Accounting Chapter 9

straight line depreciation

(cost-residual value)/useful life

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capital expenditure

An expenditure that increases the capacity or efficiency of a plant asset or extends its useful life. Capital expenditures are debited to an asset account. Examples of capital expenditures include the purchase price plus all the other costs to bring an asset to its intended use

Useful life

Length of the service period expected from an asset. May be expressed in time, such as months or years, or usage, such as units produced, hours used (for machinery), or miles driven (for a vehicle). A company's useful life estimate might be shorter than the actual life of the asset. For example, a business might estimate a useful life of five years for a delivery truck because it has a policy that after five years the truck will be traded in for a new vehicle.

Matching Principle

This allocation of a plant asset's cost over its useful life is called depreciation and follows the matching principle. The matching principle ensures that all expenses are matched against the revenues of the period. Because plant assets are used over several years, a business will record a portion of the cost of the asset as an expense in each of those years.

disposal of an asset

To dispose of the equipment, Smart Touch Learning will need to credit the asset account, Equipment, and debit Accumulated Depreciation—Equipment. The accounting clerk will record the transaction as follows

extraordinary repair

Repair work that generates a capital expenditure because it extends the asset's life past the normal expected life. An example of an extraordinary repair would be spending $3,000 to rebuild the engine on a five-year-old truck.

Problem - Changing estimates of a depreciable asset Suppose Smart Touch Learning used the truck purchased on January 1, 2025, for two full years. Under the straight-line method, accumulated depreciation would be $16,000

Straight-line depreciation = (Cost -Residual value) / Useful life = ($41,000-$1,000) / 5 years = $8,000 per year *2 years = $16,000 Remaining depreciable book value (cost less accumulated depreciation) is $25,000 ($41,000 - $16,000). Suppose Smart Touch Learning believes the truck will remain useful for six more years (for a total of eight years). Residual value is unchanged. At the start of 2027, the company would recompute depreciation as follows Revised depreciation = (Book value-Revised residual value) / Revised useful life remaining = ($25,000-$1,000) / 6 years = $4,000 per year

machinery and equipment

The cost of machinery and equipment includes the following: • Purchase price (less any discounts) • Transportation charges • Insurance while in transit • Sales tax and other taxes • Purchase commission • Installation costs • Testing costs (prior to use of the asset)

Problem - disposal of an asset on July 1, Smart Touch Learning discarded the equipment, which has a cost of $10,000 but it is not fully depreciated. As of December 31 of the previous year, accumulated depreciation was $8,000. Annual depreciation expense is $1,000 per year.

The first step in recording the disposal is to bring the asset up to date on depreciation. Because Smart Touch Learning disposes of the asset on July 1 and the asset was in service from January 1 through July 1 since the last recording of depreciation, one-half of a year's depreciation will be recorded ($1,000*1/2=$500). Steps 2 through 4 involve recording the disposal of the equipment and accumulated depreciation and calculating any gain or loss. In this situation, there is a $1,500 loss calculated as follows:

Changing estimates of a depreciable asset

When a company makes an accounting change, GAAP requires the business to recalculate the depreciation for the asset in the year of change and in future periods. They do not require that businesses restate prior years' financial statements for this change in estimate. For a change in either estimated asset life or residual value, the asset's remaining depreciable book value is spread over the asset's remaining life.

accelerated depreciation method

expenses more of the asset's cost near the start of an asset's life and less at the end of its useful life. The main accelerated method of depreciation is the double-declining-balance method.

Revenue expenditures

ordinary expenses to maintain an asset, such as getting the oil changed, replacing tires etc. Suppose that Smart Touch Learning paid $500 cash to replace tires on the truck. This expenditure does not extend the useful life of the truck or increase its efficiency.

residual value (salvage value)

the asset's expected value at the end of its useful life. When a company decides to dispose of an asset, the company will sell or scrap it. The residual value is the amount the company expects to receive when the company disposes of the asset. Residual value can sometimes be zero if a company does not expect to receive anything when disposing of the asset. If a company plans on trading the asset in for a new asset, the residual value will be the expected trade-in value

book value of a plant asset

the original cost of a plant asset minus accumulated depreciation

Which depreciation method considers the ear and tear

the units of production method

cost of land includes

• Purchase price • Brokerage commission • Survey and legal fees • Delinquent property taxes • Taxes assessed to transfer the ownership (title) on the land • Cost of clearing the land and removing unwanted buildings The cost of land does not include the following costs: • Fencing • Paving • Sprinkler systems • Lighting • Signs

lump sum purchase

A company may pay a single price for several assets as a group - a lump-sum purchase. For example, Smart Touch Learning may pay a single price for land and a building. For accounting purposes, the company must identify the cost of each asset purchased. The total cost paid (100%) is divided among the assets according to their relative market values. This is called the relative-market-value method.

