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D. Factors in Computing Depreciation/Depreciation Methods.
1. The computation of depreciation expense is based on three factors:
a. Cost.
activity, or units of output.
c. Salvage value (residual value) is an estimate of the asset’s value at
the end of its useful life.
2. There are three depreciation methods.
a. Under the straight-line method, companies expense the same
amount of depreciation for each year of the asset’s useful life. The
formula for computing annual depreciation expense is depreciable
cost (cost less salvage value) divided by useful life. The straight-
line method is simple to apply, and it matches expenses with
revenues when the use of the asset is reasonably uniform
throughout the service life.
b. Under the units-of-activity method, useful life is expressed in terms
of the total units of production or use expected from the asset. Annual
depreciation expense is computed by multiplying depreciable cost
per unit by the units of activity during the year. This method is not nearly
as popular as the straight-line method because it is often difficult for
companies to reasonably estimate total activity.
c. The declining-balance method produces a decreasing annual
depreciation expense over the asset’s useful life. Companies
compute annual depreciation expense by multiplying the book
value at the beginning of the year by the constant declining-balance
depreciation rate. This method is compatible with the expense
recognition principle in that it matches the higher depreciation
expense in early years with the higher benefits received in these
years.
E. Depreciation and Income Taxes.
1. The Internal Revenue Service (IRS) does not require taxpayers to use
financial statements.
2. Taxpayers must use either the straight-line method or a special accelerated-
(MACRS) on their tax returns.
F. Revising Periodic Depreciation.
1. If wear and tear or obsolescence indicate that annual depreciation estimates
depreciation expense.
years, not in prior periods.
3. To determine the new annual depreciation expense, the company allocates
useful life.
G. Expenditures During Useful Life.
1. Companies incur revenue expenditures to maintain the operating efficiency
Expense as incurred.
2. Capital expenditures (additions and improvements) increase the operating
efficiency, productive capacity, or expected useful life of the asset. These
expenditures are usually material in amount and occur infrequently.
H. Plant Asset Disposals.
1. Disposal by retirement: the plant asset is scrapped or discarded
a. Eliminate the book value of the plant asset at the date of disposal by
debiting Accumulated Depreciation and crediting the asset account
for its cost.
c. Record the loss.
(1) If a company retires a plant asset before it is fully depreciated,
and no cash is received, a loss is recorded by debiting Loss on
Disposal of Plant Assets.
(2) Companies report a loss on disposal of plant assets in the
its cost.
b. Debit Cash to record the cash proceeds from the sale.
c. Compute gain or loss.
(1) If the cash proceeds exceed the book value, recognize a gain by
crediting Gain on Disposal of Plant Assets for the difference.
I. Natural Resources.
1. Natural resources consist of standing timber and underground deposits of
oil, gas, and minerals.
2. Natural resources have two distinguishing characteristics.
pumping).
b. They are replaceable only by an act of nature.
4. The allocation of the cost of natural resources to expense in a rational
and systematic manner over the resource’s useful life is called depletion.
Companies generally use the units-of-activity method to compute depletion,
because depletion generally is a function of the units extracted during
the year.
J. Accounting for Intangible Assets.
accounting for plant assets.
a. The term used to describe the allocation of the cost of an intangible
asset to expense is amortization, rather than depreciation.
b. To record amortization of an intangible asset, companies debit Amor-
tization Expense and credit the specific intangible asset rather than
a contra account.
Copyright © 2014 John Wiley & Sons, Inc. Weygandt, Financial Accounting, 9/e, Instructor’s Manual (For Instructor Use Only) 9-15
c. Intangible assets with a limited life are normally amortized on a straight-
line basis. An indefinite-life intangible asset should not be amortized.
3. Patents are an exclusive right issued by the U.S. Patent Office that enables
the recipient to manufacture, sell, or otherwise control an invention for a
period of 20 years from the date of the grant.
a. The initial cost of a patent is the cash or cash equivalent price paid
to acquire the patent.
b. If the owner incurs legal costs in successfully defending a patent in
an infringement suit, such costs are considered necessary to establish
period of time.
5. A trademark or trade name is a word, phrase, jingle, or symbol that identifies
a particular enterprise or product.
incurred.
c. Because trademarks and trade names have indefinite lives, they are
not amortized.
6. A franchise is a contractual arrangement between a franchisor and a fran-
usually within a designated geographic area.
a. When a company can identify costs with the purchase of a franchise or
license, it should recognize an intangible asset.
its useful life.
c. If the life is indefinite, the cost is not amortized.
7. Goodwill represents the value of all favorable attributes that relate to a
company. These include exceptional management, desirable location, good
relations with labor unions.
a. Goodwill cannot be sold individually in the marketplace; it can be
identified only with the business as a whole.
purchased.
c. When an entire business is purchased, goodwill is the excess of cost
over the fair value of the net assets (assets less liabilities) acquired.
life.
8. Research and development costs are expenditures that may lead to pat-
K. Statement Presentation and Analysis.
1. Usually companies combine plant assets and natural resources under
“Property, plant, and equipment,” and show intangibles separately.
used, and disclose the amount of depreciation and amortization expense
for the period.
average total assets for the period.
*L. Exchange of Plant Assets.
1. Usually companies record a gain or loss on the exchange of plant assets
exchange.
2. Losses on the exchange of plant assets are recognized by debiting Loss
on Disposal of Plant Assets.
