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Depreciation Accounting

Types of Long-Lived Assets


Tangible asset
y Asset with physical substance y Property, plant, and equipment = fixed asset.

Intangible asset
y Intellectual property. y No physical substance
y Examples are patent rights, copyrights

y y

View capital asset as bundle of services Similar to prepaid expenses, cost is expensed as company benefits from the services
y y y y Land - no depreciation Plant and equipment - depreciation Natural resources - depletion Intangible assets - amortization

Depreciation Methods

Straight line method

y (original cost - residual value) /service life

Accelerated methods
y Declining balance methods y Sum of the years or years digits methods

Declining Balance Method


Depreciation = book value * depreciation rate.

y Double declining balance method = book value * 2 * straight line rate. y Straight line rate = 1/(life of asset in years).

Impaired Assets

An asset for which its remaining benefits, as measured by the sum of future cash flows the assets use will generate, is less than its book value If entity expects to hold asset
y Write asset down to fair value

If entity expects to sell asset

y Write asset down to lower of cost or fair value less cost of disposal.

Group Depreciation

Group depreciation
Treats all similar assets as a pool or group rather than calculating for each item separately. No gain or loss recognized when an individual item is disposed.
Credit asset account for original cost. Debit cash for amount of proceeds. Debit accumulated depreciation for difference.

Accumulated depreciation
Does not represent the accumulation of any tangible thing. Sum of the original cost that has been expensed. Funding the purchase of new assets is usually unrelated 7 to depreciation


When one company buys another. Goodwill = Purchase price of company fair value of net assets.
Net assets include tangible assets and recognized intangible assets net of liabilities assumed by the purchaser.


Recorded as an asset upon acquisition. Not amortized. Annual impairment test. Any write down is charged against income.

Intangible Assets with Limited Lives

Examples: patents and copyrights  If purchased, recorded at cost

Amortized over useful life Useful life can equal or be shorter than legal life

If developed internally, expense as incurred


Stern Corporation (B)

Case 7-1 Page 210


Stern Corporation

Ascertaining the PP&E and accumulated depreciation accounts Transactions..,

Jan 2, 2006: Machine sold for its book value: $3,866 (Books record: $31,233, Accumulated depreciation: $27,367) End 2006: Decrease in tool inventory accounting to $7,850 Mar 1, 2006: Sold Automobile for cash $2,336 (Books record: $8,354, Accumulated depreciation: $5,180, Net book value as of Jan 1, 2006 $3,174)

Stern Corporation

Cost of patent written off as an expense over the reminder of its legal life as of Dec 31, 2005. Patents remaining legal life was 5 years July 1, 2006: Typewriter that had cost of $1,027 and had been fully depreciated on Dec 31, 2005, was sold for $75 Oct 1, 2006: company sold a desk for $80 (Book cost of $490 with an accumulated depreciation of $395 as of Jan 1, 2006)

Depreciation Rates
Buildings: 2%  Factory machinery: 10%  Furniture and fixtures: 10%  Automotive equipment: 20%  Office machines: 10%

Included in the factory machinery cost of $3,425,585 was machine costing $85,000 that had been fully depreciated on Dec 21, 2005, and that was still in use

Stern Corporation Balance Sheet As of Dec 31, 2005 Current Assets Cash A/R Less: Allowance for Doubtful Accounts US Treasury Secuirties at Cost Inventories Total Current Assets Other Assets Investments Land Building Less: Accumulated Depreciation Factory Machinery Less: Accumulated Depreciation Furniture and Fixtures Less: Accumulated Depreciation Automotive Equipment Less: Accumulated Depreciation Office Machines Less: Accumulated Depreciation Tools Patent Prepaid Expenses Total Assets 671,344 988,257 29648 958,609 274060 1734405 3,638,418 412294 186563 2405259 663379 3425585 1642358 56484 40400 58298 37156 42534 28005 1741880 1783227 16084 21142 14529 61294 56250 100190 8,031,871


Stern Corporation Balance Sheet As of Dec 31, 2005 Current Liabilities A/P Taxes Payable Accrued Salaries, Wages, and Interest LT Debt, Due within one year Total Current Liabilities Noncurrent Liabilities LT Debt Shareholders Equity Common Stock Retianed Earnings Total Shareholders' Equity Total Liabilities and Shareholder's Equity 510,000 709354 141,478 69300 1,430,132 1247368 2503275 2851096 5354371 8,031,871 15




Gross Land Building Factory machinery Furniture and fixtures Automotive equipment Office machines Tools Patent Total $186,563 2,405,259 3,394,352 55,994 49,944 41,507 53,444 45,000 $6,232,063

