16-1

What if the Company Doesn’t Purchase (or sell) the Asset at the Beginning (or end) of the Year?

• Units-of-production Multiple the depreciation rate by the actual

usage• Straight-line or double-declining balance

Use the mid-year convention or count the time that the asset was in use

Midyear Convention

• Companies making numerous plant asset purchases and disposals spread out evenly during the course of the fiscal year frequently use the midyear convention, which reflects depreciation expense for each asset

• as if it were purchased or disposed of exactly halfway through the company’s fiscal year.

Illustration --- page 457

• PCs to Go, with a December 31 year-end, purchases its delivery truck in April 2010 and expects to dispose of it five years later in April 2015. Straight – line depreciation for each fiscal year of use would be as follows:

• Refer to page 457

Revision of Estimates

• A company originally assigns a useful life of seven years to a computer and, one year after the date of the purchase, realizes that it will have to replace the computer after a total of three year.

• When it becomes clear that they need to make an adjustment– do the following---

Revision of estimates

• Assume that on January 1, 2010, a company purchases and begins to use office equipment costing $12,000, with an expected useful life of 10 years and a salvage value of $2,000. Assuming the business uses the straight-line method of depreciation for the asset, accumulated depreciation at December 31, 2012, would be $3,000 (12,000 – 2,000)/10 X 3 = 3,000.

• The carrying value would be 9,000 (12 – 3)

Continued.

• If the company realizes that the equipment will last only four more years, after which its estimated salvage value will be $3,000, then depreciation expense for each of the remaining four years of the asset’s useful life would be calculated as follows:

Carrying value – Revised salvage valueRemaining useful life

9,000-3,0004 years = $1,500 depreciation expense per year

16-7

What is the Process Involved in Asset Disposals?• Record depreciation to date of disposal• Remove the cost of the asset (CR) and the

accumulated depreciation (DR) from the records

• Record the assets received (DR) if applicable

• Record the cash paid (CR) if applicable• Record the loss incurred (DR) if applicable• Record the gain (CR) if applicable

16-8

How Can a Company Dispose of an Asset Before its Useful Life is Over?• Discard---it is necessary to record a loss at

the date of the disposal Discard equipment that cost 50,000 with a

40,000 of accumulated depreciation at the date of the last balance sheet. Must pay $1,000 to have it removed.

Assets = Liabilities + Owner’s Equity2,000 = 2,000Depreciation expense 2,000

Accumulated Depreciation 2,000

Problem continued

• After the entry is posted, the accumulated depreciation account will have a $42,000 credit balance (previous balance of $40,000 plus $2,000. Second, we must recognize the removal of the equipment (book value = $8,000) and cash:

• Assets = Liabilities + Owners Equity• (8,000) = (9,000)• (1,000)

Journal Entry

• Accumulated Depreciation 42,000• Loss on Disposal 9,000

Equipment 50,000 Cash 1,000

Sell

• SellMust be sold for equal, less than, or

greater than.Recall when more net assets are received

than are given up, a gain results. A loss results when fewer net assets are received than are given up.

Example

Cost of Asset $80,000Accumulated depreciation (60,000)through date of saleCarrying Value at date of sale $20,000

Assets = Liabilities + Owner’s Equity+20,000-20,000Selling for the same amount of net assets

Journal Entry

Cash 20,000Accum Dep 60,000

Equipment 80,000

16-14

Exchange (Trade-In) Example

• We have a computer that originally cost $6,000 and has accumulated depreciation of $4,500. We will trade-in this computer for a new computer with a list price of $10,000. The computer company will give us a trade-in allowance of $2,000.

• Book value = $6,000 - $4,500 = $1,500.• Cash payment required = $10,000 - $2,000

= $8,000

16-15

Trade-in Example Continued

• Computer received = $10,000Less assets given up = $9,500Gain = $500

• Entry:Computer (new) 10,000Accumulated depreciation 4,500

Computer (old) 6,000Cash 8,000

Gain 500

16-16

What are Depletion and Amortization?• Depletion

The cost of a natural resource is allocated to expense

Typically, units-of-production method used• Amortization

The cost of an intangible asset is allocated to expense

Typically, straight-line method is used

Homework

• Exercise 16-9, 16-10, Problem 16-3

Ex 16-9

• (850,000 – 175,000)/25 years = $27,000 per year x 12 years = $324,000 accumulated depreciation

• (850,000 – 324,000 – 150,000) /(39-12) = $13,925.93 per year for the remaining 27 years.

