Depreciation Methods

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					Chapter6 Asset valuation
6.1 Valuing Accounts Receivable
6.2 Valuing Inventory
6.3 Valuing Fixed Assets
 6.1 Valuing Accounts Receivable

 Credit   losses
  debited to Bad Debts Expense
  considered a normal and necessary risk of doing
    business.
 Two  methods of accounting for uncollectible
  accounts are:
 1 Direct write-off method

 2 Allowance method
    Estimating Non-collectable
           Receivables
                   Methods
Direct Write-Off                       Allowance
Not based on the matching      Based on the matching
principle                      principle

Accounts are written off        Estimated bad debts are
when determined non-collectible matched against revenue

Appropriate only if            Must be followed if
amounts are not material       amounts are material
             DIRECT WRITE-OFF
                 METHOD

                            General Journal
Date       Account Titles                          Debit       Credit
 Dec. 12   Bad Debts Expense                       200
              Accounts Receivable – M.E. Doran                 200




     Warden Co. writes off M. E. Doran’s $200 balance as
     uncollectible on December 12. When this method is used,
     Bad Debts Expense will show only actual losses from
     uncollectibles.
       THE ALLOWANCE METHOD


                           General Journal
Date      Account Titles                       Debit    Credit
Dec. 31   Bad Debts Expense                   12,000
            Allowance for Doubtful Accounts            12,000




       Estimated uncollectibles are debited to Bad
       Debts Expense and credited to Allowance for
       Doubtful Accounts at the end of each period.
 THE ALLOWANCE METHOD

                           General Journal
Date     Account Titles                         Debit    Credit
Mar. 1   Allowance for Doubtful Accounts        500
             Accounts Receivable - R. A. Ware              500




 Actual uncollectibles are debited to Allowance for Doubtful
 Accounts and credited to Accounts Receivable at the time
 the specific account is written off.
       THE ALLOWANCE METHOD
                                General Journal
Date       Account Titles                            Debit     Credit
 July 1    Accounts Receivable – R. A. Ware            500
              Allowance for Doubtful Accounts                  500




 When there is recovery of an account that has been written off:



                                General Journal
Date           Account Titles                        Debit         Credit
  July 1        Cash                                     500
                  Accounts Receivable                              500
      BASES USED FOR THE
      ALLOWANCE METHOD

   Companies use one of two methods in
    the estimation of uncollectibles:
    1 Percentage of sales
    2 Percentage of receivables
   Both bases are GAAP; the choice     is
    a management decision.
   COMPARISON OF BASES OF
        ESTIMATING
      UNCOLLECTIBLES

                                      Percentage of
 Percentage of Sales                   Receivables
         Matching                     Cash Realizable Value
                                                       Allowance
 Sales              Bad Debts    Accounts                  for
                     Expense     Receivable             Doubtful
                                                       Accounts



Emphasis on Income Statement    Emphasis on Balance Sheet
Relationships                   Relationships
Estimating Uncollectibles - Aging
    of Accounts Receivable
 Method adjusts
 allowance for doubtful
 accounts to amount
 of estimated
 uncollectible
 receivables
                          NET ACCOUNTS
                           RECEIVABLE
           Aging Schedule
 Total amount in each age category
  multiplied by estimated percentage of
  uncollectibility
 Sum represents “needed” balance for the
  allowance for doubtful accounts
 Assume the following ...
Estimating Uncollectibles - Aging
    of Accounts Receivable
1 - 30 = $75,432 x .1% = $   75
Estimating Uncollectibles - Aging
    of Accounts Receivable
1 - 30 = $75,432 x .1% = $    75
31 - 60 = 67,535 x 1.5% =   1,013
Estimating Uncollectibles - Aging
    of Accounts Receivable
1 - 30 = $75,432 x .1% = $    75
31 - 60 = 67,535 x 1.5% =   1,013
61 - 90 = 15,750 x 3.0% =    473
Estimating Uncollectibles - Aging
    of Accounts Receivable
 1 - 30 = $75,432 x .1% = $    75
31 - 60 = 67,535 x 1.5% =   1,013
61 - 90 = 15,750 x 3.0% =     473
90 +   =   6,200 x 7.5% =     465
 Estimating Uncollectibles - Aging
     of Accounts Receivable
 1 - 30 = $75,432 x .1% = $        75
31 - 60 = 67,535 x 1.5% =        1,013
61 - 90 = 15,750 x 3.0% =         473
90 +    =     6,200 x 7.5% =      465
            $164,917            $2,026


