Depreciation

Depreciation Methods
Management selects the method it believes best measures an asset’s
contribution to revenue over its useful life.

Examples include:
(1) Straight-line method
(2) Units-of-activity method
(3) Declining-balance method

9-1 LO 2 Explain the concept of depreciation and how to compute it.

 Depreciation

Illustration: National College's purchased a small delivery

truck on January 1, 2014.
Cost Br. 13,000Illustration 9-7 Expected
residual value Br. 1,000
Estimated useful life in year 5 years
Estimated useful life in miles 100,000
(1 mile 1.609344 KM)=>100,000*1.609344=160,934.4km)

Required: Compute depreciation using the following.

(a) Straight-Line. (b) Units-of-Activity. (c) Declining Balance.

9-2 LO 2 Explain the concept of depreciation and how to compute it.

 Depreciation

Straight-Line
◆ Expense is same amount for each year.
◆ Depreciable cost = Cost less residual value.
Illustration 9-8

9-3 LO 2 Explain the concept of depreciation and how to compute it.

 Depreciation

Illustration: (Straight-Line Method)

Illustration 9-10

Br. 12,000 20% Br. 2,400 Br . 2,400 Br. 10,600

2015 12,000 20 2,400 4,800 8,200
2016 12,000 20 2,400 7,200 5,800
2017 12,000 20 2,400 9,600 3,400
2018 12,000 20 2,400 12,000 1,000

2014 Depreciation expense

Journal 2,400
Entry
Accumulated depreciation 2,400
Depreciable Annual Accum. Book Year Cost x Rate = Expense
Deprec. Value

9-4 LO 2 Explain the concept of depreciation and how to compute it.

 Partial
Depreciation Year
Illustration: (Straight-Line Method)
Assume the delivery truck was purchased on April 1, 2014.
From April. to Dec, is 9 month
Current
Depreciable Annual Partial Year Accum.
Year Cost Rate Expense Year Expense Deprec.
2014 € 12,000 x 20% = € 2,400 x 9/12 = € 1,800 € 1,800
2015 12,000 x 20% = 2,400 2,400 4,200
2016 12,000 x 20% = 2,400 2,400 6,600
2017 12,000 x 20% = 2,400 2,400 9,000
2018 12,000 x 20% = 2,400 2,400 11,400
2019 12,000 x 20% = 2,400 x 3/12 = 600 12,000
€ 12,000
From Jan. to March is 3 month
Journal entry:
2014 Depreciation expense 1,800
Accumulated depreciation 1,80
9-5
 Depreciation
0
LO 2

Units-of-Activity
◆ Companies estimate total units of activity to calculate
depreciation cost per unit.

◆ Expense varies based

on units of activity. Illustration 9-10

◆ Depreciable cost is
cost less residual
value.
Illustration: (Units-of-
Activity Method)
Illustration 9-11

9-6 LO 2 Explain the concept of depreciation and how to compute it.

 Depreciation
Units of Cost per Annual Accum. Book
Year Activity x Unit = Expense Deprec. Value
2014 15,000 Br. 0.12 Br. 1,800 Br. 1,800 Br. 11,200
2015 30,000 0.12 3,600 5,400 7,600
2016 20,000 0.12 2,400 7,800 5,200
2017 25,000 0.12 3,000 10,800 2,200
2018 10,000 0.12 1,200 12,000 1,000

2014 Depreciation expense

Journal
1,800
Entry Accumulated depreciation 1,800

9-7 LO 2 Explain the concept of depreciation and how to compute it.

 Depreciation
Declining-Balance
◆ Accelerated method.
◆ Decreasing annual depreciation expense over the asset’s
useful life.
◆ Twice the straight-line rate with Double-Declining-Balance.
◆ Rate applied to book value.
Illustration 9-12

9-8 LO 2 Explain the concept of depreciation and how to compute it.

 Depreciation
Illustration: (Declining-Balance Method)
Declining Illustration 9-13

Beginning Balance Annual Accum.Book Year Book value x

Rate = Expense Deprec.Value

2014 Br. 13,000 40% Br. 5,200 Br. 5,200 Br. 7,800
2015 7,800 40 3,120 8,320 4,680
2016 4,680 40 1,872 10,192 2,808
2017 2,808 40 1,123 11,315 1,685
2018 1,685 40 685* 12,000 1,000
2014 Depreciation expense 5,200
Journal

Entry Accumulated depreciation

5,200 LO 2
9-9
 * Computation of $674 ($1,685 x 40%) is adjusted to $685.