Accumulated Depreciation $711,484 1,954,426 45,604 41,965 31,129

Net $186,563 1,693,775 1,439,926 10,390 7,979 10,378 53,444 45,000 $3,455,955


Depreciation Accounting (AS 6)

Assets not included for depreciation..,

Forests Plantations Regenerative natural resources Wasting assets
Expenditure on exploration for and extraction of minerals, oils, natural gas, similar non generative assets

Expenditure on R&D Goodwill Live stock Land with unlimited useful life for the enterprise

Defined Terms

Measure of..,
Wearing out / consumption / loss of value on Usage / effluxion of time / obsolescence through technology and market change

Includes amortization of assets with predetermined useful life

Depreciable asset
Used more than one accounting period Having limited useful life Used for production or supply of goods and services

Defined Terms

Useful life
Period of usage by firm No. of production or similar units expected to be obtained by suing the asset

Depreciable amount
= historical cost estimated residual value


Factors in Assessment of Depreciation

Historical cost or revalued value of the asset

Acquisition + Installation + Commissioning + Improvements

May change due to..,

Increase or decrease in LT liability on account of exchange fluctuations Price adjustments Changes in duties Changes in similar other factor


Factors in Assessment of Depreciation

Expected useful life of the depreciable asset

Is shorter than physical life Predetermined by legal or contractual limits Directly governed by extraction or consumption Depends on operational factors [usage] Reduced by obsolescence due to..,
Technological changes Improvement in production methods Change in market demand for the product or service output of the asset Legal or other restrictions

Estimation purely based on..,

Experience with similar type of assets

Any addition or extension which retains a separate identity and is capable of being used after the existing asset is disposed of, is depreciated independently on the basis of an estimate of its own useful life

Factors in Assessment of Depreciation

Estimated Residual Value of the Depreciable Asset

A difficult matter Estimated at time of acquisition / installation or at time of subsequent revaluation of the asset Basis of determination..,
Realizable value of similar assets


Quantum of depreciation to be provided in an accounting period involves..,  Exercise of judgment by management in light of..,

Technical Commercial Accounting Legal requirements Need periodical review and revision

Depreciation Methods

Commonly employed method includes..,

Straightline method Reducing balance method

Factors in selection of method..,

Type of asset Nature of use of such asset Circumstances prevailing in business

Applied consistently to provide comparability  Combination of more than method is sometimes used  Depreciable assets which do not have material value, depreciation is often allocated fully in accounting period in which they are acquired


Changing Depreciation Method


Is treated as as a change in an accounting policy Change in method is allowed if..,

Its required by statute Compliance with an AS Results in more appropriate preparation and presentation of financial statements

On change in method
Depreciation is calculated using new method from the date of asset coming into use Deficiency or surplus on change need to be adjusted during the year of change [charged to P&L statement]

Companies Act 1956 lays down rates of depreciation in respect of various assets  Estimates useful life of an asset is shorter than under the provision of relevant statute  Depreciation provision computed by applying higher rate  Depreciable assets are disposed / discarded / demolished / destroyed, the net surplus or deficiency, if material, is disclosed separately


Depreciation Disclosure in Financial Statements

Disclosure to be made includes..,

Depreciation methods used Total depreciation for the periods for each class of assets Gross amount of each class of depreciable assets Related accumulated depreciation

Assets depreciation rates and useful life are disclosed only of they are different from the principal rates specified in the statute governing the enterprise

Accounting for Fixed Assets (AS 10)

Fixed assets include..,

Land Buildings Plant and machinery Vehicles Furniture and fittings Goodwill Patents Trade marks Designs

Assets Excluded from AS 10

Forests  Plantations  Regenerative natural resources  Wasting rights..,

Mineral rights Expenditures on exploration for extraction of minerals, oils, natural gas, and non-regenerative resources

Expenditure on real estate development  Livestock  Government grants and subsidies  Assets under leasing rights



Fixed asset
Used for producing and providing services Not held for sale

Fair market value

Price agreed in open unrestricted market between knowledgeable willing parties dealing at arms length

Gross book value - historical cost


Identification of Fixed Asset


Judgment required Aggregate individually insignificant items, and to apply the criteria to aggregate value Stand-by equipment is capitalized Servicing equipment is capitalized General machinery spares charged to P&L on consumption Any specific machinery spares which irregular in nature allocate over a period not exceeding useful life of the principal item Accounting can be improved if the total expenditure is allocated to component parts, when in practice separable, and estimates are made of useful lives of these components

