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Depreciation Methods

GAAP

     Depreciation is a systematic and rational process of distributing the cost of tangible assets over the life of assets.
     Depreciation is a process of allocation.
     Cost to be allocated = acquisition cot - salvage value
     Allocated over the estimated useful life of assets.
     Allocation method should be systematic and rational.

 

Depreciation Methods


    Depreciation methods based on time
           Straight line method
           Declining balance method          
           Sum-of-the-years'-digits method

    Depreciation based on use (activity)

 
 

Straight Line Depreciation Method


    Depreciation = (Cost - Residual value) / Useful life

[Example, Straight line depreciation] 

       On April 1, 2011, Company A purchased an equipment at the cost of $140,000.  This equipment is estimated to have 5 year useful life.  At the end of the 5th year, the salvage value (residual value) will be $20,000.  Company A recognizes depreciation to the nearest whole month.  Calculate the depreciation expenses for 2011,  2012 and 2013 using straight line depreciation method.  

       Depreciation for 2011
           = ($140,000 - $20,000) x 1/5 x 9/12 = $18,000

       Depreciation for 2012
           = ($140,000 - $20,000) x 1/5 x 12/12 = $24,000

       Depreciation for 2013
           = ($140,000 - $20,000) x 1/5 x 12/12 = $24,000



Declining Balance Depreciation Method


    Depreciation = Book value x Depreciation rate
       Book value = Cost - Accumulated depreciation
       
       Depreciation rate for double declining balance method
           = Straight line depreciation rate x 200%

       Depreciation rate for 150% declining balance method
           = Straight line depreciation rate x 150%

[Example, Double declining balance depreciation] 
 
       On April 1, 2011, Company A purchased an equipment at the cost of $140,000.  This equipment is estimated to have 5 year useful life.  At the end of the 5th year, the salvage value (residual value) will be $20,000.  Company A recognizes depreciation to the nearest whole month.  Calculate the depreciation expenses for 2011,  2012 and 2013 using double declining balance depreciation method.  

       Useful life = 5 years  -->  Straight line depreciation rate = 1/5 = 20% per year

       Depreciation rate for double declining balance method 
            = 20% x 200% = 20% x 2 = 40% per year

       Depreciation for 2011
           = $140,000 x 40% x 9/12 = $42,000

       Depreciation for 2012
           = ($140,000 - $42,000) x 40% x 12/12 = $39,200

       Depreciation for 2013
           = ($140,000 - $42,000 - $39,200) x 40% x 12/12 = $23,520

 
   Double Declining Balance Depreciation Method
 
Year Book Value
at the beginning
Depreciation Rate Depreciation Expense Book Value at the year-end
2011 $140,000 40% $42,000 (*1) $98,000
2012 $98,000 40% $39,200 (*2) $58,800
2013 $58,800 40% $23,520 (*3) $35,280
2014 $35,280 40% $14,112 (*4) $21,168
2015 $21,168 40% $1,168 (*5) $20,000

   (*1) $140,000 x 40% x 9/12 = $42,000
   (*2) $98,000 x 40% x 12/12 = $39,200
   (*3) $58,800 x 40% x 12/12 = $23,520
   (*4) $35,280 x 40% x 12/12 = $14,112
   (*5) $21,168 x 40% x 12/12 = $8,467 
 
           --> Depreciation for 2015 is $1,168 to keep book value same as salvage value.
           --> $21,168 - $20,000 = $1,168 (At this point, depreciation stops.)

 

[Example, 150% declining balance depreciation]
  
       On April 1, 2011, Company A purchased an equipment at the cost of $140,000.  This equipment is estimated to have 5 year useful life.  At the end of the 5th year, the salvage value (residual value) will be $20,000.  Company A recognizes depreciation to the nearest whole month.  Calculate the depreciation expenses for 2011,  2012 and 2013 using double declining balance depreciation method.  

       Useful life = 5 years  -->  Straight line depreciation rate = 1/5 = 20% per year

       Depreciation rate for double declining balance method 
            = 20% x 150% = 20% x 1.5 = 30% per year

       Depreciation for 2011
           = $140,000 x 30% x 9/12 = $31,500

       Depreciation for 2012
           = ($140,000 - $31,500) x 30% x 12/12 = $32,550

       Depreciation for 2013
           = ($140,000 - $31,500 - $32,550) x 30% x 12/12 = $22,785


   150% Declining Balance Depreciation Method
 
Year Book Value
at the beginning
Depreciation Rate Depreciation Expense Book Value at the year-end
2011 $140,000 30% $31,500 (*1) $108,500
2012 $108,500 30% $32,550 (*2) $75,950
2013 $75.950 30% $22,785 (*3) $53,165
2014 $53,165 30% $15,950 (*4) $37,216
2015 $37,216 30% $11,165 (*5) $26,051
2016 $26,051 30% $6,051 (*6) $20,000

   (*1) $140,000 x 30% x 9/12 = $31,500
   (*2) $108,500 x 30% x 12/12 = $32,550
   (*3) $75,950 x 30% x 12/12 = $22,785
   (*4) $53,165 x 30% x 12/12 = $15,950
   (*5) $37,216 x 30% x 12/12 = $11,165 
   (*6) $26,051 x 30% x 12/12 = $7,815 
 
           --> Depreciation for 2016 is $6,051 to keep book value same as salvage value.
           --> $26,051 - $20,000 = $6,051 (At this point, depreciation stops.)


