for units-of-production depreciation?

Compute depreciation per unit as:

(asset's total cost - salvage value) / by the total units expected to be produced during its useful life.

How can units of production be expressed?

In product or other units such as hours or miles driven.

What is the second step in the two step process for units-of-production depreciation?

Compute depreciation expense for the period: depreciation per unit * the units produced in the period.

If a machine that inspects shoes cost is 10,000, has a salvage value of 1,000 and is expected to inspect 36,000 shoes, what is it’s depreciation per unit?

(10,000 - 1,000) / 36,000 shoes = .25 per shoe.

If a machine that inspects shoes cost is 10,000, has a salvage value of 1,000 ,is expected to inspect 36,000 shoes total, and 7,000 shoes are inspected and sold in its first year, what is the depreciation expense for the first year?

.25 per shoe x 7,000 shoes = 1,750.

Review explanation for figure 10.9 under units of production method.

What does the units-of-production schedule depreciation show?

1. Depreciation expense depends on unit output.

2. Accumulated depreciation is the total of current and prior period's depreciation expense.

3. Book value declines each period until it equals salvage value. Once an asset's book value equals its salvage value, depreciation stops.

Review exhibit 10.10.

What is an accelerated depreciation method (in our case the declining-balance method)?

Has more depreciation in the early years and less depreciation in later years.

What depreciation rate does declining-balance method use?

A depreciation rate that is a multiple of the straight-line method.

What is a common depreciation rate?

Double the straight-line rate.

What is double-declining-balance (DDB)?

Using a depreciation rate that is double the straight-line rate.

What is the first step when using the declining-balance method and the depreciation rate is double the straight-line method?

1. Compute the asset's straight-line depreciation rate. (100% / number of period's in asset's useful life)

What is the second step when using the declining-balance method and the depreciation rate is double the straight-line method?

2. Double the straight-line rate to get the declining-balance rate:

Double-declining-balance rate = 2 x straight-line rate

What is the third step when using the declining-balance method and the depreciation rate is double the straight-line method?

3. Compute depreciation expense:

double-declining-balance rate (from step 2) x beginning-period book value.

Review explanation of exhibit 10.11 (starts above it).

Review the double-declining-balance depreciation schedule.

Review figure under Comparing Depreciation methods

What do many companies use in computing taxable income?

accelerated depreciation.

Why is it beneficial to companies to use accelerated depreciation in computing taxable income?

Reporting higher depreciation expense in the early years of an asset's life reduces the company's taxable income in those years and increases it in later years. The goal is to postpone its tax payments.

What is the U.S. tax law for depreciating assets called “Modified Accelerated Cost Recovery System” (MACRS)?

Allows straight-line depreciation for some assets but requires accelerated depreciation for most kinds of assets.

Why is Modified Accelerated Cost Recovery System (MACRS) not acceptable for financial reporting?

MACRS is not acceptable for financial reporting because it does not consider an asset's useful life or salvage value.

When is partial-year depreciation used?

When an asset is purchased and sold at a time other than the beginning or and end of an accounting period.

How do we calculate partial-year depreciation expense (assume straight-line method) for mid-period asset purchase?

We do the usual calculation: (cost - salvage value) / useful life in periods and then multiply by number of months / 12 that the plant asset was in use.

Review example for mid-period asset purchase.

How do we calculate partial-year depreciation expense (assume straight-line method) for mid-period asset sale?

We do the usual calculation: (cost - salvage value) / useful life in periods and then multiply by number of months / 12 that the plant asset was in use before it was sold.

Review mid-period asset sale example.

When are assets usually recorded as purchased on the 1st of a month?

If the assets are purchased on days 1 through 15 of a month.

When are assets usually recorded as purchased on the 1st of the next month?

Assets purchased on days 16 to month-end

Depreciation is based on estimates of salvage value and useful life. If our estimate of an asset's useful life and/or salvage value changes, what should we do?

Use the new estimate to compute depreciation for current and future periods.

What is revising an estimate of the useful life or salvage value of a plant asset called?

change in an accounting estimate

What does change in an accounting estimate affect?

Only affects current and future financial statements.We do not go back and reinstate (change) prior years' statements. This applies to all depreciation methods.

If at the beginning of an asset’s third year, the book value is $6,400 and the estimated number of years remaining in its useful life changes from three to four years and its estimate of salvage value changes from $1,000 to $400, what is the revised straight-line depreciation expense?

(book value - revised salvage value) / revised remaining useful life = ($6,400 - $400) / 4 years = $1,500 per year.

Review example under figure 10.8 and review the figure

Review Need-To-Know 10-2