Transcript DepreciatioN

DEPRECIATION
BAF 3M:
CHAPTER 6
AUTOMOBILE EXAMPLE
• Imagine a contracting company purchases a
brand new work truck:
• Will this truck stay new:
NO!
FIXED ASSETS BECOME USED
• The brand new truck is going to become used very
quickly.
• Mileage, dirt, scratches, stains, etc all decrease the
value of the truck
• This decrease in value is called depreciation and is
a direct result of using this vehicle to conduct the
business and earn revenue.
• This decrease in value applies to fixed assets that
lose value when used or as they age – automobiles,
machinery, equipment, etc
DEPRECTIATION: WHAT IS IT
• Definition: Allocation of the cost of a fixed asset to
the fiscal period in which it was used.
• Depreciation is an expense and appears on the
income statement.
• The decrease in value of the fixed asset will be
shown on the balance sheet through a contra
account (an account that reduces the value of
another account)
• Asset account – asset contra account = book value
CALCULATING DEPRECTIAION
• 2 methods: Straight Line and Declining Balance
• Straight Line – same amount of depreciation over
recorded each fiscal period. Use the rate of
depreciation and calculate the depreciation
amount in year 1. Depreciate the asset this same
amount each of the subsequent years.
• Declining Balance – allocates greater amount of
depreciation to early years. Use the rate of
depreciation and calculate the depreciation
amount for each year based on the book value.
STRAIGHT LINE EXAMPLE
• Our pick up truck cost $50,000 and in 5 years we feel
there will be no salvage value. The rate of depreciation
is 20% per year.
• Original Cost x rate = depreciation expense
• $50,000 x 20% = $10,000
Therefor the truck will depreciate $10,000/year till it is
worthless in 5 years
Journalized:
Date Depreciation expense – truck
$10,000
Accumulated Depreciation – Truck
$10,000
DECLINING BALANCE EXAMPLE
•
•
•
•
Same truck
Yr 1 – Original Cost x rate = depreciation expense
Yr 2 – Book Value x rate = depreciation expense
Yr 3 – Book Value x rate = depreciation expense
• Yr1 - $50,000 x 20% = $10,000
• Yr 2 - $40,000 x 20% = $8000
• Yr 3 - $32,000 x 20% = $6400
WHICH METHOD DO I USE?
• In Canada – declining balance method is used
when reporting income tax and it is referred to as
the capital cost allowance or CCA. The CCA sets
maximum rates in which classes of assets can
depreciate in any given year.
• NOTE: A company must use the CCA when
reporting income tax to the government. The
company does NOT have to use the CCA
(declining balance) method when preparing their
own books. Straight line may be more accurate.
PRINCIPLES TO FOLLOW
• Principle of Materiality – information that can affect
the decisions of the users of the financial statements
must be included when statements are prepared.
• Principle of Conservatism – where there are
acceptable alternatives (ex. depreciation
methods), the one that results in the lower net
income and net assets be chosen.