Partial
Depreciation Year
Illustration: (Declining-Balance Method)
From Jan. to Sep, is 9 month
Declining Current
Beginning Balance Annual Partial Year Accum.
Year Book Value Rate Expense Year Expense Deprec.
2014 € 13,000 x 40% = € 5,200 x 9/12 = € 3,900 € 3,900
2015 9,100 x 40% = 3,640 3,640 7,540
2016 5,460 x 40% = 2,184 2,184 9,724
2017 3,276 x 40% = 1,310 1,310 11,034
2018 1,966 x 40% = 786 786 11,821
2019 1,179 x 40% = 472 Plug 179 12,000
€ 12,000
Journal entry:
2014 Depreciation expense 3,900
9-10
 Accumulated depreciation 3,900

Depreciation
Comparison of Methods

9-11
 Annual depreciation varies considerably among the methods,
but total depreciation expense is the same (Br. 12,000) for the
fiveyear period.
LO 2

Depreciation
Component Depreciation
◆ IFRS requires that each part of an item of
property, plant, and equipment that is
significant to the total cost of the asset must
be depreciated separately.

9-12
◆ Requires that any significant parts of a plant
asset that have significantly different estimated
useful lives should be separately depreciated.

9-13
Component Depreciation
Illustration: Sur Construction builds an office building for Br. 4,000,000. The
building is estimated to have a 40-year useful life,
➢ however Br. 320,000 of the cost of the building relates to personal
property and Br. 600,000 relates to land improvements. Because the
personal property has a depreciable life of 5 years and the land
improvements have a depreciable life of 10 years, Sur must use component
depreciation. Assuming that Sur uses straight-line depreciation and no
residual value (Br. 0), component depreciation for the first year of the
office building is computed as follows.
Building cost adjusted (Br. 4,000,000 – Br. 320,000 – Br. 600,000 ) Br. 3,080,000
Component Depreciation
Building cost depreciation per year (Br. 3,080,000 / 40 ) Br. 77,000
Personal property depreciation (Br. 320,0000 / 5 ) Br. 64,000
Land improvement depreciation ( Br. 600,000 / 10 ) Br. 60,000
9-29
Total Component depreciation in first year Br. 201,000
Component Depreciation…..

9-15
Illustration: Ethiopia Airlines purchases an airplane for Br.
100,000,000 on January 1, 2016. The airplane has a useful life
of 20 years and a residual value of Br. 0. : Ethiopia Airlines
the straight-line method of depreciation for all its airplanes. :
Ethiopia Airlines identifies the following components, amounts,
and useful lives.
LO 4

9-16
 Component Depreciation
Computation of depreciation expense for : Ethiopia
Airlines for 2016.
Computation of Component Depreciation

Depreciation journal entry for 2016.

Depreciation Expense 8,600,000
Accumulated Depreciation—Airplane 8,600,000
9-17
 LO 4

9-18
 Depreciation
Depreciation and Income Taxes
Tax laws often do not require corporate taxpayers to use the same
depreciation method on the tax return that is used in preparing
financial statements.

Many corporations use

◆ straight-line in their financial statements to maximize net

income.

◆ an accelerated-depreciation method on their tax returns to

minimize their income taxes.

9-19 LO 2 Explain the concept of depreciation and how to compute it.

 Depreciation
Revising Periodic Depreciation
◆ Accounted for in the period of change and future
periods (change in estimate).

◆ No restatement of prior years depreciation expense.

Illustration: National College, purchased equipment for Br. 510,000
which was estimated to have a useful life of 10 years with a residual
value of Br. 10,000 at the end of that time. Depreciation has been
recorded for 7 years on a straight-line basis. In 2017 (year 8), it is
determined that the total estimated life should be 15 years with a
residual value of Br. 5,000 at the end of that time.

9-20 LO 2 Explain the concept of depreciation and how to compute it.

 Depreciation
Questions:
◆ What is the journal entry to correct prior years’
depreciation expense? No Entry
Required
◆ Calculate the depreciation expense for 2017.

