Financial Accounting: An Integrated Statements Approach, 2nd Edition

The accounting for revenue and capital expenditures is summarized below.

ACCOUNTING FOR DEPRECIATION

As we have discussed in earlier chapters, land has an unlimited life and therefore can

provide unlimited services. In contrast, other fixed assets such as equipment, build-

ings, and land improvements lose their ability, over time, to provide services. As a re-

sult, the cost of equipment, buildings, and land improvements should be transferred

to expense accounts in a systematic manner during their expected useful lives. This pe-

riodic transfer of cost to expense is called depreciation.

The adjusting entry to record depreciation is usually made at the end of each

month or at the end of the year. This entry debits Depreciation Expense and credits a

contra asset account entitled Accumulated Depreciation or Allowance for Depreciation.

Recall, a contra asset account is disclosed in the asset section as a subtracted amount,

thus the normal balance is a credit. The use of a contra asset account allows the origi-

nal cost to remain unchanged in the fixed asset account.

Factors that cause a decline in a fixed asset’s ability to provide services may be

identified as physical depreciation or functional depreciation. Physical depreciation oc-

curs from wear and tear from use and from the effects of weather conditions. Functional

depreciation occurs when a fixed asset is no longer able to provide services at the level

for which it was intended. Advances in technology have made functional depreciation

an increasingly important cause of depreciation. For example, a personal computer

made in the 1990s is not able to provide a wireless Internet connection, significantly

decreasing its value.

The term depreciationas used in accounting is often misunderstood because the

same term is also used in business to mean a decline in the market value of an asset.

However, the amount of a fixed asset’s unexpired cost reported in the balance sheet

usually does not agree with the amount that could be realized from its sale. Fixed as-

sets are held for use in a business rather than for sale. Since the business is assumed

to be a going concern, a decision to dispose of a fixed asset is based mainly on the use-

fulness of the asset to the business and not on its market value.

404 Chapter 9 Fixed Assets and Intangible Assets

Compute depreciation,

using the following

methods: straight-line,

units-of-production, and

declining-balance.

2

Expenditure

Revenue Expenditure

Ordinary Repairs and

Maintenance

Asset

Improvement

Extraordinary

Repair

Benefits only current period

Adds service

value to the

asset

Extends the

assest’s useful

life

Increase

fixed assets

Decrease

account

depreciation

Increase

repairs and maintenance

expense

Capital Expenditure

Benefits current

and future

periods

Benefits current

and future

periods

Revise

depreciation

for current and

future periods

Revise

depreciation

for current and

future periods