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Chapter Five Appendix

Chapter Five Appendix. DEPRECIATION METHODS. DEPRECIATION METHODS. Straight-Line Sum-of-the-Years’-Digits Double-Declining-Balance Modified Accelerated Cost Recovery System. EXAMPLE:.

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Chapter Five Appendix

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  1. Chapter Five Appendix DEPRECIATION METHODS

  2. DEPRECIATION METHODS • Straight-Line • Sum-of-the-Years’-Digits • Double-Declining-Balance • Modified Accelerated Cost Recovery System

  3. EXAMPLE: For all illustrations in this appendix, we will assume that a delivery van was purchased for $40,000. It has a five year useful life and salvage value of $4,000.

  4. STRAIGHT-LINE METHOD Under this method, an equal amount of depreciation will be taken each period. STEP #1: Compute the depreciable cost = SALVAGE VALUE COST DEPRECIABLE COST = $36,000 $40,000 $4,000

  5. STRAIGHT-LINE METHOD STEP #2: Divide the depreciable cost by the expected life of the asset. Depreciation Expense per year Depreciable Cost = Years of Life $7,200 per year $36,000 = 5 years

  6. STRAIGHT-LINE METHOD It is often convenient to use a depreciation rate per year. 20% of the asset’s depreciable cost will be recognized as Depreciation Expense each year. 100% Depreciation rate per year = Years of Life 100% 20% = 5 years

  7. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $36,000 Original Cost minus Salvage Value $40,000 - $4,000

  8. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $36,000 20% 100% / Years of Life 100% / 5 year life

  9. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $7,200 $36,000 20% Depreciable Cost x Depreciation Rate $36,000 x 20%

  10. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $7,200 $7,200 $36,000 20% Since this is the first year of the asset’s life, only this year’s depreciation has accumulated.

  11. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $7,200 $7,200 $36,000 20% $32,800 Book Value is Cost minus Accumulated Depreciation. $40,000 - $7,200

  12. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $7,200 $7,200 $36,000 20% $32,800 $36,000 2 Depreciable Cost does not change.

  13. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $7,200 $7,200 $36,000 20% $32,800 $36,000 20% 2 Depreciation Rate does not change.

  14. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $7,200 $7,200 $36,000 20% $32,800 $7,200 $36,000 20% 2 Depreciation Expense remains the same each year.

  15. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $7,200 $7,200 $36,000 20% $32,800 $14,400 $36,000 20% $7,200 2 Now two years of depreciation has accumulated. $7,200 + $7,200

  16. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $7,200 $7,200 $36,000 20% $32,800 $14,400 $36,000 20% $7,200 $25,600 2 Cost - Accumulated Depreciation $40,000 - $14,400

  17. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $7,200 $7,200 $36,000 20% $32,800 $14,400 $36,000 20% $7,200 $25,600 2 Book Value declines over the life of the asset.

  18. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $7,200 $7,200 $36,000 20% $32,800 $14,400 $36,000 20% $7,200 $25,600 2 20% $36,000 $7,200 $18,400 3 $21,600 20% $28,800 $36,000 $11,200 4 $7,200 5 $36,000 $7,200 20% $36,000 The entire Depreciable Cost has now been recognized as Depreciation Expense.

  19. STRAIGHT-LINE DEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $7,200 $7,200 $36,000 20% $32,800 $14,400 $36,000 20% $7,200 $25,600 2 20% $36,000 $7,200 $18,400 3 $21,600 20% $28,800 $36,000 $11,200 4 $7,200 $4,000 5 $36,000 $7,200 20% $36,000 Book Value has fallen to the Salvage Value.

  20. SUM-OF-THE-YEARS’-DIGITS • Depreciation is determined by multiplying the depreciable cost by a schedule of fractions. • The numerator (top) of the fraction for a specific year is the number of years of remaining useful life. • The denominator (bottom) of the fraction is determined by adding the digits of the years of the estimated life of the asset.

  21. SUM-OF-THE-YEARS’-DIGITS FORMULA: DEPRECIABLE COST Remember, Depreciable Cost is Original Cost minus Salvage Value.

  22. SUM-OF-THE-YEARS’-DIGITS FORMULA: YEARS REMAINING DEPRECIABLE COST X This is measured from the beginning of the year. For example, to calculate the first year’s depreciation…. we would say there are 5 years remaining.

  23. SUM-OF-THE-YEARS’-DIGITS FORMULA: YEARS REMAINING DEPRECIABLE COST X SUM-OF-THE-YEARS’-DIGITS 5 YEAR LIFE = 5+4+3+2+1 OR 15 10 YEAR LIFE = 10+9+8+7+6+5+4+3+2+1 OR 55

  24. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 $36,000 Original Cost minus Salvage Value $40,000 - $4,000

  25. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $36,000 Five years remaining divided by sum-of-years’-digits of 15 (5+4+3+2+1)

  26. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $12,000 $36,000 $36,000 X 5/15

  27. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $12,000 $36,000 Sum-of-the-years’-digits method recognizes large amounts of depreciation in the first year of the asset’s life and smaller amounts each subsequent year.

  28. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $12,000 $12,000 $36,000 Only this first year of depreciation has accumulated so far.

  29. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $12,000 $12,000 $36,000 $28,000 Original Cost minus Accumulated Depreciation $40,000 - $12,000

  30. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $12,000 $12,000 $36,000 $28,000 2 $36,000 Depreciable Cost does not change.

  31. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $12,000 $12,000 $36,000 $28,000 2 4/15 $36,000 Now there are 4 years remaining.

  32. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $12,000 $12,000 $36,000 $28,000 2 4/15 $9,600 $36,000 Since the rate (fraction) is smaller, the depreciation expense is also smaller in the 2nd year.

