Depreciation

Depreciation Methods
Methods
 GAAP

 Depreciation is a systematic and rational process of

distributing the cost of tangible assets over the life of
assets.
 Depreciation is a process of allocation.
 Cost to be allocated = acquisition cost - salvage value
 Allocated over the estimated useful life of assets
 Allocation method should be systematic and rational.
 Depreciation Methods

 Depreciation methods based on time:

 Straight line method
 Declining balance method
 Sum-of-the-years'-digits method
 Depreciation based on use (activity)
 Straight Line Depreciation Method

Depreciation = (Cost - Residual value) / Useful life

Ex:
On April 1, 2011, Company A purchased an equipment at the cost of
$140,000.  This equipment is estimated to have 5 year useful life.  At the end of
the 5th year, the salvage value (residual value) will be $20,000.  Company A recognizes
depreciation to the nearest whole month.  Calculate the depreciation expenses for
2011,  2012 and 2013 using straight line depreciation method.  
       Depreciation for 2011
           = ($140,000 - $20,000) x 1/5 x 9/12 = $18,000
       Depreciation for 2012
           = ($140,000 - $20,000) x 1/5 x 12/12 = $24,000
       Depreciation for 2013
           = ($140,000 - $20,000) x 1/5 x 12/12 = $24,000
 Declining Balance Depreciation Method

Depreciation = Book value x Depreciation

rate
   
 Book value = Cost - Accumulated depreciation
       
 For double declining balance method:
Depreciation rate = Straight line depreciation rate x
200%
 Double declining balance depreciation

      On April 1, 2011, Company A purchased an equipment at the cost of $140,000.  This
equipment is estimated to have 5 year useful life.  At the end of the 5th year, the
salvage value (residual value) will be $20,000.  Company A recognizes depreciation
to the nearest whole month.  Calculate the depreciation expenses for 2011,  2012 and
2013 using double declining balance depreciation method.  
       Useful life = 5 years  -->  Straight line depreciation rate = 1/5 = 20% per year
       Depreciation rate for double declining balance method 
            = 20% x 200% = 20% x 2 = 40% per year
       Depreciation for 2011
           = $140,000 x 40% x 9/12 = $42,000
       Depreciation for 2012
           = ($140,000 - $42,000) x 40% x 12/12 = $39,200
       Depreciation for 2013
= ($140,000 - $42,000 - $39,200) x 40% x 12/12 = $23,520
 Double declining balance depreciation
Book
Value Depreciation Depreciation Book Value at
Year
at the Rate Expense the year-end
beginning

2011 $140,000 40% $42,000 (*1) $98,000

2012 $98,000 40% $39,200 (*2) $58,800

2013 $58,800 40% $23,520 (*3) $35,280

2014 $35,280 40% $14,112 (*4) $21,168

2015 $21,168 40% $1,168 (*5) $20,000

 Double declining balance depreciation

   (*1) $140,000 x 40% x 9/12 = $42,000

(*2) $98,000 x 40% x 12/12 = $39,200
(*3) $58,800 x 40% x 12/12 = $23,520
(*4) $35,280 x 40% x 12/12 = $14,112
(*5) $21,168 x 40% x 12/12 = $8,467 
 
Depreciation for 2015 is $1,168 to keep book
value same as salvage value.
$21,168 - $20,000 = $1,168 (At this point,
depreciation stops.)
 RECORDING DEPRECIATION TRANSACTION

On April 3, the business purchased furniture on

account for $16,500. The furniture is expected to
last 5 years.

Furniture Accounts Payable

16,500 16,500
 RECORDING DEPRECIATION TRANSACTION

What is the adjusting entry on April 30?

General Journal
Date Accounts and Explanations PR Debit Credit
April 30 Depreciation Expense, Furniture 275
Accumulated Depreciation,
Furniture 275
To record depreciation
 Book Value

The net amount of a plant asset (cost minus

accumulated depreciation)

Plant Assets of Air & Sea at April 30, 20x5

Furniture $ 16,500
Less Accumulated Depreciation (275) $ 16,225
Building $ 48,000
Less Accumulated Depreciation (200) 47,800
Book value of plant assets $ 64,025
 ACCUMULATED DEPRECIATION VS.
DEPRECIABLE COST

 Accumulated Depreciation = Original Cost – Book Value

 Depreciable Cost = Original Cost – Salvage Value
 Depreciable Cost > Accumulated Depreciation  Book Value >
Salvage Value
 Depreciable Cost = Accumulated Depreciation  Book Value =
Salvage Value
 Book Value NEVER SMALLER than Salvage Value
 Depreciable Cost is how much an asset CAN be
depreciated
 Accumulated Depreciation is how much an asset HAS
been depreciated already
4 DIFFERENT TIMELINE
ACCTS
 ACCRUED REVENUE

Example: Products are sold at $5,000 on May 1, 2010 and cash is received on May 10, 2010.
1-May-10 10-May-10
Revenue is Cash is
recognized. received.

[Journal entry on May 1, 2010]

Debit Credit
Accounts receivable 5,000
Sales 5,000

[Journal entry on May 10, 2010]

Debit Credit
Cash 5,000
Accounts receivable 5,000
 ACCRUED EXPENSE
 Example: On May 1, 2010, Company A borrowed $100,000 from a bank and promised
to pay 12% interest at the end of each quarter.
31-May-10 30-Jun-10
Interest expense is Cash is paid at the
recognized for May. end of the quarter.

[Journal entry on May 1, 2010]

Debit Credit
Cash 100,000
Borrowings from bank 100,000

[Journal entry on May 31, 2010]

Debit Credit
Interest expense 1,000
Interest payable 1,000

$100,000 x 12% x 1/12 = $1,000 for each month.