Sum-of-the-years'-digits method

    
    Depreciation expense = (Cost - Salvage value) x Fraction
         Fraction for the first year = n / (1+2+3+...+ n)
         Fraction for the second year = (n-1) / (1+2+3+...+ n)
         Fraction for the third year = (n-2) / (1+2+3+...+ n)
           ...
         Fraction for the last year = 1 / (1+2+3+...+ n)

         n represents the number of years for useful life.
 

[Example, Sum-of-the-years-digits method]

  Company A purchased the following asset on January 1, 2011. 
   What is the amount of depreciation expense for the year ended December 31, 2011?
   Acquisition cost of the asset --> $100,000
   Useful life of the asset --> 5 years
   Residual value (or salvage value) at the end of useful life --> $10,000
   Depreciation method --> sum-of-the-years'-digits  method

  Calculation of depreciation expense
   Sum of the years' digits = 1+2+3+4+5 = 15
   Depreciation for 2011 = ($100,000 - $10,000) x 5/15 = $30,000
   Depreciation for 2012 = ($100,000 - $10,000) x 4/15 = $24,000
   Depreciation for 2013 = ($100,000 - $10,000) x 3/15 = $18,000
   Depreciation for 2014 = ($100,000 - $10,000) x 2/15 = $12,000
   Depreciation for 2015 = ($100,000 - $10,000) x 1/15 = $6,000

      Sum of the years' digits for n years
          = 1 + 2 + 3 + ...... + (n-1) + n = (n+1) x (n / 2)

      Sum of the years' digits for 500 years
          = 1 + 2 + 3 + ...... + 499 + 500
          = (500 + 1) x (500 / 2) = (501 x 500) / 2 = 125,250


Depreciation Example 1



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Intermediate Accounting:  

This section provides study guides for students in the intermediate accounting courses.  Following topics are discussed in this section.

  
  
 

    Depreciation Methods

    Straight Line Depreciation

    Declining Balance Method

    Sum-of-the-years-digits Method

    Accounting for Bonds Payable

    Price of bonds payable

    Discount on bonds payable

    Premium on bonds payable

    Amortization of discount and premium

    Early extinguishment of debts





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U.S. GAAP by Codification Topic
  
 105  GAAP Hierarchy 
 105  GAAP History 

 205  Presentation of Financial Statements 
 205-20 Discontinued Operations 
 210  Balance Sheet 
 210-20 Offsetting 
 220  Comprehensive Income 
 225  Income Statement 
 225-20 Extraordinary and Unusual Items 
 230  Statement of Cash Flows 
 250  Accounting Changes and Error Corrections 
 260  Earnings per Share 
 270  Interim Reporting
 
 310  Impairment of a Loan
 320  Investment Securities 
 320  Other-Than-Temporary Impairments, FSP FAS 115-2 
 320-10-05 Overview of Investments in Other Entities 
 320-10-35 Reclassification of Investments in Securities
 323-10 Equity Method Investments
 323-30 Investments in Partnerships and Joint Ventures 
 325-20 Cost Method Investments 
 330  Inventory

 340-20 Capitalized Advertising Costs 
 350-20 Goodwill 
 350-30 Intangibles Other than Goodwill 
 350-40 Internal-Use Software 
 350-50 Website Development Costs 
 360  Property, Plant and Equipment
 360-20 Real Estate Sales 
 
 410  Asset Retirement and Environmental Obligations 
 420  Exit or Disposal Cost Obligations 
 450  Contingencies 
 450-20 Loss Contingencies 
 450-30 Gain Contingencies
 480  Redeemable Financial Instruments 

 505-20 Stock Dividends, Stock Splits 
 505-30 Treasury Stock 

 605  SEC Staff Accounting Bulletin, Topic 13 
 605-25 Revenue Recognition - Multiple Element Arrangements 
 
 715-30 Defined Benefit Plans - Pension
 718  Share-Based Payment 
 730  Research and Development 
 730-20 Research and Development Arrangements 

 805  Business Combinations  
 810  Consolidation 
 810  Noncontrolling Interests 
 810  Consolidation of Variable Interest Entities, SFAS 167 
 
 815  Derivatives and Hedging Overview 

 820  Fair Value Measurements  
 820  Fair value when the markets are not active, FSP FAS 157-4
 825  Fair Value Option 

 830  Foreign Currency Matters 
 830-20 Foreign Currency Transactions 
 830-30 Translation of Financial Statements 
 835  Interest 
 835-20 Capitalization of Interest 
 835-30 Imputation of Interest 

 840  Leases 
 840-20 Operating Leases 
 840-30 Capital Leases 
 840-40 Sale-Leaseback Transactions
 845  Nonmonetary Transactions 

 855  Subsequent Events 
 860-20 Sale of Financial Assets, SFAS 166 
 860-50 Servicing Assets and Liabilities, SFAS 156 

 985-20 Costs of software to be sold  
 
International Financial Reporting Standards (IFRS)







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