After 7 years

First, establish Net

Equipment cost Br. 510,000 residual book value (NBV) at
value - 10,000 date of change in
Depreciable base 500,000 estimate.
Useful life (original) 10 years

Annual depreciation Br. 50,000 x 7 years = Br. 350,000

9-21 LO 2 Explain the concept of depreciation and how to compute it.

 Depreciation

Balance Sheet (Dec. 31, 2016)

Property, Plant, and Equipment
Equipment Br. 510,000
Accumulated depreciation 350,000

Net book value (NBV) Br. 160,000

After 7 years

Net book value Br. 160,000 residual

value (new) 5,000 Depreciation
Expense calculation
Depreciable base 155,000 for 2017.

9-22 LO 2 Explain the concept of depreciation and how to compute it.

 Depreciation
Useful life remaining 8 years

Annual depreciation Br. 19,375

Journal entry for 2017 and future years.

Depreciation expense 19,375

Accumulated depreciation 19,375

9-23 LO 2 Explain the concept of depreciation and how to compute it.

 Revaluation of Plant Assets
IFRS allows companies to revalue plant
assets to fair value at the reporting date.

If revaluation is used,

◆ it must be applied to all assets in a

class of assets.

9-24 LO 2 Explain the concept of depreciation and how to compute it.

 ◆ assets experiencing rapid price
changes must be revalued on an
annual basis.
Revaluation of Plant Assets
Illustration: Kality Company applies revaluation to equipment with a
book (carrying) value of Br. 1,000,000, a useful life of 5 years, and no
residual value. Kality makes the following journal entries in year 1,
assuming straight-line depreciation. (2,000,000/5=200,000, Year 1

9-25
Depreciation Expense )
At the end of year 1, independent appraisers determine that
the asset has a fair value of Br. 850,000.The entry to record
the revaluation is as follows.
Accumulated Depreciation 200,000
Equipment
Depreciation expense 200,000 150,000
Revaluation
AccumulatedSurplus
depreciation 50,000
200,000
50,000 is the difference between the fair value of Br. 850,000 and the book
value of Br. 800,000, (1,000,000 9-38 - 0200,0000= 800,000)
 Revaluation of Plant Assets
Illustration -18
9
Statement presentation of plant assets (equipment) and revaluation surplus

As indicated,
◆ Br. 850,000 is the new basis of the asset.
◆ Depreciation expense of Br. 200,000 in the income statement.
◆ Br. 50,000 in other comprehensive income.
◆ Assuming no change in the total useful life, depreciation in year 2 will
be Br. 212,500 (Br. 850,000 ÷ 4).
9-27
 Expenditures During Useful Life

Ordinary Repairs - expenditures to maintain the operating efficiency

and productive life of the unit.

◆ Debit – Maintenance and Repairs Expense.

◆ Referred to as revenue expenditures.

Additions and Improvements - costs incurred to

increase the operating efficiency, productive capacity, or
useful life of a plant asset.
◆ Debit - the plant asset affected.
◆ Referred to as capital expenditures.

9-28
 Plant Asset Disposals
LO 3 Distinguish between revenue and capital expenditures,
and explain the entries for each.
Companies dispose of plant assets in three ways—Sale,
Retirement, or Exchange (appendix).
Illustration 9-19

Record depreciation up to the date of disposal.

Eliminate asset by

(1) debiting Accumulated Depreciation, and

9-29
 Plant Asset Disposals
(2
crediting the asset account.

Retirement of Plant Assets

◆ No cash is received.

◆ Decrease (debit) Accumulated Depreciation for

the full amount of depreciation taken over the life of
the asset.

◆ Decrease (credit) the asset account for the original cost of

the asset.

◆ Record any difference as gain or loss on disposal.

9-30 LO 4 Explain how to account for the disposal of a plant asset.

 Plant Asset Disposals
Illustration: ABC Enterprises retires its computer printers,
which cost Br.32,000. The accumulated depreciation on these
printers is Br.32,000. Prepare the entry to record this retirement.

Accumulated depreciation 32,000

Equipment 32,000
Question: What happens if a fully depreciated plant asset is still
useful to the company?
Answer: In this case, the asset and its accumulated
depreciation continue to be reported on the statement of
financial position, without further depreciation adjustment,
until the company retires the asset

9-31 LO 4 Explain how to account for the disposal of a plant asset.

 Plant Asset Disposals
Illustration: Sunset Company discards delivery equipment that cost
Br. 18,000 and has accumulated depreciation of Br. 14,000. The journal
entry is?