Interest payable is a liability account.

Credit side of interest payable (a liability account) represents an increase.
 ACCRUED EXPENSE

[Journal entry on June 30, 2010]

Debit Credit
Interest expense 1,000
Interest payable 1,000

Credit side of interest payable (a liability account) represents an increase.

Debit Credit
Interest payable 2,000
Cash 2,000

Company pays $2,000 as interests for May and June.

Debit side of interest payable (a liability account) represents a decrease.
 UNEARNED REVENUE

Example: On May 1, 2010, Company A had a new lease contract with a tenant and
received $6,000 for two month rent.
1-May-10 May 31 and June 30 2010
Revenue is recognized at the
Cash is received.
end of May and June.

Revenue is recognized when Company A provides service. In this example, service is

provided when time passes.

[Journal entry on May 1, 2010]

Debit Credit
Cash 3,000
Unearned rent revenue 3,000

Unearned rent revenue is a liability account.

Credit side of unearned rent revenue (a liability account) represents an increase.

"Unearned revenue" accounts represent the amount of cash received before services are p

"Unearned revenue" accounts are liabilities of the company, because they should be
paid back to the other party if service is not provided in the future.
 UNEARNED REVENUE
[Journal entry on May 31, 2010]

Debit Credit
Unearned rent revenue 3,000
Rent revenue 3,000

Debit side of unearned rent revenue (a liability account) represents a decrease.

Credit side of rent revenue (a revenue account) represents an increase.

[Journal entry on June 30, 2010]

Debit Credit
Unearned rent revenue 3,000
Rent revenue 3,000

Debit side of unearned rent revenue (a liability account) represents a decrease.

Credit side of rent revenue (a revenue account) represents an increase.
 PREPAID EXPENSE
Example: Company A purchased an insurance for a period from May 1, 2010 to
July 31, 2010 and paid $6,000 cash for three month insurance premium.
1-May-10 May 31, June 30, July 31, 2010

Cash is paid. Expense is recognized at the

end of May, June and July.

[Journal entry on May 1, 2010]

Debit Credit
Prepaid insurance 6,000
Cash 6,000

Prepaid insurance is an asset account.

Debit side of prepaid insurance (an asset account) represents an increase.

[Journal entry on May 31, 2010]

Debit Credit
Insurance expense 2,000
Prepaid insurance 2,000

Credit side of prepaid insurance (an asset account) represents a decrease.

 PREPAID EXPENSE

[Journal entry on June 30, 2010]

Debit Credit
Insurance expense 2,000
Prepaid insurance 2,000

Credit side of prepaid insurance (an asset account) represents a decrease.

[Journal entry on July 31, 2010]

Debit Credit
Insurance expense 2,000
Prepaid insurance 2,000

Credit side of prepaid insurance (an asset account) represents a decrease.

CLOSING ENTRIES
 Closing Entries

 Prepare the accounts for the next period’s

transactions.
 Transfer the revenue, expense, and dividends
balances to Retained Earnings.
 Which Accounts Need To Be Closed?

 Temporary accounts are closed

 Revenue
 Expense
 Dividends
 Permanent accounts are not closed
 Assets
 Liabilities
 Stockholders’ equity
 Journalizing the Closing Entries
General Journal
Date Accounts and Explanations PR Debit Credit
April 30 Service Revenue 7,400
Retained Earnings 7,400

April 30 Retained Earnings 4,415

Rent Expense 1,000
Salary Expense 1,900
Supplies Expense 300
Depreciation Expense 275
Utilities Expense 400
Income Tax Expense 540

April 30 Retained Earnings 3,200

Dividends 3,200
 Posting the Closing Entries

Rent Expense Service Revenue

1,000 1,000 7,000
250
150
Salary Expense Retained Earnings 7,400 7,400
950 4,415 11,250
950 3,200 7,400
1,900 1,900 11,035

Other Expenses Dividends

1,515 1,515 3,200 3,200
 Classifying Assets and Liabilities

 List assets and liabilities in order of their relative

liquidity.
 Liquidity - how quickly an item can be converted
to cash.
Classifying Assets and Liabilities

Current assets

Long-term assets

Current liabilities

Long-term liabilities
Correction of posting
errors
 TYPES OF ERRORS

 Error of Omission – when a transaction is completely omitted

from the books
 Error of Commission-when an entry has been posted to the
correct side of the Ledger but to the wrong account
 Error of Principle-where a transaction has been treated
incorrectly as capital expenditure instead of revenue expenditure
 Compensating errors-where an error on the debit side is
compensated by an error of equal amount on the credit side.
 Error of Original entry-a wrong amount is recorded in the
subsidiary book and posted to the accounts.
 Complete Reversal Of Entries-where the correct accounts are
used but each item is shown on the wrong side of the account.
 Suspense Account

 Is created when we discovered errors before the

Final Accounts and Balance Sheet are prepared,
 The account is to records the difference between
the total of the debits and the total of the credits
in the Trial Balance and
 Suspense account helps to balance the Trial
Balance by temporarily putting into an account
which after the errors being found, the suspense
account be adjusted and become zero/nil
balance.
 Perpetual vs. Periodic System

Method >>>  Periodic Perpetual

Account used to record

Purchases Inventory
inventory purchases:

Appears on: Income Statement Balance Sheet

Merchandise cost is transferred

No adjustment to inventory is
from Inventory to Cost of
When a sale is made: necessary; merchandise cost is
Goods Sold -an Income
already on the Income Statement
Statement account

Adjust Inventory balance to

Adjust Inventory balance to agree with
agree with year-end physical
Year-end procedures: year-end physical count and
count and merchandise
merchandise value
value

Transfer Purchases balance to Cost of

Other procedures: Balances should now be correct
Goods Sold