what estimates are used in depreciation? course hero

What are the two estimates of depreciation?

The calculation of depreciation (shown at the end of Part 1) included two estimates: Salvage value. Salvage value is the estimated amount that a company will receive when it disposes of an asset at the end of the asset's useful life. Useful life.

What is depreciation in accounting?

Depreciation is an accounting method of allocating the cost of a tangible or physical asset over its useful life or life expectancy. Depreciation represents how much of an asset's value has been used up. Depreciating assets helps companies earn revenue from an asset while expensing a portion of its cost each year the asset is in use.

What are the factors that affect the amount of depreciation?

Factors Affecting Amount of Depreciation. The amount of depreciation is impacted by a number of factors. Let us take a look at some of them. There are four main factors to consider when calculating the depreciation expense are as follows: The cost of the asset. The estimated salvage value of the asset.

What is the most important criteria to follow when determining depreciation?

The most important criteria to follow is to Use a depreciation method that allocates asset cost to accounting periods in a systematic and rational manner. Question: How do factors affecting depreciation impact the amount of depreciation?

What Are the Different Methods for Calculating Depreciation?

In the United States, accountants must adhere to generally accepted accounting principles (GAAP) in calculating and reporting depreciation on financial statements. GAAP is a set of rules that includes the details, complexities, and legalities of business and corporate accounting. GAAP guidelines highlight several separate allowable methods of depreciation that accounting professionals may use. 1 

What is depreciation in accounting?

Depreciation accounts for decreases in the value of a company’s assets over time. Accountants must adhere to generally accepted accounting principles (GAAP) for depreciation. There are four methods for depreciation allowable under GAAP, including straight line, declining balance, sum-of-the-years' digits, and units of production.

What is GAAP in accounting?

GAAP is a set of rules that includes the details, complexities, and legalities of business and corporate accounting. GAAP guidelines highlight several separate allowable methods of depreciation that accounting professionals may use. 1 .

What is the sum of the years method?

The sum-of-the-years' digits method offers a depreciation rate that accelerates more than the straight-line method but less than the declining balance method. Annual depreciation is separated into fractions using the number of years of the business asset's useful life. Such assets may include buildings, machinery, furniture, equipment, vehicles, and electronics.

What is the declining balance method?

The declining balance method is a type of accelerated depreciation used to write off depreciation costs more quickly and minimize tax exposure. With the declining balance method, fixed assets depreciate at an accelerated rate rather than evenly over the asset's estimated useful life.

When to use double declining balance?

This method is often used if an asset is expected to have greater utility in its earlier years. This method also helps to create a larger realized gain when the asset is actually sold. Some companies may also use the double-declining balance method, which is an even more aggressive depreciation method for early expense management.

What is the most common method of depreciation?

The most common method of depreciation used on a company's financial statements is the straight-line method. When the straight-line method is used each full year's depreciation expense will be the same amount.

Which method is used to report depreciation?

A company has decided that it wants to use the straight-line method for reporting depreciation on its financial statements. The company purchased equipment for use in its business operation and provides the following information:

What is salvage value?

Salvage value is an estimate of the amount the company expects to receive when it disposes of the asset at the end of the asset's useful life. (It is common for companies to assume that an asset will have no salvage value.) Useful life. The useful life of an asset is an estimate of how long the asset is expected to be used in the business.

What happens if an asset's salvage value changes?

If there is a significant change in an asset's estimated salvage value and/or the asset's estimated useful life, the change in the estimate will result in a new amount of depreciation expense in the current accounting year and in the remaining years of the asset's useful life.

What is the useful life of an asset?

Useful life. The useful life of an asset is an estimate of how long the asset is expected to be used in the business. For example, a design engineer might purchase a new computer and estimate that the computer will be useful in the business for only 2 years (due to rapid advances in software and hardware).

What is the combination of an asset account's debit balance and its related contra account's credit balance?

The combination of an asset account's debit balance and its related contra asset account's credit balance is the asset's book value or carrying value. Using the account balances in the T-accounts above, the book value or carrying value of the company's equipment as of December 31, 2020 is: When the asset's book value is equal to ...

