Chapter 11 331

# Chapter 11 331 - Lecture Notes for Chapter 11(ACCT 331...

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Lecture Notes for Chapter 11 (ACCT 331) Operational Assets: Utilization and Impairment Depreciation Depreciation is the process of reducing the value of an asset and allocating it to expense over its useful (service) life in a rational and systematic manner. Such cost allocation is designed to provide for the proper matching of expenses with revenues in accordance with the matching principle. Depreciation Terms: o Depreciation is the allocation of long-term tangible assets. o Depletion is the allocation of natural resources. o Amortization is the allocation of intangible assets. Depreciation Calculation Information needed to calculate Depreciation: Cost of the item. Salvage (residual) value. [Allocation base = Cost - salvage] Service life (or useful life). Allocation Method (or depreciation method): Time based or activity based. o Depreciation Methods: Straight line Method. Decreasing Charges Methods (Accelerated Methods): Declining balance Method. Sum of the years’ digit method. Activity based method. Other methods: (Group and composite methods; Hybrid or combination methods. 1

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Straight Line Method: Under the straight-line method, Depreciation is the same for each year of the asset’s useful life. The depreciable cost is the total amount subject to depreciation and is computed as follows: (Cost - salvage). Depreciation expense is recorded over useful life as Depreciation expense = (Cost - salvage value) Number of useful years Truck purchased for \$20,000 on 1/1/97. Useful life is 12 years, salvage value = \$800. Depreciation expense 1,600 Accumulated depreciation 1,600 2 USE OF DEPRECIATION METHODS IN MAJOR U.S. COMPANIES USE OF DEPRECIATION METHODS IN MAJOR U.S. COMPANIES 78% Straight-line 4% Declining balance 7% Units-of-activity 11% Other 3 methods of recognizing depreciation 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 in the circumstances. Once a method is chosen, it should be applied consistently .
Sum-of-the-years’-digits method depreciation Depreciation expense is calculated using the following formula: [Depreciation base]x[# of yrs. remaining (incl.current yr.)] Sum of the years As with the other accelerated methods, this method records more depreciation in the early years. Example: Suppose a company purchased an asset on 1/1/90 for \$100,000 with a 6 year useful life (no salvage value) and uses the sum-of-the-years’-digits method for depreciation. Declining Balance method depreciation The declining-balance method records depreciation expense based on a fixed percentage of the current book value of the asset. Book value = Cost - accumulated depreciation of the asset.

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Chapter 11 331 - Lecture Notes for Chapter 11(ACCT 331...

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