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ACCN 2010 Chapter 9 Notes

by: Tara Watkins

ACCN 2010 Chapter 9 Notes ACCN 2010

Marketplace > Tulane University > Accounting > ACCN 2010 > ACCN 2010 Chapter 9 Notes
Tara Watkins

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These notes focus on the conceptual material covered in lecture for Chapter 9 so far as well as explanations and examples that I created to demonstrate each depreciation method.
Financial Accounting
Christine Smith
Class Notes
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This 4 page Class Notes was uploaded by Tara Watkins on Sunday March 13, 2016. The Class Notes belongs to ACCN 2010 at Tulane University taught by Christine Smith in Spring 2016. Since its upload, it has received 9 views. For similar materials see Financial Accounting in Accounting at Tulane University.


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Date Created: 03/13/16
Accounting 2010 Chapter 9 Notes  Long term assets o Are used in company operations to earn revenue o Have a useful life of more than 1 year o Are never considered a current asset (long term assets are a separate category)  3 types of long term assets o Plant assets (ex. building, land, machinery, equipment, etc)  Could also be called fixed assets or Property, Plant and Equipment  Tangible assets o Natural resources  Tangible assets o Intangible (ex. copyrights, patents, trademarks, etc)  Correctly classifying assets is important to creating accurate classified balance sheets  Classified balance sheets have to be correct so that ratios can be calculated and the information obtained can be used to make informed decisions o Land purchased speculatively (not used, saved for future use) is categorized as a long term investment o Land purchased by a company to help them earn revenue (builders, real estate companies) is categorized as inventory  4 accounting issues related to Property, Plant, and Equipment o Acquisition – accounting for a new item o Utilization – allocation of costs o Subsequent Expenditures – expenses related to the item o Disposition – sale, retirement, or death of the item  GAAP says to capitalize all costs of acquisition involved in getting it to its condition and location for use --- similar to GAAP’s inventory cost rules o Under equipment, debit:  Invoice price  Processing fees  FOB shipping point  Taxes  Insurance (during transportation)  Assembly  Unpacking  Installation  Door widening (if necessary to get equipment to the desired location for use)  Testing costs o The total capitalized costs are allocated to an expense account (Depreciation account)  As long as management has a systematic and practical approach, they can choose which method of depreciation to use o In order to decide on a depreciation method, management needs to know:  Estimated useful life/Estimated Units of Production  This estimation can vary depending on management’s plans for usage of the item  Salvage value (scrap value – how much we could get for the equipment at the end of its useful life)  3 most common depreciation methods o Straight Line Method  Time based o Declining Balance Method  Time based o Units of Production Method  Activity (Production) based  Each depreciation method yields different amounts  No matter which method is chosen, while varying each year, the same amount of costs will be allocated by the end of the equipment’s estimated useful life  Straight Line Method o S/L = Depreciable Base x (1/estimated useful life)  Depreciable base = historical cost - salvage value  If the historical cost of a new commercial oven with an estimated useful life of 5 years was $17,000 and its salvage value was $2,000, then its depreciable base would be $15,000. ($17,000 – 2,000 = $15,000)  1/estimated useful life is also called the straight line rate  Assuming the same data and depreciable base as above, the S/L would be:  $15,000 x (1/5) = $3,000 <- depreciation expense  So therefore each year, we would debit the Depreciation expense account by $3,000 and credit the contra-asset account Accumulated Depreciation Expense  Each year, the net book value of the equipment decreases by the depreciation amount (in this case, it decreases by $3,000 every year)  Ex. year 1 – Acc. Dep. Exp = 3,000, net book value = 14,000 year 2 – Acc. Dep. Exp = 6,000, net book value = 11,000 year 3 – Acc. Dep. Exp = 9,000, net book value = 8,000 year 4 – Acc. Dep. Exp = 12,000, net book value = 5,000 year 5 – Acc. Dep. Exp = 15,000, net book value = 2,000  Net book value does NOT equal fair value (what you would get if you sold the equipment at a certain time)  This is not a valuation process, it is simply a cost allocation process  At the end of the equipment’s estimated useful life, the book value should never be lower than its salvage value  Advantage:  Easy to calculate  Disadvantage:  Does not follow the matching principle very well  Declining Balance Method o Decl. Balance = Book value x ? x S/L rate  ? is a number set by management  Using the same numbers as earlier (starting book value of $17,000, salvage value of $2,000 and an estimated useful life of 5 years) and a ? value of 2, the declining balance would be:  Year 1 = 17,000 x 2 x 1/5 = 6,800 <- Dep. Exp. Acc. Dep. Exp. = 6,800, net book value = 10,200 Year 2 = 10,200 x 2 x 1/5 = 4,080 <- Dep. Exp. Acc. Dep. Exp. = 10,880, net book value = 6,120 Year 3 = 6,120 x 2 x 1/5 = 2,448 <- Dep. Exp. Acc. Dep. Exp. = 13,328, net book value = 3,672 Year 4 = 3,672 x 2 x 1/5 = 1,468.80 <- Dep. Exp. Acc. Dep. Exp. = 14,796.80, net book value = 2,203.20 *Year 5 In this example, in year 5, the depreciation expense calculated would cause the book value to be below the salvage value. Since this is not allowed to happen, we would just record the depreciation expense of $203.20 which would make the net book value $2,000 (equal to the salvage value).  Advantage:  Follows the matching principle well  Disadvantage:  If there is remaining estimated useful life left after you reach the point when the accumulated depreciation expense equals the depreciation base (in the example above, this does not occur but if it did, it would be $15,000), then it does not follow the matching principle well because in those years, you are reporting $0 in depreciation expenses.  Units of Production Method o Units of production = depreciation base x (actual production/estimated production)  Estimated Production is 10,000, year 1 actual = 3,000, year 2 actual = 2,000, year 3 actual = 1,500, year 4 actual = 4,500, year 5 actual = 2,400 Ex. Year 1 = $15,000 x (3,000/10,000) = 4,500 – Dep. Exp. Acc. Dep. Exp. = 4,500, net book value = $12,500 Year 2 = $15,000 x (2,000/10,000) = 3,000 – Dep. Exp. Acc. Dep. Exp. = 7,500, net book value = $9,500 Year 3 = $15,000 x (1,500/10,000) = 2,250 – Dep. Exp. Acc. Dep. Exp. = 9,750, net book value = $7,250 Year 4 = $15,000 x (4,000/10,000) = 6,000 – Dep. Exp. **this calculation would make the Acc. Dep. Exp. higher than the depreciation base and the net book value lower than the salvage value so the actual depreciation value for year 4 that would be reported would be $5,250. In year 5, no depreciation expense would be reported because the oven has already been fully depreciated.  A different result is reported each year based on production  Advantage:  Follows the matching principle very well if revenue matches production (if what is made sells)


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