Plant Assets and Depreciation (2)
>> Thursday, January 14, 2010
Depreciation Methods
We will study a couple of depreciation methods. There are other methods. If you study international accounting, you will find that other countries deal with these issues in a very different way than we do in the US. But we're #1, so we must be right (hee, hee).
Depreciation Method | my silly comments |
Straight-Line Method | causes problems with my spell checker because of the hyphenated word |
Declining-Balance Method | oh, no. another hyphenated word. my spell checker is not happy today |
MACRS (income tax method) | US congress made up this word. its not in my spell checker dictionary either. whatever they were drinking that night, I want a bottle of it. |
OK, let's try this again.
Depreciation Method | my serious comments |
Straight-Line Method | an easy method that allocates an equal amount of depreciation to each time period; salvage value is used |
Declining-Balance Method (200% & 150% DB) | allocates more depreciation expense to the early years of an asset's life, when it is new; since there should be less down-time and fewer repairs in the early years, the company should get more use out of the asset in the beginning of it's life; no salvage value is used. |
MACRS (income tax method) | uses the double-declining balance method, but you only take one-half year's depreciation in the first year, and then you switch to the straight-line method in the middle of the asset's life, so a 5 year asset takes 6 years to depreciate. salvage value? salvage value? we don't need no stinking salvage value!! I still want a bottle of whatever they were drinking when they dreamed this one up. |
[It is a little known fact that the US congress is responsible for the rapid growth of the computer industry during the 1980s and 1990s. The MACRS depreciation rules were so complex everyone had to buy computers just to do the calculations each year. Millions of computers were sold, just to calculate MACRS depreciation ........ OK, I'm just kidding. You didn't really think I was serious, did you?. Hey, this is week 8, we're almost done.]
Selling or disposing of Fixed Assets
After selling or disposing of fixed assets, the company no longer has the asset. This requires a journal entry to remove everything in the accounting records relating to the asset.
The depreciable cost and accumulated depreciation relating to the asset must both be removed, or reversed. There might be a gain or loss when disposing of assets. There might also be incidental costs relating to disposing of the asset. All these things should be included in the journal entry recording the disposal.
Let's assume on September 1, the ledger shows these balances for a piece of equipment.
General Ledger
Equipment
Date | Description | | | |
Sep-1 | Balance forward | | | |
| | | | |
Accumulated Depreciation - Equipment
Date | Description | | | |
Sep-1 | Balance forward | | | |
| | | | |
Removing these amounts from the books with a journal entry
When assets disposed of there might be a gain, loss or a wash (no gain or loss). In either case all such journal entries will start from the same place, removing the related asset cost and accumulated depreciation. This journal entry does not balance; is the beginnings of a journal entry, and must be completed when all the information is available.
General Journal
| Account | | |
| Accumulated Depreciation | | |
| |||
| | | |
Equipment | | ||
| To record disposal of equipment | | |
Notice the exact opposite of the account balances is entered for each account. This causes the account balances to go to zero after this journal entry is posted.
General Ledger
Equipment
Date | Description | | | |
Sep-1 | Balance forward | | | |
Sep-15 | Disposal of asset | | | |
Accumulated Depreciation - Equipment
Date | Description | | | |
Sep-1 | Balance forward | | | |
Sep-15 | Disposal of asset | | | |
The asset and related accumulated depreciation have both been removed from the books.
Calculating Book Value
Book Value is the difference between the asset cost and accumulated depreciation:
Equipment cost | $ 7,000 |
Less: accumulated depreciation | -5,600 |
Book Value before sale | $ 1,400 |
Gains and losses are calculated using the Book Value.
Equipment sold for a Gain
If the equipment is sold for more than its book value there will be a gain. Gains are similar to revenues, and will be recorded with a credit entry. Let's say the equipment is sold on September 15 for $2,000. The gain will be:
Selling Price | $ 2,000 |
Less: Book Value | - 1,400 |
Gain | $ 600 |
We'll begin with the journal entry we started above, and add the additional information, the selling price and gain or loss, in the right places.
General Journal
| Account | | |
| Accumulated Depreciation | | |
Cash | | ||
| Gain on disposal of equipment | | |
Equipment | | ||
| To record disposal of equipment | | |
The journal entry is now in balance. Did you notice what I did? I started the journal entry with what I already knew - the cost and accumulated depreciation. I left 2 lines blank in the middle of the journal entry, so the sales price and gain or loss could be recorded.
Equipment sold for a Loss
If the equipment is sold for less than its book value there will be a loss. Losses are similar to expenses, and will be recorded with a debit entry. Let's say the equipment is sold on September 15 for $1,000. The loss will be:
Selling Price | $ 1,000 |
Less: Book Value | - 1,400 |
Loss | ($ 400) |
We'll begin with the journal entry we started above, and add the additional information, the selling price and gain or loss, in the right places.
General Journal
| Account | | |
| Accumulated Depreciation | | |
Cash | | ||
| Loss on disposal of equipment | | |
Equipment | | ||
| To record disposal of equipment | | |
Equipment sold for a Wash
If the equipment is sold equal to its book value there will be a wash. Let's say the equipment is sold on September 15 for $1,400.
Selling Price | $ 1,400 |
Less: Book Value | - 1,400 |
Wash | $ 0 |
We'll begin with the journal entry we started above, and add the additional information, the selling price and gain or loss, in the right places. In this case there is a wash, so no gain or loss is recorded. The equipment is simply removed from the books.
General Journal
| Account | | |
| Accumulated Depreciation | | |
Cash | | ||
Equipment | | ||
| To record disposal of equipment | | |
Equipment Junked
If the equipment is junked there will be a loss equal to its book value. We call this abandonment. The item is usually just thrown in the trash, or hauled to the dump. Sometimes a company will have to pay to have the item hauled away. Incidental costs are revenue expenditures, and are not included in calculating the capital gain or loss.
Selling Price | $ 0 |
Less: Book Value | - 1,400 |
Loss | ($ 1,400) |
We'll begin with the journal entry we started above, and add the additional information, the selling price and gain or loss, in the right places.
General Journal
| Account | | |
| Accumulated Depreciation | | |
Loss on abandonment of equipment | | ||
Equipment | | ||
| To record abandonment of equipment | | |
Intangibles are assets that have no physical existence. They are legal assets or accounting assets, such as copyrights, patents, trademarks or goodwill. We use a simple form of amortization, usually straight-line, to allocate the cost of these items to expenses.
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