Accounting for Depreciation

LOC 1
Accounting for Depreciation
 Fixed assets other than land lose their ability over
time to provide services
 Costs of equipment, buildings, and land
improvements should be transferred to expense
accounts in a systematic manner during their
expected useful lives.
 Adjusting entry to record depreciation is usually
made at the end of each month or at the end of
the year
 Adjusting Entry

Account Debit Credit

Depreciation expense $7,000

Provision / Accumulated depreciation - $7,000

truck
 Depreciation
Accumulated/Provision for depreciation
 Shows the amount that the asset has lost in value since its
purchase
Depreciation expense
 Shows the amount that the asset has lost in value this
period/ year .
Factors that cause a decline the ability of a fixed
asset to provide services may be identified as
 Physical depreciation
 Occurs from the wear and tear while in use and from the action
of the weather
 Functional depreciation
 Occurs when a fixed asset is no longer able to provide services
at the level for which it was intended.
 Factors in Computing
Depreciation Expense
The fixed asset’s initial cost
Its expected useful life(year)

Its estimated value at the end of

its useful life.(scrap value/

residual value/ salvage)
 Depreciation Methods

Straight line method

Declining / Reducing balance
method
 Straight line Method
Provides for the same amount of
depreciation expense for each year of
the asset’s useful life
Annual depreciation expense =
Cost – scrap value
No of expected Life
Or
= Cost x %
 Example 1
A machine had a cost of $24,000, salvage value of
$2,000 and useful life of 5 years
Annual depreciation expense =

Cost – Salvage value

Life
= ($24,000 - $2,000)
5 years

= $4,400 annual depreciation

 Adjusting entry

Account Debit Credit

Depreciation expense $4,400

Accumulated depreciation - truck $4,400

 Example 2
A machine had a cost of $30,000,
salvage of $5,000 and useful life of 6
years. Compute depreciation under the
straight line method?

(30,000 – 5000) = 4,167 annual

6
 Example 2
What is depreciation expense in year 3?
= 4,167.
 Declining Balance Method
(Reducing Balance Method)
Provides for a declining periodic
expense over the estimated useful life
of the asset.
Net Book value (NBV)
= Cost – Accumulated depreciation
 Declining Balance Method
(Reducing Balance Method)
Depreciation expense =
Beginning of Net book value X Rate %

 Rule: the book value may never by less than

the salvage value of the asset
 Example 3:
A machine had a cost of $24,000, salvage value of $2,000,
estimated life of five year. The rate is 40%. Compute depreciation
Year Cost Acc. Book Rate Depreciation NBV
Depreciation
value at (cost –
beginning Acc. Dep)
of year

1 $24,000 $24,000 40% $9,600 $14,400

2 24,000 9,600 14,400 40% 5,760 8,640

3 24,000 15,360 8,640 40% 3,456 5,184

4 24,000 18,816 5,184 40% 2,073.60 3,110.40

5 24,000 20,889.60 3110.40 1,110.40 2,000

Another way of calculation
Yea Accumulated
r Depreciation
1 Cost 24,000
-Depreciation (40%x24,000) (9,600) 9,600
NBV 14,400 +
2 Depreciation (40%x14,400) (5,760) =15,360
NBV 8,640
3 Depreciation (40%x8,640) (3,456) 18,816
NBV 5,184
4 Depreciation (40%x,5184) (2,074) 20,890
NBV 3,110
5 Depreciation (3110-2000) (1,110) 22,000
NBV 2,000
 Revision of Depreciation
Revising the estimates of the residual
value and the useful life is normal
Used to determine depreciation
expense in future periods
 Example 4
Assumed a fixed asset purchased for
$130,000 was originally estimated to have a
useful life of 30 years and a residual value of
$10,000. The asset has been depreciated for
10 years by the straight line method.
At the end of ten years, the asset’s book
value of $90,000. During 11th year, it is
estimated that the remaining useful life is 25
years and that the residual value is $5,000.
Compute depreciation expense for the 11 th
year using the new information provided.
 Answer
Depreciation expense=
= $130,000-$10,000
30
= $ 4,000.00 per year before changes

Accumulated Depreciation balance

=$4,000 X 10 years
= $40,000

Book value
= $130,000.00 – $40,000 = $90,000
 Answer
New depreciation expense =
Book value – new salvage
Remaining life
= ($90,000-$5,000)
25
= $ 3,400.00 per year for remaining years
 Disposal of Fixed Assets
Discarding of Fixed Assets
 When asset has no residual value and is
fully depreciated.
 Example 8
 Asset with a cost of $25,000 and fully
depreciated is discarded

Account Debit Credit

Accumulated Depreciation $25,000

Fixed Asset $25,000

 Selling of Fixed Assets
Three things can happen
 Sale at book value
 No gain or loss
 Sale below book value
 Loss is recognized
 Sale after book value
 Gain is recognized
 Selling at book value
Example 9:
 Asset with cost of $25,000 and Accumulated
Depreciation of $10,000 is sold for $15,000 cash.

Account Debit Credit

Cash $15,000
Accumulated depreciation $10,000
Fixed Asset $25,000
 Selling price above book
value
Gain is recognized
Example 10:
 Asset with cost $25,000, Accumulated
Depreciation of $10,000 is sold for $20,000 cash.

Account Debit Credit

Cash $20,000
Accumulated depreciation $10,000
Fixed Asset $25,000
Gain on disposal of asset $5,000
 Selling price below book value
Loss is recognized
Example 11: Asset with cost of $25,000, Accumulated
Depreciation of $10,000 is sold for $12,000 cash.

Account Debit Credit

Cash $12,000
Accumulated Depreciation $10,000
Loss on disposal of asset $3,000
Fixed Asset $25,000
Exchanging Similar Assets
 Old equipment is often traded in for new
equipment having a similar use.
 The seller allows the buyer an amount for

the old equipment traded in called TRADE

IN ALLOWANCE.
 The remaining balance – the amount owed

is either paid in cash or recorded as a

liability – called BOOT
 Gain on exchanges
Not recognized for financial reporting
purposes.
When trade-in allowance exceeds the book
value of an asset traded in and no gain is
recognized, the cost recorded for the new
asset can be determined in either of two
ways:
 Cost of new asset = List price + Unrecognized gain
 Cost of new asset = Cash given + book value of oldNot
recognized for financial reporting purposes.
 Example 9
New equipment is purchased with a list price
of $5,000, trade in allowance of old is $1,100,
cost of old equipment is $4,000, accumulated
depreciation $3,200. Record the entry. New
equipment is purchased with a list price of
$5,000, trade in allowance of old is $1,100,
cost of old equipment is $4,000, accumulated
depreciation $3,200. Record the entry.
 Example 9
Account Debit Credit
Fixed Asset – new $800
Accumulated Depreciation $3,200
Fixed Asset – old $4,000
 Losses on Exchange
 For financial reporting purposes, losses are
recognized on exchanges of similar fixed
assets.
 If trade in is less than the book value of

the old equipment, there is a loss

 Example 10
New equipment is purchased with a list price
of $5,000, trade in allowance of old is $700,
cost of old equipment is $4,000, accumulated
depreciation $3,200. Record the entry.

Account Debit Credit

Fixed Asset – new $700
Accumulated Depreciation $3,200
Loss on exchange of asset $100
Fixed Asset – old $4,000