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Lecture15_Spring_2009

# Lecture15_Spring_2009 - Lecture15 Spring2009...

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Lecture 15 Spring 2009 Property, Plant and Equipment   PP&E Accounting for

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Goals of Today’s Class Review of Depreciation Accelerated Depreciation (Declining Balance) Change in Depreciation Delta Case Study
Declining Balance Depreciation Method  Modifies the normal straight-line rate to accelerate depreciation  Commonly 2 times the straight-line rate (double-declining balance)  Or 1.5 times the straight-line rate (150%-declining balance)  Straight-line annual percentage rate = 100% / useful years 100% / 4 years = 25% Double-declining will use 2 x 25% = 50% 150%-declining will use 1.5 x 25% = 37.5%  Begins with Book Value and ends with Salvage Value

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Double-Declining Balance Method Year Book Value, Beg Straight- Line  % 200% of  SL Depr. Expense Book  Value, End 1 2 3 4 25% 25% 25% 25% 50% 50% 50% 50% 20,000 10,000 10,000 10,000 5,000 5,000 5,000 2,500 2,500 Too low—need to stop at Salvage Value 1,000 4,000 0
What happens when estimates change? On January 1, 20x1, a firm acquired a depreciable asset at a cost of \$160,000. The estimated useful life of the asset and its salvage value were determined to be 20 years and \$10,000 respectively. The firms uses the straight line method for depreciation. What is annual depreciation? (160,000-10,000)/20 = 7,500 At the end of 20x10 (10 years later) what would the balance sheet look like? Equipment 160,000 Accumulated Depreciation 75,000 Book Value of Equipment 85,000

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What happens when estimates change? At the start of 20x11 the firm revises its estimate of the useful life, determining that 5 years are left (instead of 10 from the original estimate). What do we do? We do NOT make retro-active adjustments to the financial statements. That is, we do not restate depreciation for the last 10 years to 10,000 per year [ i.e.,(160,000-10,000)/15] which would give a book value of 60,000 at the start of 20x11. We simply revise the depreciation charge going forward. Thus, for the remaining 5 years annual depreciation is: [(160,000-75,000)-10,000]/5 = 15,000 This is called the prospective method and it is used to account for all changes in the estimates used to derive the amounts reported in the financial statements. But it is NOT used if a firm changes accounting method (i.e., straight line to accelerated).
An Example for Changes in Estimates Note extracted from Delta’s 1994 Annual Report Depreciation and Amortization -- Prior to April 1, 1993, substantially all of the Company's flight equipment was being depreciated on a straight-line basis to residual values (10% of cost) over a 15-year period from the dates placed in service. As a result of a review of its fleet plan, effective April 1, 1993, the Company increased the estimated useful lives of substantially all of its flight equipment. Flight equipment that was not already fully depreciated is being depreciated on a straight-line basis to residual values (5% of cost) over a 20-year period from the dates placed in service. The effect of this change was a \$34 million decrease in depreciation expense and a \$22 million (\$0.44 per common share) decrease in net loss for fiscal 1993. Ground property and equipment are depreciated on a

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Lecture15_Spring_2009 - Lecture15 Spring2009...

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