Lesson 11 Flashcards
Depreciation
is the accounting process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset.
What is depreciation
it is the means of cost allocation
Depletion
is used to describe the reduction in the cost of natural resources (such as timber, gravel, oil, and coal) over a period of time.
Amortization
is the expiration of intangible assets, such as patents or copyrights.
What are the three basic questions to ask before establishing a depreciation schedule?
- What depreciable base is to be used for the asset?
- What is the asset’s useful life?
- What method of cost apportionment is best for this asset?
What are the two functions to establish the depreciation base?
- the original cost
- salvage or disposal value
Salvage Value
is the estimated amount that a company will receive when it sells the asset or removes it for service.
What are the two factors companies retire assets?
- physical factors (such as casualty or expiration of physical life)
- Economic factors (obsolescence)
What are physical factors?
are wear and tear, decay, and casualties that make it difficult for the asset to perform indefinitely.
What factor sets the outside limit of the service life of an asset?
The physical factors.
What are the three categories of economic or functional factors?
- inadequacy
- supersession
- obsolescence
inadequacy
results when an assets ceases to be useful to a company because the demands of the firm have changed.
Supersession
is the replacement of one asset for another more efficient asset.
obsolescence
is the catchall situations that don’t fall into inadequacy and supersession
What are the 4 methods of depreciation?
- Activity method (units of use or production)
- Straight line method
- decreasing-charge methods (accelerated)
- Special depreciation methods
What are the two kinds of Decreasing charge method of depreciation?
- Sum of the years’ digits
- Declining balance method
What are the two kinds of Special Depreciation methods?
- Group and composite methods
- hybrid or combination methods
Activity Method
assumes that depreciation is a function of use or productivity instead of the passage of time.
A company considers the life of the asset in terms of either the output it provides (units it produces) or an input measure of machine hours.
The activity method calculation formula?
(Cost less Salvage Value) X Hours this year = depreciation charge
When would companies use the activity method?
When the company desire low depreciation during periods of low productivity and high depreciation during high productivity.
straight line method
considers depreciation as a function of time rather than a function of usage.
straight method calculation formula
Cost less Salvage Value / Estimated Service Life = Depreciation Charge
What are the two main objectives to straight line method?
Because of the assumptions of:
1. the asset’s economic usefulness is the same each year
2. the maintenance and repair expense is essentially the same each period.
What do decreasing charge methods do?
provide for a higher depreciation cost in the earlier years and lower charges in later periods.
What is another name for Decreasing Charge Methods?
Accelerated Depreciation
Why do companies choose decreasing charge methods?
Because companies should charge more depreciation in earlier years because the asset is most productive in its earlier years.
Sum of the years’ digits method
results in a decreasing depreciation charge based on decreasing fraction of depreciable cost (cost- salvage value)
Declining balance method
utilizes a depreciation rate (expressed as a percentage) that is some multiple of the straight line method.
What method of depreciation does not deduct the salvage value?
Declining balance method
What is the major difference between the service life and its physical life of an asset?
Service life refers to the time an asset will be used by a company and physical life refers to how long the asset will last.
Dixon Company purchased a depreciable asset for $32,000. The estimated salvage value is $4,000, and the estimated useful life is 4 years. The double-declining balance method will be used for depreciation.
What is the depreciation expense for the second year on this asset?
$8,000
Correct. Double declining method ignores salvage value. It calculates depreciation at 200% of the straight-line rate each year and multiplies that by the book value of the asset at the beginning of the period. Since the asset in this case has a useful life of 4 years, the straight-line depreciation rate is 25% per year. The double-declining method rate, therefore is 50%. First year depreciation is $32,000 x 50% = $16,000. The book value at the beginning of the 2nd year is $16,000 ($32,000 - $16,000). The second year depreciation is $16,000 x 50% = $8,000.
The term “depreciable base,” or “depreciation base,” as it is used in accounting, refers to which of the following?
The total amount to be charged to expense over an asset’s useful life
The depreciable base of an asset is the amount of the asset’s cost that will be deducted as depreciation expense over the life of the asset.