Book Value

A depreciable asset's cost minus accumulated depreciation.

Land Improvements

A depreciable improvement to land, such as fencing, sprinklers, paving, signs, and lighting. Land and land improvements are two entirely separate assets. Recall that land is not depreciated. However, the cost of land improvements is depreciated over that asset's useful life.

units of production method

A depreciation method that allocates a varying amount of depreciation each year based on an asset's usage. Depreciation per unit = (Cost -Residual value) / Useful life in units Units of production depreciation = depreciation per unit * current year usage

Relative-Market-Value Method

A method of allocating the total cost (100%) of multiple assets purchased at one time. Total cost is divided among the assets according to their relative market values.

obsolete

An asset is considered obsolete when a newer asset can perform the job more efficiently, such as new technology.

Partial-year depreciation

= [(Cost -Residual value) / Useful life] * (Number of months / 12 months) = [($41,000-$1,000) / 5 years] *(6 / 12) = $4,000

The four steps to disposal of an asset

1. Bring the depreciation up to date. 2. Remove the old, disposed-of asset and associated accumulated depreciation from the books. 3. Record the value of any cash received (or paid) in the disposal of the asset. 4. Finally, determine the amount of any gain or loss. Gain or loss is determined by com-paring the cash received and the market value of any other assets received with the book value of the asset disposed of

Factors in Computing Depreciation

1. Capitalized cost 2. Estimated useful life 3. Estimated residual value

What depreciation is not

1. Depreciation is not a process of valuation. Businesses do not record depreciation based on changes in the asset's market value. 2. Depreciation does not mean that the business sets aside cash to replace an asset when it is used up. Depreciation has nothing to do with cash.

Building

Architectural fees • Building permits • Contractor charges • Payments for materials, labor, and miscellaneous costs • Purchase price • Costs to renovate the building to ready the building for use, which may include any of the charges listed under the "Constructing a Building" column

depreciable cost

Depreciable cost = Cost - Estimated residual value

double declining balance method

Depreciation is recorded at twice the straight-line rate, but the balance is reduced each period. (cost - accumulated depreciation) x 2 x (1/useful life)

Problem - Relative market value method Smart Touch Learning paid a combined purchase price of $100,000 on August 1, 2025, for the land and building. An appraisal indicates that the land's market value is $30,000 and the building's market value is $90,000. It is clear that the company got a good deal, paying less than fair market value, which is $120,000 for the combined assets. But how will the accountant allocate the $100,000 paid for both assets?

First, calculate the ratio of each asset's market value to the total market value for both assets. The total appraised value is $120,000. Total market value = Land market value + Building market value = $30,000 + $90,000 =$120,000 The land makes up 25% of the total market value and the building 75%, as follows: Percentage of total value = Land market value / Total market value = $30,000 / $120,000 = 25% Percentage of total value = Building market value / Total market value =$90,000 / $120,000 =75% the land is assigned the cost of $25,000 and the building is assigned the cost of $75,000. Then is journalized: Debit Land for $25000 Debit building for $75000 Credit Note Payable for $100000

Furniture and Fixtures

Furniture and fixtures include desks, chairs, file cabinets, display racks, shelving, and so forth. The cost of furniture and fixtures includes the basic cost of each asset (less any dis-counts), plus all other costs to ready the asset for its intended use. For example, for a desk, this may include the cost to ship the desk to the business and the cost paid to a laborer to assemble the desk.

Property, Plant, and Equipment (PP&E)

Long-lived, tangible assets, such as land, buildings, and equipment, used in the operation of a business. If it's not used in the operation of a business then that's an investment not a plant asset.

Can land be depreciated?

No, because there's no such thing as depreciation on land, it doesn't become less useful

Capitalized

Recording the acquisition of land, building, or other assets by debiting (increasing) an asset account

Cost Principle

acquired assets (and services) should be recorded at their actual cost. The actual cost of a plant asset is its purchase price plus taxes, purchase commissions, and all other amounts paid to ready the asset for its intended use

straight-line method

allocates an equal amount of depreciation each year. Straight-line depreciation = (Cost -Residual value) / Useful life