Financial Accounting and Reporting/Cost Allocation

Depreciation

Definition

Depreciation is the systematic allocation of the cost of an asset over its useful life. Depreciation is treated as an expense for the period incurred, and is accumulated for the whole useful life of an asset as a contra-account to a specific PPE account. The proforma entry is:

General Journal  - Page xx

Date		Description	Post Ref.	Dr	Cr
20xx xxx	xx	Depreciation Expense		xxx
		Accumulated Depreciation			xxx

Depreciation Methods

Basic Formula

Depreciation expense is calculated based on the depreciable amount (D) and not on the actual cost of the asset, i.e.,$Dep.exp.=f(D)$, where D is the difference between the Original Cost (C) and the Scrap Value (S) or $D=C-S$.

Straight-line method

The straight-line method is based on the following assumptions;

1. The asset wastage is a function of time and independent of usage, i.e., $Dep.exp=f(D,t)$
2. The wastage is constant or linear.

Consider the following illustration: ABC Co. has a $30,000 threshold for capitalization of assets. As a policy, any asset acquired for less than $30,000 are expensed immediately. The company reported the following purchases related to PPE for the year:

Item	Purchase date	List Price	Trade discount	Cash discount	Taken?	Fair value at yeat end of current period
65E	January 31	54,000	none	3%	no	75,000
65F	March 15	15,700	10%	2%	no	13,200
65G	April 1	46,470	none	none	none	49,000
65H	June 15	4,599	none	1%	yes	3,000
65I	September 1	100,000	none	3%	yes	104,000
65J	November 30	48,000	2%	2%	yes	43,000
Land acquired for capital appreciation	November 30	540,000	n/a	n/a	none	562,000

Prior to this, the company reported the following amounts in their previous year's financial statements;

Account	Cost	Fair Value at year-end of current period	Accumulated Depreciation	Scrap value	Useful life remaining
Land on operating lease	549,000	760,000	n/a	n/a	n/a
Building on operating lease	2,590,000	1,543,000	325,000	20% of cost	15 yrs
Building on finance lease	2,490,000	3,209,000	126,000	15% of cost	10 yrs
Building used as headquarters	23,500,000	12,040,000	5,450,000	12% of cost	16 yrs