College Accounting, by Heintz and Parry

1. College Accounting,by Heintz and Parry Chapter 19: Accounting for Long-Term Assets

2. When Nick purchased the point-of-sale terminals, Eddie had another question for him. “Now that we have some expensive equipment, do you want to switch to an accelerated method of depreciation?”“Jumping Jupiter, for crying out loud, hold the cellular phones! You mean there’s another choice of methods to do my accounting again? My word, I always thought accounting was straightforward: debit this, credit that. Okay, explain the different methods of depreciation to me, but get a pencil and paper and talk verrrrysloooowly.”“Up until now, we’ve been using the straight-line method of depreciation . . .” Question: What is the formula for calculating straight-line depreciation?

3. Answer: The formula is:Cost - Salvage Value = $4500 - $300 = $840/year ($70/month) Useful Life 5 Cost = purchase price (including things like taxes, freight, installation, etc.)Useful Life = the number of years the company intends to use the assetSalvage Value = what the company expects to receive for it at the end of its useful lifeIf we keep using this method, our monthly adjustment will be:Date Description P. R. Debit Credit2001 June 10 Depreciation Exp.-Computer Equip. 70.00 Accumulated Depr’n.-Comp. Equip. 70.00

4. Nick was focused now. ”Okay, Dr. Debit, what are these ‘accelerated’ methods you mentioned? Do we depreciate our asset in five years instead of seven or something?”“No, but we take more depreciation in the earlier years than in the later years. This makes sense for many assets where the repairs and maintenance go up in the later years. The accelerated depreciation can tend to smooth out the total expenses over the asset’s useful life.The most common accelerated depreciation method is the double-declining balance method. The word ‘double’ is used because we calculate the depreciation at double the straight-line rate.”

5. The Double-declining-balance method has the following formula:Book Value X (2 X the Straight-Line Rate) = Depreciation for the YearBook value = Cost - Accumulated Depreciation(Note: No salvage value is subtracted.)The factor 2 X the straight-line rate is most easily calculated as: 200%useful lifeIn this case, 200% divided by 5 = 40%. In year 1, depreciation is $4,500 X 40% = $1800/year (or $150/month) and the entry is: Date Description P. R. Debit Credit 2001 June 10 Depreciation Exp.-Computer Equip. 150.00 Accumulated Depr’n.-Comp. Equip. 150.00

6. The depreciation goes down in later years because the book value is lower. In our example, the book value next year would be:$4500 cost - $1800 accumulated depreciation = $2700so the depreciation next year would be$2700 Book Value X 40% Depreciation Rate = $1080 Depreciation for the Year ($90/month)which is significantly less than the $1800 in depreciation taken this year. The entry would be: Date Description P. R. Debit Credit 2002 June 30 Depreciation Exp.-Computer Equip. 90.00 Accumulated Depr’n.-Comp. Equip. 90.00

7. The sum-of-the-years’-digits method is the second common accelerated method. The formula is: (Cost - Salvage Value) X Remaining Useful Life Sum-of-the-Years’-DigitsThe sum of the years’ digits when the useful life is 7 years is 7 + 6 + 5 + 4 + 3 + 2 + 1 = 28so the calculation in the first year would be(4500 - 300) X 7 = $1,050/year ($87.50/month) 28 The second year we would use the fraction 6/28, then 5/28, 4/28, etc. Our monthly entry would be:Date Description P. R. Debit Credit 2001 June 30 Depreciation Exp.-Computer Equip. 87.50Accumulated Depr’n.-Comp. Equip. 87.50

8. Nick looked perplexed. ”The one thing wrong with all of these methods is they don’t seem to account for the reality of whether we really wore out the asset this year.”“Good point, Nick. There is one method that tries to do that. It’s the units-of-production method. The formula is:Cost - Salvage Value = Depreciation Per Unit Useful Life (in units) This is just like the straight-line method, except that the useful life is measured in units of production, not years. For example, if it were a car, you would estimate the useful life in miles to be driven. Then the total depreciation for a period is:Depreciation Per Unit X Units Produced”

9. “We probably would not use the units-of-production method with our point-of-sale terminals, but let’s just say that we expected them to last for a certain number of sales transactions (let’s say 210,000). Depreciation would be:Cost - Salvage Value = $4,500 - 300= $.02 per transactionUseful Life (in units) 210,000If we had 3,000 transactions in June, depreciation would be:Depreciation Per Unit X Units Produced = Depr’n. for Period$.02 X 3,000 = $60.00Our monthly adjustment would be:Date Description P. R. Debit Credit 2001 June 30 Depreciation Exp.-Computer Equip. 60.00Accumulated Depr’n.-Comp. Equip. 60.00