Total A/R Balance      Needed allowance balance
Estimating Uncollectibles - Aging
    of Accounts Receivable
 Suppose Asian Art’s allowance balance,
 before adjustment, is $1,500
 Whatadjusting entry will bring the allowance
 account balance to its “needed” amount?

   ALLOWANCE FOR DOUBTFUL ACCOUNTS

                           $1,500   8/1/xx

                           $2,026   8/31/xx
Estimating Uncollectibles - Aging
    of Accounts Receivable
 Anentry which increases (credits) allowance
 account balance for the difference

   ALLOWANCE FOR DOUBTFUL ACCOUNTS

                          $1,500   8/1/xx
                          $ 526 8/31/xx
                          $2,026  8/31/xx
           PERCENTAGE OF
            SALES BASIS
 Management estimates what percentage of
  credit sales will be uncollectible.
 Expected bad debt losses are
  determined by applying the
  percentage to the sales base
  of the current period.
 Better match
     Expenses with revenues
                  PERCENTAGE OF
                   SALES BASIS

                               General Journal
Date          Account Titles                           Debit        Credit
Dec. 31        Bad Debts Expense                          8,000
                  Allowance for Doubtful Accounts                   8,000




       If net credit sales for the year are $800,000, the estimated bad
       debts expense is $8,000 (1% X $800,000).
Chapter6 Asset valuation
   6.1 Valuing Accounts Receivable
   6.2 Valuing Inventory
   6.3 Valuing Fixed Assets
 Inventory Cost Flow for a Merchandising
                Company



                             Purchases*

                                            Cost of
                                            Goods Sold
Beginning                   Cost of Goods   (expense)
Inventory                   Available for
                            Sale
                                             Ending
*Including delivery costs                    Inventory
incurred to acquire                          (asset)
merchandise

                                Slide 7.4
        FORMULA FOR
     COST OF GOODS SOLD


                 Cost of         Ending         Cost of
Beginning                   _
            +     Goods                     =   Goods
Inventory                       Inventory
                Purchased                        Sold




the effects on cost of goods sold can
be determined by entering the
incorrect data in the above formula
and then substituting the correct data
Inventory Systems




                    Perpetual



                    Periodic
Perpetual vs. Periodic Inventory Systems
    Perpetual Inventory System                         Periodic Inventory System
    Sales revenue and cost of                       Sales revenues is booked when a
     goods sold recorded                              sale is made . . . but not cost of
     simultaneously when a sale is                    goods sold
     made                                            Records documenting quantity and
    A “perpetually” updated record                   per unit cost of individual inventory
     of the quantity of individual                    items are typically not maintained
     inventory items and their per                   Period-ending inventory is
     unit costs is maintained                         determined via a physical count,
    Key advantage: “information                      then cost of goods sold is
     availability”                                    computed
    Key disadvantage: cost . . .                    Key advantage: low cost
     but this disadvantage is                        Key disadvantage: lack of readily
     gradually fading away                            available inventory data

