33 depreciation is a process of cost allocation not a

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Unformatted text preview: atching principle. 3.3 Depreciation is a process of cost allocation, not a process of asset valuation. 3.4 The carrying amount (or net book value) (cost less accumulated depreciation) of a longlived asset may differ significantly from its fair market value. 3.5 Accumulated depreciation, a contra account, represents the total cost of a long-lived asset that has been charged to expense over the periods used. 3.6 A decline in revenue producing ability may occur because of: 3.6.1 Physical factors such as wear and tear. 3.6.2 Economic factors such as obsolescence, which is the process of becoming out of date before the asset physically wears out. 4. Depreciation Methods 4.1 The calculation of depreciation expense is based on three factors: 4.1.1 Cost. 4.1.2 Useful life (service life) is an estimate of the expected productive life of the asset. Useful life may be expressed in terms of time, units of activity, or in units of output. 4.1.3 Residual value (salvage value) is an estimate of the asset’s value at the end of its useful life. Regardless of the method used, an asset is never depreciated below its estimated residual value. Estimated residual value can be no lower than $0. 4.2 There are three common methods of depreciation: straight-line, diminishing-balance (or declining-balance), and units-of-production. All three methods are acceptable under GAAP. 4.2.1 Under the straight-line method, depreciation is the same for each year of the asset’s useful life. The formula for calculating annual depreciation expense is depreciable cost (cost less residual value) divided by useful life. The straightline method is simple to apply, and it matches expenses with revenues appropriately when the use of the asset is reasonably uniform throughout service life. The formula for computing annual depreciation expense is: Depreciable Cost (Cost – Residual value) = Depreciation expense Useful Life (in years) BCIT – FMGT 1152 – Accounting for the Manager 4 of 8 To illustrate the computation, assume that the Benoit Company purchased a delivery truck for $11,000 on January 1 with an estimated residual value of $1,000 at the end of its four-year service life. Annual depreciation is $2,500 [($11,000- $1,000) / 4]. To calculate the annual rate of depreciation: 100% ÷ Estimated Useful Life= Straight-line Depreciation Rate 100% ÷ 4 years = 25% If an asset is acquired partway through the year, the depreciation is prorated for the time the asset was in use during the year. Depreciation is usually rounded to the nearest month. If acquired before the 15th of the month, use the whole month to c...
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