Depreciation

- All fixed assets except land are depreciated, meaning that they lose value due
to the passage of time
- Depreciation is not a process of valuation (do not take market value into
consideration at all)
- Depreciation does not mean that the organization sets aside cash to replace
assets when they are used up. (Depreciation has nothing to do with cash).
(Horngren 486).
- Depreciation of an asset depends on:
o Cost
o Estimated useful life
o Estimated residual value or Salvage Value (Depreciable cost = Cost
Estimated Residual Value)

Depreciation methods:
- There are many depreciation methods. Three are the most commonly used.
- All methods work differently in how they will derive yearly depreciation, but
they will all result in the same total depreciation over the total life of the asset.

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 1. Straight Line Method
- This method allocates an equal amount of depreciation to each year.
Depreciation expense = [Cost Salvage Value] / Useful Life
Where: cost of the asset = purchasing price + Transportation + Installation cost
Example:
Company A purchased a new machine on July 1st, 2008. The machine is expected to
have a 5-year life and $1,000 residual value. Associated with the purchase of the
machine are the following expenditures.
Machine Purchasing price $10,000
Transportation cost 2,000
Installation cost 1,000
Required:
- Compute the depreciation expense throughout the machines life using the
straight line method.
- Prepare the necessary journal entries at the end of the 1st and 4th year.

Depreciation expense = [(10,000 + 2,000 + 1,000) 1,000] /5 = $2,400/year.

Year Depreciation Accumulated
ending Cost expense Depreciation Book value
2008 $13,000 $2,400 * 6/12 $1,200 $11,800
2009 13,000 2,400 3,600 9,400
2010 13,000 2,400 6,000 7,000
2011 13,000 2,400 8,400 4,600
2012 13,000 2,400 10,800 2,200
2013 13,000 $2,400 * 6/12 12,000 1,000
= 1,200 Equal to the salvage value

On December 31st, 2008, and 2013 the entry will be as follows:

Depreciation expense 1,200
Accumulated depreciation 1,200
For all other years, the entry will be as follows:
Depreciation expense 2,400
Accumulated depreciation 2,400
2. Units of Production Method (UOP)
- This method allocates a fixed amount of depreciation to each unit of output.
- The unit of output can be: miles, units, or hours depending on the asset
nature.

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 Units of production
depreciation per unit of = [Cost Residual Value] * 1/Life in units
output
Example:
On 1/1/2011, company XYZ bought a truck for $41,000 to be used in its day to day
operations. The truck was estimated to be driven for 20,000 miles for the first year,
30,000 the second, 25,000 the third, 15,000 the fourth, and 10,000 the fifth (for a total
of 100,000 miles). At the end of its life, the truck will have a residual value of $1,000.
Required:
- Compute the depreciation expense throughout the machines life using the
Units of production method.

Units of production
depreciation per unit of = [41,000 1,000] * 1/100,000
output = $0.40 / mile
- The depreciation schedule will look like follows:
Depreciation for the year
Date Asset Depreciation Number of Depreciation Accumulated Book Value
Cost / unit Units Expense Depreciation
1/1/2011 $41,000 $41,000
31/12/11 0.40 * 20,000 = $ 8,000 $ 8,000 33,000
31/12/12 0.40 * 30,000 = 12,000 20,000 21,000
31/12/13 0.40 * 25,000 = 10,000 30,000 11,000
31/12/14 0.40 * 15,000 = 6,000 36,000 5,000
31/12/15 0.40 * 10,000 = 4,000 40,000 1,000

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 3. Double Declining Balance Method
- This method writes-off more depreciation near the start of the assets life, and
less towards the end.
- This method multiplies decreasing book value by a constant percentage that is
twice the straight line rate.

Double Declining
Accelerated
Balance = [Cost Accumulated Depreciation] * 2/Life
Depreciation = [100 % / Useful Life] * 2
Depreciation
Rate
Example:
- In the previous example, compute the depreciation expense throughout the
machines life using the double declining balance method.

Accelerated
Depreciation = [100 % / 5] * 2 = 40%
Rate

Depreciation for the year

Date Asset Double Book Value Depreciation Accumulated Book Value
Cost Declining Expense Depreciation
Rate
1/1/2011 $41,000 $41,000
31/12/11 40 % 41,000 = $ 16,400 $ 16,400 24,600
31/12/12 40 % 24,600 = 9,840 26,240 14,760
31/12/13 40 % 14,760 = 5,904 32,144 8,856
31/12/14 40 % 8,856 = 3,542 35,686 5,314
31/12/15 = 4,314 40,000 1,000
Note: Last year depreciation is a plug-in figure put in the table to reduce the book
value down to the residual amount. ($5,314 1,000 = $4,314)

Review summary problem on page 495 in the Horngren book