10. Nick was ready with his decision. “The terminals aren’t supposed to need expensive repairs, and I don’t want to keep track of sales transactions, so I would rather just stick with straight-line depreciation. Thanks for helping me make an informed decision, though, Eddie.”“No problem, Nick. Now we have to figure out journal entries for the equipment we’re replacing.”“That piece-of-junk printer is just getting tossed in the garbage, so we don’t even need an entry for that, right?”“Actually, we do. It wasn’t even fully depreciated yet, so discarding it will impact our net income for the month.”Question: What accounts would be debited and credited when discarding an asset (computer equipment) that still has a book value?

11. Answer: The computer equipment account would be credited and the accumulated depreciation account would be debited to get the equipment off of the books. To balance the entry, a new income statement account called Loss on Discarded Computer Equipment would be debited for the amount of the book value.The entry would look like this:Date Description P. R. Debit Credit2001 June 10 Accum. Depr’n.-Computer Equip. 120.00 Loss on Discarded Computer Equip. 180.00 Computer Equipment 300.00

12. “I got really lucky on the old computer and those expensive speakers that you had me buy. I sold them to a customer for very close to what I paid for them.”“Great, we might actually recognize a gain on that sale.”The transaction did result in a “gain on sale of computer equipment,” which is easily calculated as the difference between the debits and credits after you debit cash for the amount received, debit accumulated depreciation, and credit computer equipment:Date Description P. R. Debit Credit2001 June 10 Cash 1100.00 Accum. Depr’n.-Computer Equip. 180.00 Computer Equipment 1200.00 Gain on Sale of Comp. Equip. 80.00Question: How would the entry be different if the company only received $900 for the computer and speakers?

13. Answer: The cash account and the accumulated depreciation account would still be debited, and the computer equipment account would still be credited to get the equipment off of the books. To balance the entry, a new income statement account called Loss on Sale of Computer Equipment would be debited for the difference between the cash received and the book value.The entry would look like this:Date Description P. R. Debit Credit2001 June 10 Cash 900.00 Accum. Depr’n.-Computer Equip. 180.00 Loss on Discarded Computer Equip. 120.00 Computer Equipment 1200.00

14. “The tricky part is probably the transaction to buy the point-of -sale terminals themselves, because the company took my old computerized cash registers as a trade-in. The trade-in value wasn’t much, but I didn’t want the hassle of trying to sell them.”“You are right, Nick, trade-ins can be difficult. This one should be fairly easy, because it sounds like we took a loss on the trade-in. Let’s see.”The entry did indeed show a loss:Date Description P. R. Debit Credit2001 June 10 Computer Equipment (new) 4,500.00 Accum. Depr’n.- Comp. Equipment 150.00 Loss on Exchange of Comp. Equip. 100.00 Computer Equipment (old) 500.00 Cash 4,250.00

15. “Eddie, you make it sound like gains are harder to record, but it would be almost the same entry with a credit to a gain account, right? What’s harder about that?”“Nick, it’s not harder, it’s impossible! When exchanging similar assets, you’re allowed to recognize a loss, but not a gain.”“Why not? Boy, it’s no wonder you need a degree to do accounting, when you have all these silly rules.”“Actually, this rule is very logical. As you know, many companies give generous trade-ins as a way to give discounts off of their inflated list prices. When that happens, a buyer would be crediting a ‘gain on exchange’ just to balance out the unrealistically high ‘price’ of their new equipment. For example, the company could’ve told you the equipment price was $5,000 and offered you a $750 trade-in on your cash registers so that you would pay the same $4,250 in cash. The trade-in wouldn’t really be worth $750, because the new equipment isn’t really worth $5,000. ”Question: What would the entry be in this case?

16. Answer: “Here is the entry, with the debit for the new equipment being the difference between the other debits and credits, not the $5,000 list price.The other thing you should know, Nick, is that you can’t recognize a gain or a loss for tax purposes.”“Thanks for telling me, Eddie, but make sure you write yourself a note for the end of the year. You’re my accountant, you know.” Date Description P. R. Debit Credit2001 June 10 Computer Equipment (new) 4,600.00 Accum. Depr’n.- Comp. Equipment 150.00 Computer Equipment (old) 500.00 Cash 4,250.00