When will straight line depreciation end?

Straight-line depreciation was used (resulting in depreciation of $2,000 in each full year) In 2019 the company realized that the equipment would not be useful after December 31, 2020 (instead of December 31, 2021) The estimated salvage value at the end of the equipment's useful life remains at $0. Instead of the original useful life ...

How does an appraiser determine the value of a site?

An appraiser typically estimates the value of a site by assuming the site is unimproved and ready to be utilized for its highest and best use. There are two types of costing used in cost appraising: (1) replacement cost. (2) reproduction cost. Define replacement cost.

How to do cost approach?

There are five steps to the cost approach procedure: (1) The appraiser must begin by estimating the site value. (2) The appraiser must estimate the improvements' reproduction cost. (3) The appraiser must estimate the amount of depreciation from all causes, and then he must categorize each element of depreciation into one of the three major types ...

How is the value of a house determined?

Determined by the appraiser, and based on his observation of how old the house appears to be, taking into consideration the house's design, condition and any economic forces that influence the house's value.

When is the economic life of a house over?

A house's economic life is over once the improvements stop adding value.

Can an appraiser assume that a home will continue to deteriorate?

The appraiser cannot assume that the home will continue to deteriorate at the exact rate it is currently deteriorating.

Changing Depreciation Estimates

Through this course, you will start by addressing the two “big questions” of accounting: “What do I have?” and “How did I do over time?” You will see how the two key financial statements – the balance sheet and the income statement - are designed to answer these questions and then move on to consider how individual transactions aggregate to make up these financial statements.

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As firms operate, they often use long-lived assets to execute their business models. Some of these assets are tangible, such as factories or computers. Others are intangible, such as trademarks and brands.

What are the factors to consider when calculating depreciation expense?

There are four main factors to consider when calculating the depreciation expense are as follows: The cost of the asset. The estimated salvage value of the asset. Salvage value (also called residual value) is the amount of money that the company expects to recover, less the disposal costs, on the date the asset is scrapped, sold, or traded in.

How to calculate depreciation expense?

The amount of depreciation is impacted by a number of factors. Let us take a look at some of them. There are four main factors to consider when calculating the depreciation expense are as follows: 1 The cost of the asset. 2 The estimated salvage value of the asset. Salvage value (also called residual value) is the amount of money that the company expects to recover, less the disposal costs, on the date the asset is scrapped, sold, or traded in. 3 Estimated useful life of the asset. Useful life refers to the window of time that a company plans to use an asset. Useful life can be expressed in years, months, working hours, or units produced. 4 Obsolescence should be considered when determining an asset’s useful life and will affect the calculation of depreciation. For example, a machine capable of producing units for 20 years may be obsolete in six years; therefore, the asset’s useful life is six years in this case.

What is accounting theory?

Accounting theory suggests that companies should make use of a depreciation method that closely reflects the company’s’ economic circumstances. Thus, companies can choose a method that allocates the asset cost to accounting periods according to benefits received from the use of the asset.

Why do we need to provide depreciation?

Need to Provide Depreciation. Depreciation needs to be provided because an asset is bound to undergo wear and tear over a period of time. This reduces the working capacity and effectiveness of the asset. Hence, this should reflect the value of the asset, at which it is carried in the books of accounts. Also, every asset becomes obsolete ...

Why does every asset become obsolete over time?

Also, every asset becomes obsolete over a period of time, as new technology and innovation take over. The value of the asset will hence decrease over time and this must be accounted for.

Is depreciation required under the matching principle?

The Matching principle says that the expense of a period must be recognized in the same period in which we recognize it’s revenue. So an asset which generates income must be depreciated as per given provisions.

Is depreciation an expense?

The amount of depreciation is an expense for an entity. Thus, it is imperative to make the correct and accurate calculations. Let us understand what is depreciation and why we need to provide for it.

Explanation

Formula

Example

Recording of Depreciation

Why Depreciation Is used?

Advantages

Disadvantages

Conclusion – Depreciation

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