Amortization Chapter 10 Part 2 FACTORS IN CALCULATING

Amortization Chapter 10 – Part 2

FACTORS IN CALCULATING AMORTIZATION

AMORTIZATION METHODS Three methods of recognizing amortization are: 1. Straight-line, 2. Units of activity, and 3. Declining-balance. Each method is acceptable under generally accepted accounting principles. Management selects the method that is appropriate for their company. Once a method is chosen, it should be applied consistently.

STRAIGHT-LINE METHOD

Straight Line Example • Amit buys a new truck for his business, the truck was purchased for $12, 500, it has a useful life of 5 years. After 5 years, the truck can be sold to a scrap yard for $2500. • Using the Straight Line Method, what is the yearly amortization expense?

STRAIGHT-LINE METHOD • Amortization is constant for each year of the asset's useful life

DECLINING-BALANCE METHOD • The calculation of periodic amortization is based on a declining net book value (cost less accumulated amortization) of the asset. • The amortization rate remains constant from year to year, but the net book value to which the rate is applied declines each year. Net Book Value (at beginning of year) Straight-line Rate (x declining balance rate multiplier, if any) Amortization Expense

Declining Balance Example • Using the previous info (Amit’s truck, P: $12, 500, SV $2, 500, UL: 5 years. • Using the calculate the Amortization Expense for Amit’s truck for years one and two.

DECLINING-BALANCE METHOD • Accelerated methods result in more amortization in early years and less in later years

UNITS-OF-ACTIVITY METHOD To use the units-of-activity method, 1) the total units of activity for the entire useful life are estimated, 2) the amount is divided into amortizable cost to calculate the amortization cost per unit, and 3) the amortization cost per unit is then applied to the units of activity during the year to calculate the annual amortization. Amortized Cost Amortizable Cost per Unit Total Units of Activity during the Year Amortizable Cost per Unit Amortization Expense

Units of Activity Example • Using the previous info (Amit’s truck, P: $12, 500, SV $2, 500. • But now, Amit’s Truck has useful life of 300, 000 km. • Calculate the amortization expense for Amit’s Truck if: – Year 1: Truck’s Mileage: 50, 000 km – Year 2: Truck’s Mileage: 30, 000 km

UNITS-OF-ACTIVITY METHOD • Useful life is expressed in terms of total units of production or activity expected from the asset

REVISING PERIODIC AMORTIZATION • If annual amortization is inadequate or excessive, a change in the periodic amount should be made. • When a change is made, 1. there is no correction of previously recorded amortization expense and 2. amortization expense for current and future years is revised. Revised amortization expense = Net book value at time of revision – revised salvage value Remaining useful life