Ex 16-10

• $36,000 – 28,000 = $8,500 carrying valuea. 10,000 – 8,500 = 1,500 gainb. 8,000 – 8,500 = (500) lossc. 9,000 – 8500 = 500 gain

Problem 16-3(1) Straight-line: Depreciation Carrying

Expense** Value Year 1 $50,000 $300,000 Year 2 50,000 250,000 Year 3 50,000 200,000 Year 4 50,000 150,000 ** ($400,000 - $50,000)/7 years = $50,000/year(2) Units-of-production: Depreciation Carrying Expense*** Value Year 1 $56,000 $294,000 Year 2 61,600 234,400 Year 3 67,600 164,800 Year 4 74,536 90,264

*** ($400,000 - $50,000)/25,000 hours = $14/hour 4,000 hours * $14 = $56,000

(4,000 * 1.1) = 4,400 * $14 = $61,600(4,400 * 1.1) = 4,840 * $14 = $67,600(4,840 * 1.1) = 5,324 * $14 = $74,536

Problem 16-3

(3) Double-declining-balance: 1/7 * 2 = .2857 is double the straight-line rate

Depreciation Carrying Expense* Value

Year 1 $114,280 $285,720 Year 2 81,630.20 204,089.80 Year 3 58,308.46 145,781.34 Year 4 41,649.73 104,131.61

*$400,000 * 0.2857 = $114,280 $285,720 * 0.2857 = $81,630.20

$204,089.80 * 0.2857 = $58,308.46 $145,781.34 * 0.2857 = $41,649.73b. The straight-line method produced the lowest deprecation expense, and therefore the

highest income in Year 1. The double-declining balance method produced the highest depreciation expense, and therefore the lowest income in Year 1.

Ex 16-12

Nelson Enterprises: $425,000 - $260,000 = $165,000 carrying value;

$575,000 - $165,000 = $410,000 gainThe $410,000 gain is recognized and the building acquired should be

recorded at its fair market value of $575,000.

Lamb Corporation: $750,000 - $160,000 = $590,000 carrying value $575,000 - $590,000 = $15,000 loss

The $15,000 loss should be recognized and the new building should be recorded at its fair market value of $575,000.

Problem 16-4

a. $63,500 + $4,785 + $100 + 2,850 = $71,235b. ($71,235 - $6,000)/8 = $8,154 * 1/2 year = $4,077c. The cost of the transmission should be capitalized as an

extraordinary repair and the cost of the tune-up should be expensed as an ordinary repair.

d. 2008 $ 4,077 2009 8,154 2010 8,154

$ 20,385Accumulated Depreciation at the end of 2010

$71,235 - $20,385 = $50,850 carrying value plus $5,000 extraordinary repair = $55,850 - $6,000 salvage value

= $55,850/7.5 years remaining life = $7,447

Problem 16-5

a.$32,000/8 = $4,000 per year; $770,000/15,400,000 = $0.05 per ton

b.$4,000/2 = $2,000c.2,500,000 * $0.05 = $125,000d.2,000,000 * $0.05 = $100,000

Problem 16-6

a. $685,000 - $274,000 = $411,000 carrying value (1) $365,000 - $411,000 = ($46,000) recognized loss (2) $425,000 - $411,000 = $14,000 recognized gain (3) $400,000 - $411,000 = ($11,000) recognized loss (4) $450,000 - $411,000 = $39,000 recognized gain

Problem 16-6

• (1) • Cash 365,000• Accumulated depreciation 274,000• Loss of sale of equipment 46,000• Motorcoach

685,000• (2)• Investment in stock 425,000• Accumulated depreciation 274,000•

Motorcoach685,000

• Gain on sale of equipment 14,000

Problem 16-6

(3)Motorcoach (new) 825,000Accumulated depreciation 274,000Loss on trade of equipment 11,000

Motorcoach (old) 685,000Cash 425,000

(4)Cash 60,000

N/R 340,000 Limousine 50,000

Accumulated depreciation 274,000Motorcoach (new) 685,000Gain 39,000