Components of Cost

Purchase price Import duties Non-refundable taxes or levies Directly attributable cost in bringing the asset to its working condition..,
Site preparation Initial delivery and handling costs Installation costs special foundations for plant Professional fees architect fees or engineers fees


Deduct trade discount and rebates from purchase price Commissioning cost.., Expenditure on test runs Expenditure on experimental production

Components of Cost

Costs may undergo changes subsequent to acquisition due to..,

Exchange fluctuations Price adjustments Changes in duties or similar factors


Administration and general overheads expenses are excluded Any specific direct admin and OH expenses related to making the asset workable is included Expenses during prolonged period between installation and commercial start up
Will be charged to P&L statements Treated as deferred revenue expenditure amortized over a period not exceeding 3 to 5 years after commencement of commercial production


Self-Constructed Fixed Assets

Gross book value = costs of construction  Internal profit to be eliminated


Non-Monetary Consideration

FA acquired in exchange for another asset Cost of FA = FMV of consideration given When asset is same; cost = net book value FA acquired in exchange for shares in the enterprise,
Cost of FA = FMV (or) Cost of FA = FMV of shares


Improvements and Repairs

Expenditure increasing future benefits Added to gross book value Includes..,
Addition Extension


Amount Substituted for Historical Cost

Methods valuing assets

Can be restated by appraisal by competent valuer Indexation and reference to current prices

Revalued amount is presented as..,

Restating gross book value and accumulated depreciation; net book value = net revalued amount Restating the net book value by adding therein the net increase on account of revaluation

Upward revaluation does not provide a basis for crediting to the P&L statement the accumulated depreciation existing at the date of revaluation

Amount Substituted for Historical Cost

Different bases of valuation can be sued in same financial statements for..,

Separate item in each of the categories of fixed assets Different categories of fixed assets


Systematic basis of valuation is required when select assets are revalued Not appropriate to have revalued class of assets net book value more than recoverable amount of the assets of that class

Amount Substituted for Historical Cost

Increase in net book value on revaluation is directly credited to

Owners account in the name revaluation reserve P&L account, if earlier a revaluation loss is charged to P&L account

Any decrease in value charged to..,

P&L account Revaluation reserve, if there was charge in increase done earlier

Retirement and Disposals

On disposal the FA are eliminated from financial statements  Assets retired from active use and held for disposal are stated at lower of net book value or realizable value, expected loss accounted in P&L account  Gain or loss on disposal of an asset in recognized in P&L account in a historical cost financial statement  On disposal of revalued asset

Difference between net book value and net disposal proceed to P&L account, but loss to the extent of increase in revaluation reserve will be charged to revaluation reserve account Any unsettled amount in revaluation reserve will be transferred to general reserve

Valuation of Fixed Assets in Special Cases

Hire purchase
Proportional value to the extent of payment is shown in the balance sheet Appropriate disclosure regarding HP should be made

Joint ownership with others

Extent of its share in balance sheet including..,
Original cost Accumulated depreciation Written down value

Can be also grouped with similar fully owned assets

Several assets purchased for a consolidated price

Consideration is apportioned to the various assets on a fair basis as determined by competent valuers

Fixed Assets of Special Types

Recorded in books only when some consideration in money or money;s worth has been paid for it Arises from..,
Business connections Trade name Reputation of an enterprise Intangible benefits enjoyed by an enterprise

Goodwill is written off over a period Many of them they retain it as an asset without writing off



Special disclosure required in financial statements

Gross and net book values of FA at the beginning and end to show..,
Additions Disposals Acquisitions Other movements

Expenditure incurred on account of FA in the course of construction or acquisition On revaluation of FA, show disclose..,
Method adopted to compute the revalued amounts Nature of any indices used Year of any appraisal made Whether an external value was involved?

Stafford Press
Case: 7-3 Page: 213

Stafford Press
Founded in: 1996  Founded as: one-man job printing firm  Founded in: a small southwestern town  Owner: Lucas Stafford  Product line: concentrated on special line of printing  Experienced: rapid growth due to high degree of technical proficiency


Stafford Presss Competitive Disadvantage

Major market: metropolitan area  Metropolitan area located 300 miles away from the plant  2006

Accumulated extra cash to finance a move near the primary market Expand and modernize facilities at the time of move Moved to suburb

