Learning Outcomes
- Compute depreciation using the straight-line method
To apply the straight-line method, a firm spreads the cost of the asset out across the asset’s useful life at a steady rate. The formula for calculating depreciation under the straight-line method is:
Depreciation Expense = ( Cost − Salvage ) / Useful Life
Let’s say Spivey Company uses the straight-line method for buildings, using a useful life of 40 years. Now you, as the accountant, have determined that even at the end of 40 years, the buildings will have a salvage (also known as scrap or residual) value equal to 10% of the original cost in addition to whatever value the underlying land might have.
Here is the list of fixed assets we created:
As of 12/31/20X1 | |||
Spivey Company | |||
Asset | Description | Date Purchased | Cost |
---|---|---|---|
1 | Land | 2/1/20X1 | 262,800 |
4 | Land | 10/1/20X1 | 120,000 |
Total Land | 382,800 | ||
2 | Building | 7/1/20X1 | 490,000 |
5 | Building | 10/1/20X1 | 600,000 |
Total Buildings | 1,090,000 | ||
3 | Machine | 7/1/20X1 | 162,000 |
6 | Delivery Van | 10/1/20X1 | 45,000 |
7 | Machine | 10/1/20X1 | 99,500 |
8 | Office Furniture | 10/1/20X1 | 70,000 |
9 | Computer | 10/1/20X1 | 5,500 |
Total Machinery and Equipment | 382,000 | ||
Total PP&E | $ 1,854,800 |
We have two buildings to depreciate:
The first building was purchased on July 1, 20X1 for $490,000 and has a salvage value of $49,000, and a useful life of 40 years.
Depreciation Expense = ( Cost − Salvage ) / Useful Life
($490,000 − $49,000) / 40 = $11,025 cost allocated per year to the income statement, or $918.75 per month.
The rate is 1/40, or 2.5% per year.
The building was only in service for half of the year, so booking the depreciation monthly would result in $918.75 X 6 months = $5,512.50. If the depreciation was only booked at the end of the year, you would take the full year depreciation and prorate it by multiplying it by ½, and you would get $5,512.50. Most companies book depreciation monthly using an automatic, recurring journal entry that is updated each time an asset is bought or sold.
The second building was purchased on October 1:
(600,000 − 60,000) / 40 = $16,000 per year, or $1,333.33 per month.
The first year’s depreciation expense would be $4,000 ($1,333.33 × 3 months) and then $16,000 every year thereafter for 39 years. In year 41, assuming the building is still in use, the last journal entries would be January through September and would total $12,000. Total depreciation would look like this:
Years | Amount | Total |
---|---|---|
1 (3 months) | 4,000 | 4,000 |
2-40 | 16,000 | 624,000 |
41 (9 months) | 12,000 | 12,000Single line |
640,000Double line |
We call the running total of depreciation expense “accumulated depreciation” and it will be equal to the historical cost less the estimated salvage value.
PRACTICE QUESTION