Accumulated depreciation 14,000

Loss on disposal of plant assets 4,000
Equipment 18,000
Companies report a loss on disposal in the “Other income and
expense” section of the income statement.

9-32 LO 4 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.

9-33 LO 4 Explain how to account for the disposal of a plant asset.

 Plant Asset Disposals
Gain on Sale
Illustration: On July 1, 2014, Bright Company sells office furniture
for Br. 16,000 cash. The office furniture originally cost Br. 60,000.
As of January 1, 2014, it had accumulated depreciation of Br.
41,000. Depreciation for the first six months of 2014 is Br. 8,000.
Prepare the journal entry to record depreciation expense up to the date
of sale.

July 1 Depreciation expense 8,000

Accumulated depreciation 8,000

9-34 LO 4 Explain how to account for the disposal of a plant asset.

 Plant Asset Disposals
After the accumulated depreciation balance is updated, the company
computes the gain or loss. The gain or loss is the difference between the
proceeds from the sale and the book value at the date of disposal. Illustration
9-20 shows this computation for Bright Company, which has a gain on
disposal of Br. 5,000

Illustration: Bright records the sale as follows.

July 1 Cash 16,000
Accumulated depreciation 49,000
Equipment 60,000

9-35 LO 4 Explain how to account for the disposal of a plant asset.

 Gain on disposal of plant assets 5,000
Plant Asset Disposals

Illustration: Assume that instead of selling the office furniture

for Br. 16,000, Bright sells it for Br. 9,000.
Illustration 9-21
Computation of loss
on disposal

July 1 Cash 9,000

Accumulated depreciation 49,000
9-36 LO 4 Explain how to account for the disposal of a plant asset.
 Extractable Natural Resources
Loss on disposal of plant asset 2,000
Equipment 60,000
Natural resources consist of standing timber and resources
extracted from the ground, such as oil, gas, and minerals.

IFRS defines extractive industries as those businesses

involved in finding and removing natural resources located in
or near the earth’s crust.

Standing timber is considered a biological asset under IFRS. In

the years before they are harvested, the recorded value of
biological assets is adjusted to fair value each period.

9-37 LO 5 Compute periodic depletion of extractable natural resources.

 Extractable Natural Resources
Acquisition cost of an extractable natural resource is the
◆ price needed to acquire the resource and ◆ prepare it for its

intended use.

Depletion - allocation of the cost to expense in a rational and

systematic manner over the resource’s useful life.
◆ Depletion is to natural resources as depreciation is to plant
assets.

◆ Companies generally use units-of-activity method.

◆ Depletion generally is a function of the units extracted.

9-38 LO 5 Compute periodic depletion of extractable natural resources.

 Extractable Natural Resources
Illustration: Lane Coal Company invests Br. 50 million in a mine
estimated to have 10 million tons of coal and no residual value. In the
first year, Lane extracts and sells 800,000 tons of coal. Lane
computes the depletion expense as follows:

Br. 50,000,000 ÷ 10,000,000 = Br. 5 depletion cost per ton

Br. 5 x 800,000 = Br. 4,000,000 annual depletion expense

Journal entry:

Depletion expense 4,000,000

9-39 LO 5 Compute periodic depletion of extractable natural resources.

 Extractable Natural Resources
Accumulated depletion 4,000,000
Illustration 9-23
Statement presentation of accumulated depletion

Extracted resources that have not been sold are reported as

inventory in the current assets section.

9-40 LO 5 Compute periodic depletion of extractable natural resources.

 Intangible Assets
Intangible assets are rights, privileges, and competitive
advantages that result from ownership of long-lived assets that do
not possess physical substance.

Limited life or indefinite life.

Common types of intangibles:

◆ Patents ◆ Trademarks and Trade
Names
◆ Copyrights
◆ Franchises or licenses
◆ Goodwill
Limited-Life Intangibles:
9-41 LO 6 Explain the basic issues related to accounting for intangible assets.
 Accounting for Intangible Assets
Companies classify
◆ Amortize to expense. Amortization

◆ Credit asset account. Expense as an

operating expense
Indefinite-Life Intangibles: in the income
statement. ◆
No amortization.

Similar to property, plant, and equipment, IFRS

permits revaluation of intangible assets to fair
value, except for goodwill.

