| LO2 - Explain, calculate, and record depreciation using the units-ofproduction, straight-line, and double-declining balance methods. |
The role of depreciation is to allocate the cost of a PPE asset (except land) over the accounting periods expected to receive benefits from its use. Depreciation begins when the asset is in the location and condition necessary for it to be put to use. Depreciation continues even if the asset becomes idle or is retired from use, unless it is fully depreciated. Land is not depreciated, as it is assumed to have an unlimited life.
Depreciation is an application of the matching principle.
| According to generally accepted accounting principles, a company should select a method of depreciation that represents the way in which the asset’s future economic benefits are estimated to be used up. |
There are many different ways to calculate depreciation. The most frequently used methods are usage-based and time-based. Regardless of depreciation method, there are three factors necessary to calculate depreciation:
- cost of the asset
- residual value
- estimated useful life or productive output.
Residual value is the estimated worth of the asset at the end of its estimated useful life. This concept was not introduced when depreciation was briefly discussed in Chapter 3. A long-lived asset is not depreciated below its residual value.
Useful life is the length of time that a long-lived asset is estimated to be of benefit to the current owner. This is not necessarily the same as the asset’s economic life. If a company has a policy of replacing its delivery truck every two years, its useful life is two years even though it may be used by the next owner for several more years.
Productive output is the amount of goods or services expected to be provided. For example, it may be measured in units of output, hours used, or kilometres driven.
- 1440 reads