  33. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $12,000 $12,000 $36,000 $28,000 2 4/15 $9,600 $21,600 $36,000 There are now two years of depreciation accumulated. $12,000 + $9,600

  34. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $12,000 $12,000 $36,000 $28,000 2 $18,400 4/15 $9,600 $21,600 $36,000 Book Value falls as the asset ages.

  35. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $12,000 $12,000 $36,000 $28,000 2 $18,400 $9,600 $21,600 $36,000 4/15 3 $11,200 $36,000 3/15 $7,200 $28,800 $36,000 $4,800 $33,600 $6,400 4 2/15 2/15 $36,000 $36,000 5 $2,400 The entire depreciable cost has been recognized as Depreciation Expense.

  36. SUM-OF-THE-YEARS’-DIGITSDEPRECIATION SCHEDULE Accumulated Depreciation (end of year) Depreciable Cost Depreciation Expense Book Value (end of year) x = Year Rate 1 5/15 $12,000 $12,000 $36,000 $28,000 2 $18,400 $9,600 $21,600 $36,000 4/15 3 $11,200 $36,000 3/15 $7,200 $28,800 $36,000 $4,800 $33,600 $6,400 4 2/15 2/15 $36,000 $4,000 $36,000 5 $2,400 Book value now matches the Salvage Value.

  37. DOUBLE-DECLINING-BALANCE • Book Value is multiplied by a fixed rate. • often double the straight-line rate • Once the book value is reduced to the expected salvage value, no more depreciation may be recognized. • Similar to Sum-of-the-Years’-Digits, larger amounts of depreciation are taken in the early years of the asset’s life.

  38. DOUBLE-DECLINING-BALANCE FORMULA: Book Value Cost minus Accumulated Depreciation equals Book Value. For an asset’s first year depreciation, Book Value equals Original Cost.

  39. DOUBLE-DECLINING-BALANCE FORMULA: Book Value x (Straight-Line Rate) 2 100% / Useful Life For our example…… 100%/5years = 20%

  40. Double-Declining-BalanceDepreciation Schedule Book Value (Beginning of Year) Accumulated Depreciation (end of year) Depreciation Expense Book Value (end of year) x = Year Rate 1 $40,000 Original Cost minus Accumulated Depr. $40,000 - $0

  41. Double-Declining-BalanceDepreciation Schedule Book Value (Beginning of Year) Accumulated Depreciation (end of year) Depreciation Expense Book Value (end of year) x = Year Rate 1 40% $40,000 Twice the Straight-Line Rate 2 (100%/5) or 2 x 20%

  42. Double-Declining-BalanceDepreciation Schedule Book Value (Beginning of Year) Accumulated Depreciation (end of year) Depreciation Expense Book Value (end of year) x = Year Rate 1 40% $40,000 $16,000 Book Value x twice the Straight-Line Rate $40,000 x 40%

  43. Double-Declining-BalanceDepreciation Schedule Book Value (Beginning of Year) Accumulated Depreciation (end of year) Depreciation Expense Book Value (end of year) x = Year Rate 1 40% $40,000 $16,000 $16,000 First year’s depreciation is all that has accumulated.

  44. Double-Declining-BalanceDepreciation Schedule Book Value (Beginning of Year) Accumulated Depreciation (end of year) Depreciation Expense Book Value (end of year) x = Year Rate 1 40% $40,000 $16,000 $16,000 $24,000 Original Cost minus Accumulated Depreciation $40,000 - $16,000

  45. Double-Declining-BalanceDepreciation Schedule Book Value (Beginning of Year) Accumulated Depreciation (end of year) Depreciation Expense Book Value (end of year) x = Year Rate 1 40% $40,000 $16,000 $16,000 $24,000 2 $24,000 The Book Value at the end of one year becomes the next year’s beginning Book Value.

  46. Double-Declining-BalanceDepreciation Schedule Book Value (Beginning of Year) Accumulated Depreciation (end of year) Depreciation Expense Book Value (end of year) x = Year Rate 1 40% $40,000 $16,000 $16,000 $24,000 2 $24,000 40% Rate will be the same every year. Always twice the straight-line rate

  47. Double-Declining-BalanceDepreciation Schedule Book Value (Beginning of Year) Accumulated Depreciation (end of year) Depreciation Expense Book Value (end of year) x = Year Rate 1 40% $40,000 $16,000 $16,000 $24,000 2 $24,000 40% $9,600 Depreciation Expense will be smaller each year because the book value is declining each year.

  48. Double-Declining-BalanceDepreciation Schedule Book Value (Beginning of Year) Accumulated Depreciation (end of year) Depreciation Expense Book Value (end of year) x = Year Rate 1 40% $40,000 $16,000 $16,000 $24,000 2 $24,000 $25,600 40% $9,600 Two years’ depreciation has accumulated…. $16,000 + $9,600

  49. Double-Declining-BalanceDepreciation Schedule Book Value (Beginning of Year) Accumulated Depreciation (end of year) Depreciation Expense Book Value (end of year) x = Year Rate 1 40% $40,000 $16,000 $16,000 $24,000 2 $24,000 $25,600 40% $9,600 $14,400 Original Cost - Acc. Depreciation $40,000 - $25,600

  50. Double-Declining-BalanceDepreciation Schedule Book Value (Beginning of Year) Accumulated Depreciation (end of year) Depreciation Expense Book Value (end of year) x = Year Rate 1 40% $40,000 $16,000 $16,000 $24,000 2 $24,000 $25,600 40% $9,600 $14,400 3 $14,400 $8,640 40% $5,760 $31,360 $8,640 $5,184 4 $3,456 $34,816 40% Book Value can fall only to the amount of the Salvage Value. $5,184 - $4,000 = $1,184 to go!!

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