I'm Larry Walther, this is principlesofaccounting.com, Chapter 10.
And in this module, we will look at the straight-line method and
units-of-output depreciation methods.
Under the straight-line method, the annual depreciation is calculated
by dividing the depreciable base by the service life.
Assume we have a $100,000 asset and a $10,000 salvage value,
that gives us a $90,000 depreciable base, and we have a four-year life.
And so looking at our depreciation calculations,
we'll take the depreciable base, 100,000 minus 10,000 divided by four years,
and get an annual depreciation charge of 22,500 per year.
At the end of the first year,
our accumulated depreciation in the aggregate will be 22,500.
The next year, our calculations repeat, and
we have an additional 22,500 of depreciation.
Cumulatively now, we have 45,000 of accumulated depreciation to be reported as
an offset against the asset's cost in the balance sheet.
And this process will contain you for each of the next two years.
If we were to look at the journal entry for any given year,
we would debit depreciation expense and credit-accumulated depreciation.
Now the applicable depreciation expense would be included in each year's
income statement.
The appropriate balance sheet disclosure, for example,
at the end of year 3 would look like this.
We have the equipment minus three years at 22,500 per year or 67,500 of accumulated
depreciation, giving us the 32,500 net book value at the end of the third year.
If we're dealing with fractional periods, for example,
we may not buy an asset on the first day of the year.
We might assume that the asset was bought on the first or last day of the year.
But we might also start from the date of acquisition.
And so with the straight line method, this is not going to be terribly complex,
let's assume we bought an asset on the first day of April, so January, February,
and March had gone by.
There's only nine months left to go in the first calendar year, and
we're only going to record nine month's worth of depreciation.
So here's the calculation now.
The depreciable base cost, $100,000 minus $10,000 salvage value.
The $90,000 depreciable base divided by the four years gives us an annual amount
of 22,500.
We're only going to take nine-twelfths of that, representing 9 out of
12 months in the first year, so we get depreciation expense of 16,875, and
that gives us our accumulated depreciation.
Now in the next year, we'll book a full year's worth of depreciation, or
22,500, and our accumulated depreciation has grown to 39,375 by the end
of the second year of use.
If we jump to the last year, let's assume that the asset only lasts 3 months into
the last year, that is, the last 3 months of the four year useful life.
The depreciation expense calculation, 100,000 minus 10,000, that's our
depreciable base, divided by four years would give us the annual amount.
And we only want three-twelfths of that or 5,625 at that point.
I'm assuming nothing would appear on the balance sheet at the end of the year,
that we would have disposed of the asset then, at the end of March, year five.
Obviously, some companies would continue to carry fully depreciated assets on
their books, if indeed they were continuing to use those assets.
But, at least in ideal theoretical context, that as you finish depreciation,
the assets are also finally consumed.
Recognize that spreadsheets, electronic spreadsheets,
provide tools for depreciation calculation.
So here, I have a function that's in cell B2.
It equals SLN or straight-line depreciation.
And we're going to include our variables 100,000 for
cost as the first variable, 10,000 as the second variable for the salvage value, and
then the number of years.
And if we enter that into the cell B2, it will return the value 22,500.
You can actually bring up the robots that help with the functions and
fill in the blanks for cost, salvage value, and life.
And it calculates the value, and
we'll have you establish that in a particular cell.
So there's quite a few crutches so you don't actually have to remember
all the details of these types of formulas in spreadsheet.
Let's look at units of output.
It's very much like the straight-line,
except rather than using time as the allocation base,
we're going to use units of production as the allocation base.
A life is measured by identifiable units of consumption.
A printing machine might produce 4 million copies.
An aircraft engine may last 50,000 hours.
So as we print copies or as we run the engine, we're gonna be allocating
a proportionate amount of cost to represent the amount consumed.
Let's have an example.
We have an air filtration system at a hospital that has an 8,000 hour life.
The system has a $100,000 cost and 10,000 salvage value.
The expected utilization is 1,000 hours during the first year,
3,000 hours during the second, and then 2,000 for each of the next two, so
there's our total 8,000 hours of utilization.
In the first year, we expect to use 1,000 of the total 8,000.
So one-eighth of of the depreciable base is consumed, producing depreciation
expense of 11,250, that's one-eighth of the depreciable base.
The next year we used it 3,000, so you can see we're taking three-eighths of
the depreciable base or 33,750 for expense.
And so it would go for subsequent periods.
And so this is not often used, but indeed, it's used for some special situations.
For example, maybe the airline industry would probably be the best example l
could cite,
very expensive engines with determinable useful lives measured in hours.