DEPRECIATION
Plant Assets:
Plant assets are resources that have three characteristics: they have a physical substance
(a definite size and shape), are used in the operations of a business and are not intended for sale
to customers. They are also called property, plant, and equipment; plant and equipment; and
fixed assets.
DETERMINING THE COST OF PLANT ASSETS:
1 )LAND:
Companies record as debits (increases) to the Land account all necessary costs
incurred to make land ready for its intended [Link] a company acquires vacant land, these costs include
expenditures for clearing, draining, filling, and grading.
Sometimes the land has a building on it that must be removed before construction
of a new building. In this case, the company debits to the Land account all demolition
and removal costs, less any proceeds from salvaged materials.
Land 115000
Cash 115000
2) Buildings:
Buildings are facilities used in operations, such as stores, offices, factories, warehouses,
and airplane hangars. Companies debit to the Buildings account all necessary
expenditures related to the purchase or construction of a building. When a
building is purchased, such costs include the purchase price, closing costs (attorney’s
fees, title insurance, etc.) and real estate broker’s commission. Costs to make
the building ready for its intended use include expenditures for remodeling and
replacing or repairing the roof, floors, electrical wiring, and plumbing. When a new
building is constructed, cost consists of the contract price plus payments for architects’
fees, building permits, and excavation costs.
Equipment:
Equipment includes assets used in operations, such as store check-out counters,
office furniture, factory machinery, delivery trucks, and airplanes. The cost of equipment, such
as Rent-A-Wreck vehicles, consists of the cash purchase price, sales taxes, freight charges,
and insurance during transit paid by the purchaser. It also includes expenditures required in
assembling, installing, and testing the unit. However, Rent-A-Wreck does not include motor
vehicle licenses and accident insurance on company vehicles in the cost of equipment. These
costs represent annual recurring expenditures and do not benefit future periods. Thus, they are
treated as expenses as they are incurred.
Merten makes the following summary entry to record the purchase and related
Factory Machinery 54,500
Cash 54,500
(To record purchase of factory machine)
For another example, assume that Lenard Company purchases a delivery
truck at a cash price of $22,000. Related expenditures consist of sales taxes
$1,320, painting and lettering $500, motor vehicle license $80, and a three-year
accident insurance policy $1,600. The cost of the delivery truck is $23,820, computed
as follows
Delivery truck 23820
Cash 23820
Prepaid insurance 1600
Cash 600
License expense 80
Cash 80
DEPRECIATION
depreciation is the process of allocating to expense the cost of a plant asset over its useful
(service) life in a rational and systematic manner. Cost allocation enables companies to
properly match expenses with revenues in accordance with the matching principle
It is important to understand that depreciation is a process of cost allocation. It is not a
process of asset valuation. No attempt is made to measure the change in an asset’s market value
during ownership. So, the book value (cost less accumulated depreciation) of a plant asset may
be quite different from its market value.
Factors in Computing Depreciation:
1)Cost.
2) Useful life.
is an estimate of the expected productive life, also called service life, of the asset. Useful life may be expressed
in terms of time, units of activity (such as machine hours), or units of output. Useful life is an estimate.
Salvage value. Salvage value is an estimate of the asset’s value at the end of its useful life. This value may be
based on the asset’s worth as scrap or on its expected trade-in value. (scrap value or residual value)
Depreciation is generally computed using one of the following methods:
Straight-line
1.
2. Units-of-activity
3. Declining-balance
STRAIGHT-LINE:
Cost−salvage value
useful life
= depreciation per year
Depreciation rate * Depreciable cost=Depreciation per year
Where depreciable coat =cost –salvage value
Depreciation rate= 100%/useful life
Equipment= 13000
Salvage value= 1000
Useful life =5
2400
Under the straight-line method, companies expense the same amount of depreciation
for each year of the asset’s useful life. It is measured solely by the passage
of time. In order to compute depreciation expense under the straight-line method,
companies need to determine the depreciable cost. Depreciable cost is the cost of the
asset less its salvage value. It represents the total amount subject to depreciation.
Under the straight-line method, to determine annual depreciation expense, we
divide the depreciable cost by the asset’s useful life. Illustration 10-9 shows the computation
of the first year’s depreciation expense for Barb’s Florists.
PRACTICAL QUESTION:
Calculate depreciation expense with the following Data:
Machine purchased on July 1, 2010 =100000
Salvage value =10000
Depreciable cost: 1000000-10000=90000
Useful life= 10
Depreciation per year= 9000
Depreciation for 2010= 9000*6/12 (as the machine was purchased on july1)
Depreciation Expense for 2010= 4500
UNITS-OF-ACTIVITY
Cost−salvage value
Life∈units
= Depreciation cost per unit
Machine 13000
Salvage 1000
Cost –salvage /unit 12000/100000 0.12
Total unit of activity=100000
Calculate depreciation for 2010 and 2011 when machine produced
15000 and 13000 units
Depreciation expense 15000*0.12=1800
13000*0.12=1560
Depreciation per period= Unit produced*per unit cost
Under the units-of-activity method, useful life is expressed in terms of the total units
of production or use expected from the asset, rather than as a time period. The
units-of-activity method is ideally suited to factory machinery. Manufacturing companies
can measure production in units of output or in machine hours.
DECLINING-BALANCE:
(cost – accumulated depreciation) * rate of depreciation
The method is so named because the periodic depreciation is based on a
declining book value (cost less accumulated depreciation) of the [Link] this
method, companies compute annual depreciation expense by multiplying the book
value at the beginning of the year by the declining-balance depreciation rate. The
depreciation rate remains constant from year to year, but the book value to which
the rate is applied declines each year.
2010:
Machine 13000
Depreciation 40%
2010: (13000-0)*0.4=5200
2011: (13000-5200)*0.4=3120
2012: (13000-8320)*0.04=1872
Retirement of Plant Assets:
3.1 Sale of Plant Assets
A
