Chapter 11 lecture notes - CHAPTER 11 Depreciation and...

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11-1 CHAPTER 11 Depreciation and Depletion
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11-2 LECTURE OUTLINE Chapter 11 can be covered in two class sessions. Most students are already familiar with the three primary chapter topics: depreciation accounting, income tax depreciation and depletion accounting. A. Depreciation, Depletion, and Amortization: Procedures to indicate that the service potential of an asset has declined. Depreciation and depletion are discussed in this chapter. Amortization is discussed in Chapter 12. 1. Depreciation is a decline in service potential due to physical and economic factors. 2. Depreciation accounting is the process of allocating the cost of tangible assets to expense in a rational and systematic manner over the periods of use. It is not a process of valuation. 3. Factors to be considered in the depreciation process: a. Depreciation base. This is equal to the original cost minus the expected salvage value. b. Estimated service life. Describe the difference between the physical life of an asset and its service life. (1) An asset’s physical life is limited by physical factors such as wear and tear. These factors set the outside limit for an asset’s useful life. (2) An asset’s service life is limited by economic factors such as inadequacy, supersession, and obsolescence. B. Methods of Depreciation. Describe the characteristics of these methods and the factors that influence the choice of method, as described below.
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11-3 1. Activity Methods: Assumes that depreciation is a function of use. The life of the asset is considered in terms of either the output it provides or the number of units of activity it works. An estimate of units of output or service units is often difficult to measure. This method is not appropriate in situations where depreciation is a function of time instead of activity. 2. Straight-line Method: This method is widely used because of its simplicity in charging a constant amount each period. This method assumes that the asset’s economic usefulness is the same each year and that repair and maintenance expenses are essentially the same each year. 3. Decreasing Charge (Accelerated Depreciation) Methods: Justified on the grounds that since the asset is more efficient in the earlier years more depreciation should be charged in those years. a. Sum-of-the-Years’-Digits Method. This method requires multiplication of the asset’s depreciable cost by a fraction that decreases each year of the asset’s service life. Each fraction uses the sum of the years’ digits as a denominator and number of years estimated life at the beginning of the year as a numerator. b. Declining Balance Methods. The declining balance rate remains constant and is applied to the remaining book value, which declines each year. Salvage value is ignored in computing periodic depreciation.
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