Balance Sheet Before the Move to Suburb

Stafford Press Condensed Balance Sheet (Prior to Move) Assets Liabilities Current assets Current liabilities Cash $395,868 Common stock Other current assets $251,790 Retained earnings Total current assets $647,658 Property and equipment Land $34,034 Buildings $350,064 Less: Accumulated depreciation $199,056 Net value $151,008 Equipment $265,093 Less: Accumulated depreciation $178,922 Net value $86,171 Total liabilities Total assets $918,871 and owner's equity $160,223 $400,000 $358,648

50 $918,871

Transaction Arose from the Move

Land + building at old site sold for cash: $149,860

Accumulated depreciation on building: $199,056 [shown in B/S) Cost of land: $34,034 [shown in B/S) Cost of building: $350,064 [shown in B/S) Loss on sale of fixed assets: $35,182 [plug figure] Cost that appeared on book: $73,645 Accumulated depreciation: $40,890 Net book value: $32,755 Gain on sale of fixed assets: $2,445 [plug figure] Invoice cost: $112,110 Cash discount taken: 2% Actually paid: $109,868 Payment to truck delivered: $450 Time spent by Stafford employees on installation of the machine: 60 hours Ordinarily workers received wage at $15 per hour, but their time was ordinarily charged to printing jobs at $30.50 per hour, the difference representing an 51 allowance for overhead ($12.15) and profits ($3.35)

Equipment sold for cash: $35,200

Purchased a new printing press

Transaction Arose from the Move

Purchased land to build new plant: $140,000

An run down building on the land was torn down for: $21,235 Paid for permanent drainage facilities installation: $13,950

Purchased a new composing machine

Invoice cost: $28,030 [cash paid: $20,830, Trade-in allowance: $7,200] Could be sold outright for: $6,050 Cost as new machine: $12,000 Accumulated depreciation: $5,200 Net value: $6,800

Transaction Arose from the Move

Erected building: $561,000

Paid in cash: $136,000 Borrowed on mortgage: $425,000

Trucking / costs associated with moving to new location / installation: $8,440

Time spent by Stafford press employees: 125 hours


Transaction Arose from the Move

During moving a piece of equipment was dropped and damaged

Cost of equipment: $10,000 Amount spent to repair: $3,220 Reduction in salvage value by: $660 [from $1,950 to $1,290] Up until that time, equipment was depreciated at $850 per year [representing a 10% rate after deduction of estimated salvage value of $1,950] Accumulated depreciation: $3,220


Discussion Question
Analyze the effect of each of these transactions on the items in the balance sheet and income statement  For transactions that affect owners equity, distinguish between those that affect the net income of the current year and those that do not  Show the appropriate JEs


Journal Entry (1)

Cash Accumulated Depreciation (bldgs.) Loss on Sale of Fixed Assets Land Buildings Debit Credit 149,860 199,056 35,182 34,034 350,064

Journal Entry (2)

Debit Credit 35,200 40,890 73,645 2,445

Cash Accumulated Depreciation (eqpt.) Equipment Gain on Sale of Fixed Assets

Journal Entry (3)

Debit Credit
Equipment (109,868 + 450 + 1,629) Cash (possibly other items) 111,947 111,947


Journal Entry (4)

Land Cash Land Cash Land Cash Debit Credit 140,000 140,000 21,235 21,235 13,950 13,950

Journal Entry (5)

Equipment (new) (20,830 + 6,800) Accumulated Depreciation (old) Cash Equipment (old) Debit Credit 27,630 5,200 20,830 12,000

This is the entry when equipment traded in was similar, then the journal entry is constructed so that no gain or loss on disposal is recorded

Equipment (new) (20,830 + 6,050) Accumulated Depreciation (old) Loss on Sale of Fixed Assets Cash Equipment (old)

Debit Credit 26,880 5,200 750 20,830 12,000

This is the entry is when assumed that the trade-in was not similar

In either case trade-in allowance $7,200 is irrelevant In the second case loss $750 is the difference between the fair value of trade-in, $6,050, and its $6,800 net book 60 value

Journal Entry (6)

Buildings Cash Mortgage Payable

Debit Credit 561,000 136,000 425,000


Journal Entry (7)

Debit Credit
Moving Expense (8,440 + 3,394) 11,834 Cash Assumed that move has been made out of necessity I.e. old property11,834
had been condemned or taken by eminent domain, so moving cost not capitalizaed Labor charges not accounted as total no. of workers hours not given

Journal Entry (8)

Maintenance (or Moving) Expense Cash Moving Expense (or Deprec. Expense) Equipment (or Accum. Deprec.) Debit Credit 3,220 3,220 660 660

The repair of the damage during the move has not improved the equipment so as to constitute a betterment; thus it is expensed

