A QUICK DEPRECIATION AND AMORTIZATION DISCUSSION

Recall the Elements needed for Depreciation:

· Cost

· Salvage value

· Lifetime in years, sometimes months

· Useful life, in units (if using units of activity)

Recall the formula:

Cost less Salvage value/ lifetime or useful life

And now, the so called straight line method.

Assume an asset costs $13,000, with salvage value of $1000, lifetime of 10 years.

13,000 - $1,000 =12,000/ 10 years or $1,200 year or $1,200/12 months = $100/month

the $12,000 is the so called “depreciable cost”

Thus:

Year Dep Cost Rate Annual Dep Exp Accu. Dep Book Value

Year 1 $12,000 * 10%= 1,200 $1,200 11,800**

Yr. 2 1,200 2,400 10,600

Yr. 3 1,200 3,600 9,400

Yr 4 1,200 4,800 8,200

Yr. 5 1,200 6,000 7,000

Etc

After 10 years, 12,000 1,000

** 13,000 – 1,200= 11,800

Recall the basic entry:

Dr. Depr Exp 1,200

Cr. Acc dep- asset 1,200

To record annual depreciation expense

Declining Balance:

Basically double the straight line method, except salvage value is not removed

Thus,

Yr. 1 13,000 * 20% 2,600 2,600 10,400***

Yr. 2 10,400 * 20% 2,080 2,080 8,320

Etc.

After 10 years: 12,000 $1,000

*** 13,000 – 2,600= 10,400

Units of activity:

Generally based on a certain dollar value per unit. For example, miles, copies, pages, etc.

Assume $12,000/100,000 miles = .12/mile

Yr. 1 15,000 miles $1,800 1,800 11,200****

Yr. 2 10,000 miles 1,200 3,000 10,000

Etc until mileage of 100,000 is achieved

**** 13,000 – 1,800= 11,200

Where then it looks like:

Total Units 100,000 miles $12,000 $12,000 $1,000

Notice this might be after 3 years or any number of years, not necessarily 10 years!

As you see, generally speaking, Straight line gives us more or less a straight line, if we graphed it, while the declining balance gives us a very large amount initially and steadily declines, while the units of activity can go all over the place.

See the text for a very good graph, but using other assumptions, on pages 407-409.

If we have to revise depreciation (for example, the item is expected to last longer), we change the depreciation for FUTURE PERIODS but do NOT go back to the already taken depreciation.

Capital improvements would generally be added into the cost of the depreciable asset, while ordinary expenditures (repairs, etc) would not.

An impairment is a permanent decline in an asset, maybe because the asset has become obsolete.

What if we sell a capital asset?

First we need to make sure the years depreciation has been posted (at least up to the time of the sale).

Assume we sell office equipment for $15,000 on July 1. Assume Depreciation for year has not been entered, thus:

Assume Depreciation for the year is $16,000, thus for year to date the entry would be: ( ½ of the amount, i.e.,½ year)

Deprec. Expense $8000

Accum Deprec $8000

Assume Existing Accum Deprec is $40,000 BEFORE this entry.

Thus, we then compute the gain/loss.

Cost of Equipment $60,000

Less: Accum Depr

(40,000 + 8000) -48,000

Book value 12,000

Proceeds: 15,000

GAIN 3,000

Thus: Cash $15,000

Accum Dep 48,000

Office Equp 60,000

Gain on Sale 3,000

If the proceeds had only been $10,000, there would be a loss:

60,000- 48,000= 12,000 - $10,000 proceeds = 2000 loss

Thus: Cash 10,000

Accum Dep 48,000

Loss 2,000

Office Equip 60,000

Intangible Assets are AMORTIZED, not depreciated, usually 40 years.

But, there is an Exception for Patents:

Patent Expense 7,500

Patent 7,500

Here, patent is amortized over less of 20 years or useful life ,here assuming patent is $60,000 and useful life of 8 years. Notice there is no “accumulated Amortization”, rather the Patent and other amortized assets are directly reduced.