Machinery Purchased by the Bedding Company: Accounting for Depreciation Using the Straight Line Method
Depreciation is defined as the part of the cost of a fixed asset that is expensed for a particular year or period. Except for land, all property and equipment are subject to depreciation. Depreciation is the decrease in the asset’s utility through use.
The straight-line method is one of the depreciation calculation methods that results in the equitable distribution of charges over the life of the asset. The formula is: Depreciation = cost – residual value / estimated useful life.
Cost is the price paid for the asset. The residual value or salvage value is the estimated amount assigned to the asset or that can be received from the sale of the asset after its estimated life. The useful life is the estimated useful life of the asset.
Suppose the Bed Linens Company purchased machinery to make its bedding at $ 10,000. Your accountant and management estimated that the machine tool is expected to have a save value or salvage value of $ 1000 at the end of its five-year life.
In this case, the total amount of depreciation that must be taken on the books of Bed Linens Company over the useful life of the asset is only $ 9,000 or $ 1,800 for each year of useful life.
When the salvage value is estimated and subtracted from the cost of a fixed asset, the result is called the estimated net cost. Therefore, if a car purchased for $ 40,000 is expected to have a useful life of six years and a salvage value of $ 4,000 at the end of its life, $ 40,000 is called cost or gross cost and $ 36,000 It is called an estimated cost. Net cost.
The cancellation of an equal fraction of the cost of the asset each year is called the straight-line depreciation method.
Using the straight-line method, the percentage of the original cost charged each year, called the depreciation rate, is obtained by dividing 1 over the number of years. For example, if an asset is to be written off in five years, the depreciation rate is 20%.
Under the straight-line method, the amount of depreciation expense for a given year is determined by multiplying the estimated net cost by the depreciation rate. Therefore, if the estimated net cost is $ 9000 and the depreciation rate is 10%, the annual amount of depreciation expense will be $ 900. It is recorded by charging the depreciation expense. $ 900 and crediting the depreciation accumulated-machine tool .. $ 900.
The factors that are relevant to the depreciation of an asset are:
(1) original cost;
(2) estimated salvage value; Y
(3) shelf life.
Under the straight-line method, equal amounts of depreciation expense are taken each year. The concept behind this method is that the availability of a fixed asset to provide service is the same from year to year during its life.
The date of the asset must be taken into account in determining the depreciation expense. If the asset was acquired on July 1, 2009, the depreciation will be for half a year, that is, if the company’s accounting period ends on December 31.
Depreciation expenses will be shown among operating expenses in the Income Statement, while accumulated depreciation will be shown in the Balance Sheet as a deduction from the respective asset.
There are other apportionment methods for depreciation in addition to the straight-line method. One of these methods takes into account the fact that many assets provide more service in their early years than later, due to decreased mechanical efficiency, increased maintenance costs, and the increasing likelihood of obsolescence.