DEPRECIATION SCENARIO Alicias Alpaca Rides has been struggling

DEPRECIATION

SCENARIO Alicia’s Alpaca Rides has been struggling of late, so they decide to buy a flashy new truck (on account of course), which is capable of faster speeds and hauling many more Alpacas which is supposed to generate more revenue! The truck costs $72, 000. How should it be journalized? Truck 72000 A/P 72000 Seems straight forward, but isn’t this a cost of doing business? …. . We are supposed to expense costs of doing business….

ASSET EXPENSE So far with our expense adjustments, we have transferred the amounts from their respective holding asset to an expense once used…. But how much of the truck would be used up in the 1 st year? ? ? Think of some ideas for determining this.

STRAIGHT- LINE DEPRECIATION We could assume the truck will be used equally in each year of its life. An assumption would need to be made to determine the useful life of the long-term asset. If we assumed the truck would last 6 years…. The cost of the truck would be split evenly into the 6 years. $72, 000 / 6 years = $12, 000 / year

JOURNAL ENTRY The expense account used is not called Truck Expense, but rather Depreciation Expense. Depreciation: The allocation of the initial cost of an asset over time OR reduction of the value of an asset over time due to wear and tear Journal entry after one year: Depreciation Expense Truck 12000 The cost principle tells us that an asset must always be listed at the price it was purchased for.

ACCUMULATED DEPRECIATION To satisfy the cost principle, so that the user of our financial statements can still always see the original price, we show a separate account for the accumulated reduction in the asset’s price… Depreciation Expense 12000 Accumulated Depreciation – Truck 12000 Accumulated Depreciation: Our first contra-asset, although it is an asset, it increases on the credit side, because it is a decrease in assets Why is it an asset then? We want to be able to quickly verify the current cost value of an asset, so we list it’s accumulated depreciation account right

BALANCE SHEET

CALCULATING DEPRECIATION This first method of depreciation (reducing the asset value over time), is called STRAIGHT-LINE Depreciation, as the same depreciation expense is applied each year of the asset’s life. Depreciation Salvage for one year = Original Cost - Estimated Value ______________ Estimated Useful Life (years)

EXAMPLE •

OTHER LONG-TERM ASSETS Depreciation can be calculated similarly for Buildings, Equipment, Vehicles, etc. Land is not depreciated, because it is an asset that is assumed to exist indefinitely.

DECLINING-BALANCE METHOD Is it really fair to assume that an asset has the same effect on revenues in Year 1 as it does in its final year of its useful life? Think about a building in its 1 st year, compared to 50 th. Instead a % of the asset’s current value could be used to calculate depreciation.

EXAMPLE 2 – DECLINING BALANCE METHOD •

SPECIFICS •

USING TABLE Computers are purchased on January 1, 2001 for $22, 000. They depreciate at a rate of 30%. Useful life 7 years. Ending Value of $2, 000. Year Rate Depreciation Book Expense Value $22, 000 1 30% $6, 600 15, 400 2 30% 4, 620 10, 780 3 30% 3, 234 7, 546 4 30% 2, 264 5, 282 5 30% 1, 585 3, 697 6 30% 1, 109 2, 588 7 * 588 2, 000

HOMEWORK Page 214 # 3 -6