300609 Depreciation Flashcards
On January 2, 20X1, Lem Corp. bought machinery under a contract that required a down payment of $10,000, plus 24 monthly payments of $5,000 each, for total cash payments of $130,000. The cash equivalent price of the machinery was $110,000. The machinery has an estimated useful life of 10 years and estimated salvage value of $5,000. Lem uses straight-line depreciation. In its 20X1 income statement, what amount should Lem report as depreciation for the machinery?
$10,500
$11,000
$12,500
$13,000
$10,500
The machinery is recorded at the cash equivalent price of the machinery, $110,000.
Straight-line depreciation for 20X1 = $(110,000 - $5,000) / 10 years
= $ 105,000 / 10 years
= $ 10,500
The total cash payment of $130,000 includes interest of $20,000.
Cash Equivalents
Cash equivalents are short-term, highly liquid investments that have both of the following characteristics: they are readily convertible to known amounts of cash AND are so near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Generally, only investments with original maturities of three months or less qualify under that definition. Original maturity means original maturity to the entity holding the investment. For example, both a three-month U.S. Treasury bill and a three-year U.S. Treasury note purchased three months from maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not become a cash equivalent when its remaining maturity is three months.
Cash Equivalents
Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations).
FASB ASC Glossary
Depreciation
Depreciation is the process of systematic, rational allocation of the cost of operational assets to the accounting periods benefited. Depreciation is not a process of valuation (FASB ASC 360-10-35-4), does not represent a reserve to replace the asset, and does not mean that cash will be available to replace the asset. Depreciation allowed for tax purposes often differs from depreciation allowed for accounting.
Depreciation
Accounting depreciation attempts to match the cost of the asset to the revenues generated over the life of the asset. It represents accrual accounting and has no effect on cash flows (a noncash expense). Depreciation expense must be added back to accounting income when reconciling to cash from operations using the indirect method.
Depreciation
Computation of depreciation requires the following:
Acquisition cost
Estimated useful life
Estimated residual (salvage) value
Depreciation method (four GAAP alternatives):
Straight-line
Sum-of-the-years’-digits
Double-declining balance
Units of production—units of product and machine hours
Depreciation
Factors which cause the need for depreciation include the following:
Physical factors:
Wear and tear
Effects of time and other elements
Deterioration and decay
Functional factors:
Inadequacy of capacity
Obsolescence
Depreciation
In the macroeconomic sense, depreciation is the part of business earnings/gross profit that is considered the replacement of capital stock used or worn out during the period. It is not included in net profit and is not a factor payment. (It is not a claim on the value of output by a factor of production.) Depreciation represents replacement investment, the amount that must be reinvested to maintain the existing level of capital stock, and the amount by which capital contributes to current production. It is a component of GNP (approximately 10%) and is computed by the income approach to national income accounting. Depreciation is the difference between gross and net investment.
Depreciation
In the foreign exchange sense, depreciation is the decline in the value of one currency against or in relation to another, in the sense that it now takes more of a particular currency to buy a unit of a foreign currency. Devaluation is the official change in the value of a country’s currency.
Example: Country A has an inflation rate of 5% and Country B has an inflation rate of 10%. The goods of Country A become relatively cheaper because the relative prices have changed, thus:
increasing the demand in Country B for Country A’s goods,
increasing the demand for Country A’s currency (to be able to import Country A’s goods), and
decreasing the demand for (i.e., depreciating) Country B’s currency by approximately 5% (10%–5%).
Interest
Interest is the charge for the use of money over time. It is the time value of money. Interest is the amount paid (or received) in excess of the amount borrowed (loaned). Interest is a financing expense (income) and is dependent on the interest rate, the principal amount, and the number of interest periods.
Interest = Principal × Interest rate × Time periods
Interest = Amount to be repaid - Amount received (loaned)
Interest
Simple interest: Interest is computed on the same principal amount each time period, regardless of the amount of interest accrued to date.
Interest
Compound interest: Interest is charged on the principal plus all interest previously accrued (interest computed on interest).
Interest
In macroeconomics, interest is a factor payment or factor income. It is a component of gross national product (GNP) (approximately 10%) and is used in the income approach to national income accounting. Interest includes payments received from banks on savings, from firms on loans, and other miscellaneous income.
Interest is analogous to wages, rent, and profit as a component of factor payments or factor income.
Salvage Value
Salvage value is the amount estimated to be recoverable on disposal (by sale, trade-in, or other means) or retirement from service of an operational asset (net of any costs of disposal, such as dismantling and selling expenses). The remaining carrying amount, after deduction of salvage value, is then fully depreciated (depreciated to the end of the asset’s useful life).