                                      Slide 7.5
PERPETUAL VS. PERIODIC
Inventory Costing Methods


          Specific Unit Cost
          Weighted-Average Cost
          First-In-First-Out (FIFO)
          Last-In-First-Out (LIFO)
USING ACTUAL PHYSICAL
             FLOW COSTING
   Costing of the inventory is complicated because
    specific items of inventory on hand may have
    been purchased at different prices.
   The specific identification method tracks the
    actual physical flow of the goods.
   Each item of inventory is marked, tagged, or
    coded with its specific unit cost.
   Items still in inventory at the end of the year are
    specifically costed to arrive at the total cost of the
    ending inventory.
SPECIFIC IDENTIFICATION
        METHOD
USING ASSUMED COST FLOW
        METHODS
 Other cost flow methods are allowed since specific
  identification is often impractical.
 These methods assume flows of costs that may be
  unrelated to the physical flow of goods.
 For this reason we call them assumed cost flow
  methods or cost flow assumptions. They are:
  1 First-in, first-out (FIFO).
  2 Last-in, first-out (LIFO).
  3 Average cost.
                    FIFO
 The   FIFO method
   earliest goods purchased are the first to be sold.
   often parallels the actual physical flow of
    merchandise.
   the costs of the earliest goods purchased are the
    first to be recognized as cost of goods sold.
FIFO
AVERAGE COST
             AVERAGE COST

 The   average cost method
   assumes goods available for sale are homogeneous.
   the cost of goods available for sale is allocated on the
    basis of the weighted average unit cost incurred.
   weighted average unit cost is applied to the units on
    hand to determine cost of the ending inventory.
        PERPETUAL SYSTEM -
          AVERAGE COST
The average cost method in a perpetual inventory
   system is called the moving average method.
   Under this method a new average is computed
   after each purchase. The average cost is
   computed by dividing the cost of goods
   available for sale by the units on hand. The
   average cost is then applied to
1. the units sold, to determine the cost of goods
   sold, and,
2. the remaining units on hand, to determine the
   ending inventory amount.
                 LIFO
 The LIFO method assumes that the latest
  goods purchased are the first to be sold.
 LIFO seldom coincides with the actual
  physical flow of inventory.
 Under LIFO, the costs of the latest goods
  purchased are the first goods to be sold.
LIFO
                     FIFO vs. LIFO
 Frequency of Use:
70                                     When balance sheet
60                                      valuation is deemed the
50
                        FIFO            key issue, FIFO is
                        LIFO
                                        typically preferred to
40
                                        LIFO
30                      Avg.
                        Cost
                                       If income measurement
20
                        Other           is more important, LIFO
10                                      is typically preferred to
0
                                        FIFO


                           Slide 7.15
   Financial Statement Effects of
         Costing Methods
                 Advantages of Methods


  Weighted              First-In,            Last-In,
  Average               First-Out            First-Out



                     Ending inventory     Better matches
 Smooths out          approximates      current costs in cost
price changes.           current         of goods sold with
                    replacement cost.        revenues.
Tax Effects of Costing Methods
 The Internal Revenue Service (IRS)
 identifies several acceptable methods
   for inventory costing for reporting
             taxable income.

                  If LIFO is used for tax
                purposes, the IRS requires
                  it be used in financial
                        statements.
Consistency in Using Costing
         Methods
The consistency principle requires a company
  to use the same accounting methods period
  after period so that financial statements are
           comparable across periods.
    Applying the Lower-of-Cost-or-
         Market (LCM) Rule
   This rule requires ending inventory to be
    stated at the lower of cost or market value.
   The conservatism principle provides the
    justification for the LCM rule.
   “Market value” is generally current
    replacement cost”            for purposes of
    the LCM rule.
   Two alternative              approaches to
    applying the LCM                    rule: item-
    by-item basis and        total inventory basis.

                       Slide 7.16
       Lower of Cost or Market

     The lower of cost or market may be
     applied:
1.     Either directly to each item,
2.     To each category, or
3.     To the total of the inventory
     Whichever method is selected, it
     should be consistently applied!
Chapter6 Asset valuation
   6.1 Valuing Accounts Receivable
   6.2 Valuing Inventory
   6.3 Valuing Fixed Assets
        Determining Costs of Fixed
                 Assets
 Include all expenditures necessary to bring an
    item to a salable condition and location.