The decrease in salvage value, $660, could be expensed immediately


Journal Entry (8)

However, I dont think an event that changes a fixed assets future salvage value is any more relevant, in terms of the cost concept, than an event that changes its current market value. Thus, in my view, rather than adjusting the cost of the asset, it is better to amortize the reduction in salvage value by adjusting the depreciation charge for the rest of the equipments useful life, which constitutes a change in an estimate. Since the accumulated depreciation was $3,220, and annual depreciation was $805, the asset was 4 years old, and thus had 6 years left of useful life. The amount of remaining depreciation is the net book value at the end of 4 years, $6,780, less the newly estimated S1,290 salvage value, or $5,490. Divided by 6 years, the new annual depreciation expense on this item would be $915. (Easier, though not quite as thorough: the $660 lesser salvage value, spread over 6 years, is $110 per year, added to the current depreciation charge of $805, makes a total of $915.)


Discussion Question

Adjust the balance sheet in Exhibit 1 to show the effect of these transaction


Revised Balance Sheet After the Move

Stafford Press Condensed Balance Sheet (Revised to Reflect Move) Assets Liabilities and Owners Equity Current assets: Current liabilities $160,223 Cash $121,912 Long-term liabilities 425,000 Other current assets 251,790 Common stock 400,000 Total current Assets 373,702 Retained earnings 310,857 Plant and equipment: Land 175,185 Buildings $561,000 Less accumulated Depreciation 0 561,000 Equipment 319,025 Less: accumulated depreciation 132,832 186,193 Total assets $1,296,080 Total liabilities and owners equity $1,296,080

Accounting for Property, Plant, and Equipment and Other Assets

Depreciation: expense matched with revenues  Depletion: expense matched with revenues in the case of natural resources [forest land, mineral deposits]  Amortized: expense matched with revenues in the case of intangible assets  Three phases of accounting for PPE..,

Determining cost of fixed asset Amortizing cost over the useful life of the asset Removing it from the accounts at the end of the assets life

Cost of Fixed Assets

Total amount of expenditures necessary to ready the asset for its intended use, which includes..,
Price of acquiring legal title Costs of delivery Installation Training of employees Modification of facilities to use the asset

Cost of Fixed Assets

Costs of New Laboratory Furnace - Jan 1, 2004 Purchase price of new furnace 13,000 Less: Trade-in allowance -3000 Less: Discount for cash -500 9,500 Value of old furnace 3000 Total assets paid 12,500 Freight charges for delivery 500 Installation costs 2000 Training costs for employees 1000 Total cost 16,000

Estimating Depreciation

Estimate salvage value Salvage value = expected selling price of the asset any removal costs Depreciable cost = cost salvage value Use appropriate depreciation method based on following two criteria..,
Not subject to manipulation by management distorting income Some resemblance to the decline in value of assets measured on historical cost basis

Straight-Line Depreciation
An equal portion of depreciable cost is charged to some measure of length of an assets life  Measure may be..,

Periods of time Units of products

Accumulated depreciation: contra asset


Straight-Line Depreciation
Depreciation - Straight Line Method Purchase price of new furnace 13,000 Less: Trade-in allowance -3000 Less: Discount for cash -500 9,500 Value of old furnace 3000 Total assets paid 12,500 Freight charges for delivery 500 Installation costs 2000 Training costs for employees 1000 Total cost 16,000 Less: Salvage value -6000 Depreciable cost 10,000 Estiamted life: 5 years Expected metal melt: 250,000 pounds Shedule of Depreciation Expense Expected Melt (in Time Year pounds) Base 1 40,000 2,000 2 45,000 2,000 3 50,000 2,000 4 55,000 2,000 5 60,000 2,000 Total 250,000 10,000

Use Base 1600 1800 2000 2200 2400 10,000


Declining Balance Method

Principle: an asset is most productive in the early years of its use  Charging each period a fixed percentage of the original cost of the asset less any previously accumulated depreciation




Long-Lived Fixed Assets

Physical assets with a life > 1 year  Categories

Plant and equipment depreciation Natural resources depletion Land appreciation


Importance of Accounting Numbers Related to Long-Lived Fixed Assets

Major determinant of many companies book value used in..,

Equity valuations Debt covenants

Determines companys cost structure and ability to improve its capital and employee productivity  Influences periodic income through depreciation and depletion charges  Improve or depress current profits by lowering or raising the level of maintenance expenditures required to maintain FAs


GAAP Depreciation Methods

Production (Use) method  Straight-line depreciation

Used by majority of firms

Accelerated depreciation
Mostly confined to tax reporting