Depreciation Methods

1. Hartnell College Depreciation Methods Presentationby Robert J. Maffei

2. Depreciation The cost is spread out over its estimated useful life in the form of an expense given various depreciation methods. Depreciation is an expense based on the expectation that an asset will gradually decline in usefulness due to time, wear and tear, or obsolescence.

3. Depreciation Methods • Straight-line depreciation allocates an equal amount of the cost of a plant asset to expense during each fiscal period of the asset’s expected useful life. • Accelerated depreciation allocates a larger portion of the cost of a plant asset to expense early in the asset’s life. Double-Declining-Balance is an example of an accelerated method. Continued

4. Depreciation Methods • Units-of-production depreciation allocates an asset’s cost to depreciation expense based on unit of output or activity (rather than per fiscal period).

5. Straight-line Accelerated Units-of- production Other Depreciation 12% 5% 1% 82% Depreciation Methods Used by Major U.S. Corporations for Financial Reporting Data Source: AICPA, Accounting Trends and Techniques, 2001

6. = $12,000 per year Straight-Line Calculation Mom’s Cookie Company purchased equipment on January 1, 2004, at a cost of $50,000. Management expects the equipment to have a four-year life and a $2,000 residual value. Cost – Residual Value Expected Life $50,000 – $2,000 4 years Straight-Line Depreciation

7. Depreciation Accumulated Depreciation is a contra-asset account that offsets Equipment.

8. Book Value The book value of a plant asset is the net cost of the asset after accumulated depreciation (the contra account) has been subtracted. $50,000 Beg. Book Value -12,000 Accum. Depre. $38,000 End. Book Value

9. An equal amount of depreciation is recorded each fiscal year. Straight-Line Depreciation Schedule

10. 2 4 2 x straight-line Expected useful life Double-declining-balance depreciation expense = $50,000 x = Book Value x $25,000 Accelerated Depreciation If Mom’s Cookie Company used double-declining-balance method, it would Multiply the straight-line rate by two, e.g. 2/1 x ¼ = 2/4

11. $6,250 – $2,000 (residual value) Double-Declining Balance Depreciation Schedule Accelerated Depreciation

12. Reasons for Using Accelerated Depreciation 1. An asset is more useful earlier in its life than later, and the useful life may be difficult to estimate. 2. Depreciation expense is deductible in computing taxable income and income taxes. The second reason is the most common reason for using accelerated depreciation.

13. Comparison of Straight-Line and Accelerated Depreciation Methods in 2004 Accelerated Straight-Line Income before depreciation and taxes $100,000 $100,000 Depreciation expense 12,000 25,000 Pretax income 88,000 75,000 Income taxes (35%) 30,800 26,250 Net income $ 57,200 $ 48,750

14. $0.20 per mile Mom’s Cookies Activity Depreciation At the beginning of 2005, Mom’s Cookie Company purchased a truck for $30,000. Management expects the useful life of the truck to be 100,000 miles, at which time it will be sold for $10,000. Cost – Residual Value Expected Units $30,000 – $10,000 100,000 miles Units-of-Production Depreciation

15. Mom’s Cookies Activity Depreciation If the truck were driven 12,000 miles in 2005, Hydro would record depreciation expense of $2,400 (12,000 x $0.20). Units-of-Production Depreciation