Financial Accounting: An Integrated Statements Approach, 2nd Edition

guidelines may also be helpful in determining depreciation for financial reporting pur-

poses. Companies often use different useful lives for similar assets.

Guidelines are also necessary for determining when an asset is placed into and out

of service. In practice, many businesses assume that assets placed in or taken out of

service during the first half of a month are treated as if the event occurred on the first

day of that month. That is, these businesses compute depreciation on these assets for

the entire month. Likewise, all fixed asset additions and deductions during the second

half of a month are treated as if the event occurred on the first day of the next month.

We will follow this practice in this chapter.

A business is not required to use a single method of computing depreciation for

all its depreciable assets. The methods used in the accounts and financial statements

may also differ from the methods used in determining income taxes and property

taxes. The three methods used most often are (1) straight-line, (2) units-of-production,

and (3) declining-balance. Exhibit 5 shows the extent of the use of these methods in

financial statements.

Straight-Line Method

Thestraight-line methodprovides for the same amount of depreciation expense for

each year of the asset’s useful life. For example, assume that the initial cost of a depre-

ciable asset is $24,000, its estimated residual value is $2,000, and its estimated life is

five years. The annual depreciation is computed as follows:

$24,000 Initial Cost$2,000 Estimated Residual Value

$4,400 Annual Depreciation

5-Year Estimated Life

The adjusting entry for depreciation would be recorded as follows:

406 Chapter 9 Fixed Assets and Intangible Assets

Straight-line

Declining-balance

Units-of-production

Other

Exhibit 5

Use of Depreciation

Methods

Source:Accounting Trends and Techniques, AICPA, 58th edition, 2004.

Dec. 31 Depreciation Expense 4,400

Accumulated Depreciation 4,400

Q.A truck that cost

$35,000 has a residual

value of $5,000 and a

useful life of 12 years.

What are (a) the deprecia-

ble cost, (b) the straight-

line rate, and (c) the

annual straight-line

depreciation?

A.(a) $30,000

($35,000$5,000),

(b) 8 1/3%(1/12),

(c) $2,500 ($30,000

8 1/3%)

When an asset is used for only part of a year, the annual depreciation is prorated.

For example, assume that the fiscal year ends on December 31 and that the asset in the

above example is placed in service on October 1. The depreciation for the first fiscal

year of use would be $1,100 ($4,400— 123 ).

SCF BS IS

—AT SET Ec