LO 6 Explain the basic issues related to accounting for intangible assets.

9-42
 Accounting for Intangible Assets
Patents
◆ Exclusive right to manufacture, sell, or otherwise control an
invention for a specified number of years from the date of
the grant.

◆ Capitalize costs of purchasing a patent and amortize over

its legal life or its useful life, whichever is shorter.

◆ Expense any Research and Development costs in

developing a patent.

◆ Legal fees incurred successfully defending a patent are

capitalized to Patent account.
Illustration: National Labs purchases a patent at a cost of Br.
720,000. National estimates the useful life of the patent to be
9-43 LO 6 Explain the basic issues related to accounting for intangible assets.
 Accounting for Intangible Assets
eight years. National records the annual amortization for the
ended December 31 as follows.
Cost Br. 720,000
Useful life ÷ 8 years
Annual expense Br. 90,000

Dec. 31
Amortization expense 90,000
Patent 90,000
LO 6

Copyrights
◆ Give the owner the exclusive right to reproduce and sell an
artistic or published work.
9-44
 Accounting for Intangible Assets
◆ Granted for the life of the creator plus a specified number of
years, commonly 70 years.

◆ Capitalize costs of acquiring and defending it.

◆ Amortized to expense over useful life.

9-45 LO 6 Explain the basic issues related to accounting for intangible assets.
 Accounting for Intangible Assets

Trademarks and Trade Names

◆ Word, phrase, jingle, or symbol that identifies a particular
enterprise or product.
► Wheaties, Monopoly, Kleenex, Coca-Cola, Big Mac, and
Jetta.

◆ Legal protection for specified number of years, commonly

20 years. Protection may be renewal indefinitely.

◆ Capitalize cost of acquisition.

◆ No amortization.

9-46 LO 6 Explain the basic issues related to accounting for intangible assets.
 Accounting for Intangible Assets

Franchises and Licenses

◆ Contractual arrangement between a franchisor and a
franchisee.
► BP (GBR), Subway (USA), and Europcar are
franchises.

◆ Franchise (or license) with a limited-life should be

amortized to expense over its useful life.

◆ Franchise (or license) with an indefinite life is not

amortized.

9-47 LO 6 Explain the basic issues related to accounting for intangible assets.
 Accounting for Intangible Assets

Goodwill
◆ Includes exceptional management, desirable location,
good customer relations, skilled employees, high-quality
products, etc.

◆ Only recorded when an entire business is purchased.

◆ Goodwill is recorded as the excess of cost over the fair

value of the net assets acquired.

◆ Internally created goodwill should not be capitalized.

◆ Not amortized.

9-48 LO 6 Explain the basic issues related to accounting for intangible assets.
 Research and Development Costs

Expenditures that may lead to

◆ patents,

◆ copyrights, All R & D costs

are expensed
◆ new processes, and ◆ new when incurred.

products.

Research and Development Costs

9-49 LO 6 Explain the basic issues related to accounting for intangible assets.
 Illustration: Laser Scanner Company spent Br. 1 million on
research and Br. 2 million on development of new products. Of
the Br. 2 million in development costs Br. 500,000 was incurred
prior to technological feasibility and Br. 1,500,000 was incurred
after technological feasibility had been demonstrated. The
company would record these costs as follows.
Research expense 1,000,000
Development expense 500,000
Development costs 1,500,000
Cash 3,000,000

9-50 LO 6 Explain the basic issues related to accounting for intangible assets.
 Illustration: Identify the term most directly associated with
each statement.
1. The allocation of the cost of an extractable
natural resource to expense in a rational and Depletion
systematic manner.
2. Rights, privileges, and competitive
advantages that result from the ownership Intangible
of long-lived assets that do not possess
Assets
physical substance.
3. An exclusive right granted by a government
to reproduce and sell an artistic or Copyrights
published
work.

9-51 LO 6 Explain the basic issues related to accounting for intangible assets.
 Illustration: Identify the term most directly associated with
each statement.
4. A right to sell certain products or services or
to use certain trademarks or trade names Franchises
within a designated geographic area.
5. Costs incurred by a company that often lead to patents or
new products. These Research costs must be expensed
as incurred.

9-52 LO 6 Explain the basic issues related to accounting for intangible assets.
 Presentation Illustration 9-24

LO 7
9-53
9-54