    Minus                                     Plus
  Discounts                                  Taxes
                        Invoice
Plus Import               Cost                  Plus
  Duties                                     Insurance


               Plus              Plus
              Freight         installation
                                  fee
Computing Depreciation . . . key terms

     Depreciation: the process of systematically
      allocating the cost of an asset over its useful life
     Salvage value: the estimated value of an
      asset at the end of its useful life
     Depreciable cost: an asset’s acquisition
      cost less its salvage value
     Book value: an asset’s cost less its accumulated
      depreciation
     Three factors to consider when computing
      depreciation: cost, estimated useful life, and
      salvage value

                            Slide 8.8
Depreciation Methods: Overview

            Depreciation
              Methods



 Activity   Straight-   Decreasing
               line      Charge


                        Double Declining Balance
                        Sum-of-the-years’ digits
   Depreciation Methods: Units-of-
          Production Method
 Is a function of usage rather than time.
 Estimated life is in terms of total input/output of
  asset.
 Depreciation expense is computed as:
 Cost – Salvage Value x Input/Output this period
            Total Estimated Input/Output
Depreciation Methods: Straight-Line

 Is a function of time rather than usage
 Results in an equal amount of
  depreciation expense for a given period
 Depreciation Expense is computed as:
          Cost – Salvage Value
             Estimated Life
Depreciation Methods: Decreasing Charge
              (Accelerated)
     These methods result in higher depreciation
     expense in the earlier years and lower
     charges in the later years.

     Two decreasing charge methods are:
  1. Declining balance
  2. Sum-of-the-years’-digits
Depreciation Methods: Declining Balance
  1.   Salvage value is not deducted when computing
       depreciable base.
  2.   Utilizes a depreciation rate (%) that is some
       multiple of the SL rate.
  3.   The depreciation rate is multiplied by the asset’s
       book value at the beginning of the period to get the
       depreciation expense for the period.
  4.   Since the book value decreases over time this
       results in a decreasing amount of depreciation
       expense over time.
  5.   An asset’s book value can never be less than its
       estimated salvage value.
 DDB Depreciation Method . . .
       one example
      Asset cost                $40,000
      Acquisition date          1/1/98
      Salvage value             $6,000
      Estimated useful life 5 years
Accelerated depreciation rate = 20% x 2 = 40%
 2007 depreciation expense = $40,000 x 40% = $16,000
 2008 depreciation expense = $24,000 x 40% = $9,600


                            Slide 8.14
 Depreciation Methods: Sum-of-the-
Depreciation Methods: Sum-of-the-Years’
              Years’ Digits
                Digits
    A fraction is multiplied by the depreciable base to
     arrive at the depreciation expense per period.
    The fraction is:
    1. Numerator: number of years remaining in the asset’s
       life as of the beginning of the period.
    2. Denominator: sum of the years in the life
    3. For example, a 5 year life property would have
       depreciation expense for the first year as:
    4. (Cost – Salvage value) X 5 (years remaining)
                                    15 (computed as
                                        5+4+3+2+1)
  The cost of goods available for
    sale is allocated between
 a. beginning inventory and ending inventory.
 b. beginning inventory and cost of goods on
  hand.
 c. cost of goods purchased and cost of
  goods sold.
 d. beginning inventory and cost of goods
  purchased.
  The cost of goods available for
    sale is allocated between
 a. beginning inventory and ending inventory.
 b. beginning inventory and cost of goods on
  hand.
 c. cost of goods purchased and cost of
  goods sold.
 d. beginning inventory and cost of goods
  purchased.
Depreciation is a process of:
a.   valuation.
b.   cost allocation.
c.   cash accumulation.
d.   appraisal.
Depreciation is a process of:
a.   valuation.
b.   cost allocation.
c.   cash accumulation.
d.   appraisal.
Thank You

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