Chapter 8 Condensed (Day 2)
I. Property, Plant, and Equipment (PPE)
II. Acquisition and maintenance of PPE
III. Fixed asset turnover ratio
IV. Depreciation and Depletion
V. Asset Impairment
VI. Disposal, Retirement and Trading of PPE – don’t forget to study this!
VII. Intangible Assets
VIII. Amortization
How do you get PP&E off your books? Depreciation
IV. Depreciation and Depletion
A. Depreciation is the process of allocating the cost of buildings and equipment over
their productive lives using a systematic and rational method
We depreciate it not down to zero necessarily, but down to the “salvage value.”
Depreciation is NOT a process of determining an asset’s current market value.
Periodic Adjusting Entry:
Dr. Depreciation Expense (Operating expense in I/S)
Cr. Accumulated Depreciation (Contra Asset Account in B/S)
Example: 7/1/01 Zagreb Corp purchases an automobile for $29,000 for $9,000 cash and signs a
note for the balance. Zagreb paid $1,000 to paint to company logo on the car.
That $1,000 painting cost is capitalized, making the value of the automobile $30,000.
Dr. Automobile $30,000
Cr. Cash $10,000
Cr. Notes Payable $20,000
Adjusting Entry (12/31/01) to recognize Depreciation Expense – Based on the Depreciation
schedule, Zagreb determines that $5,000 of depreciation should be recorded relating to this
automobile for the year 2010.
Dr. Depreciation Expense $5,000
Cr. Accumulated Depreciation (Automobile) $5,000
Automobile Accumulated Depreciation
(Automobile)
30,000 5,000
30,000 5,000
1 Zagreb Corp
Balance Sheet
12/31/01
Current Assets:
Long Term Assets:
Land $100,000
Building 200,000
Accumulated Depreciation (Building) (100,000)
Automobile 30,000
Accumulated Depreciation (Automobile) (5,000)
Total PP&E 225,000
How did you get the $5,000 of depreciation? How do you calculate the depreciation schedule?
B. Calculating Depreciation
1.Three amounts are required for each depreciable asset:
Acquisition cost
Estimated useful life – the expected service life of the asset
Estimated residual (or salvage) value - estimated amount to be
recovered by the company at the end of the asset’s estimated useful
life
Three methods to calculate depreciation:
a. Straight-line (used by 95% of companies)
b. Units of production
c. Declining balance (used for tax purposes, required by IRS)
a. Straight line method - Allocates the cost of an asset in equal periodic amounts over
its useful life
Straight-Line Formula:
Depreciation Expense = memorize
Depreciation expense can be manipulated because residual value and useful life are estimates (see below)
Example: PPE, Inc., purchased a new machine on September 1, 2007, at an invoice price of
$95,000. Additional costs include freight charges of $500, and installation cost of $1,200.
The machine has an estimated salvage of $6,700. It is estimated that the machine will be
productive for six (6) years operating a total of 120,000 machine hours.
Acquisition Cost: $95,000 + $500 + $1,200 = $96,700
Salvage Value: $6,700 (estimate)
Useful life: 6 years (estimate)
2 Determine the annual depreciation for both Dec 31, 2007 and Dec 31, 2008 using the straight
line depreciation method:
$96,700 – 6,700 = $15,000 per year
6 years
2007 2008
4 months
(a) Straight-line: (15,000/(4/12)) = $5,000 12 months = $15,000
Calculating Depreciation:
$96,700 – 6,700 = $90,000 / 6 years
The depreciable case is $90,000
Balance Sheet
12/31/07
Long Term Assets:
Machine 96,700
Accumulated Depreciation (Machine) (5,000)
Net Machine 91,700
2007 Depreciation Expense Entry
Dr. Depreciation Expense 5,000
Cr. Accumulation Depreciation - Equipment 5,000
Balance Sheet
12/31/08
Long Term Assets:
Machine 96,700
Accumulated Depreciation (Machine) (20,000)
Net Machine 76,700
2008 Depreciation Expense Entry
Dr. Depreciation Expense 15,000
Cr. Accumulation Depreciation - Equipment 15,000
Why do you show the original cost of the machine? So that investors can see how old the machine is
b. Units-of-Production Method - Allocates the cost of an asset over its useful life
based on the relation of its periodic output to its total estimated output
Requires a lot of information but is more accurate
Units-of-Production Formula: memorize
Depreciation Expense =
Where estimated total production is in hours available or units capable of being produced
3 Example: PPE, Inc., purchased a new machine on September 1, 2007, at an invoice price of
$95,000. Additional costs include freight charges of $500, and installation cost of $1,200.
The machine has an estimated salvage of $6,700. It is estimated that the machine will be
productive for six (6) years operating a total of 120,000 machine hours.
Acquisition Cost = 95,000 + 500 + 1,200 = $96,700
Salvage Value = $6,700
Estimated Total Production = 120,000 hours
Determine the annual depreciation for both Dec 31, 2007 and Dec 31, 2008 using the units-
of-production depreciation method. Assume the machine operated for 4,000 and 15,000
hours, respectively for 2007 and 2008.
2007 2008
(96,700 – 6,700) / (96,700 – 6,700) /
120,000 * 4,000 = 120,000 * 15,000 =
(b) Units-of-production: 3,000 11,250
Balance Sheet
12/31/07
Long Term Assets:
Machine 96,700
Accumulated Depreciation (Machine) (3,000)
Net Machine 93,700
Balance Sheet
12/31/08
Long Term Assets:
Machine 96,700
Accumulated Depreciation (Machine) (14,250)
Net Mac
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