Change in Estimate: Depreciation - Video Tutorials & Practice Problems

On a tight schedule?

Get a 10 bullets summary of the topic

1

concept

Change in Depreciation Estimate for Useful Life and Salvage Value

Video duration:

12m

Play a video:

So remember that the useful life of an asset and the residual value of an asset are both estimates. Well, sometimes we get better information and we want to update those estimates. What do we do? Let's check it out. So, the useful life of an asset, like we said, is an estimate at the time that we purchased the asset. But at a later date, we may reevaluate that with new data. So when we change the useful life or the residual value of an asset, this is regarded as a change in accounting estimate. Okay. There's different changes that we can make. A change in accounting estimate is a type of change that makes us uh make our changes going forward. Okay. So, we're gonna change our calculations going forward into the future. All right. Remember we're dealing with estimates here, back when we made depreciation expense in prior years while we were using the old estimates. Well, that was the best information we had. And it wasn't technically wrong. We were doing our best. Right? So, we don't need to make any retroactive changes. We don't need to go to last year and change the depreciation expense from last year and update our financial statements. No, we're gonna leave those as is and then we're gonna use our new estimates to change our calculations going forward. Okay. So, when we when we deal with these changes in estimated useful life, we're generally going to just deal with straight line depreciation in this class because it's a little more complicated when we have other methods. So they usually just stick to straight line depreciation to make sure that you understand the idea. All right. So, how are we gonna do this? Well, we're gonna have to use the remaining depreciate ble whoops, The remaining depreciate the value of the asset. And we're going to recalculate depreciation expense. So what's gonna happen is we're gonna have been doing some depreciation based on our original estimates, and then there's gonna come a day that we're gonna change our estimates on that day we have to re evaluate our our depreciation expense per year, because we're gonna be doing this in straight line method. So, we're gonna figure out how much remaining depreciate the value we have and then we're gonna adjust our depreciation expense for the remaining life. Okay? So, again, like I said, this is a change in estimate, and another estimate is the salvage value. So, if we're gonna reevaluate our salvage value, what we would just change that in our calculation as well, and then update our depreciation expense based on the new data. Ok, So, how do we calculate this remaining depreciated value? Well, the remaining depreciation value, it's going to be similar to the netbook value. Except we also consider the salvage, the salvage cost. Excuse me? The salvage value. So, we've got our initial cost. What we paid for it minus the accumulated depreciation. Right? And that's what we're used to. Right? So, the initial cost minus accumulated depreciation. That's our net book value. And then we're gonna take out the remaining salvage value as well for the amount that we're going to depreciate, right? Because we don't want to depreciate the salvage value. That's what we want to have left at the end. So to find out how much depreciation value we have, the initial cost minus accumulated depreciation. The depreciation we took in prior years with our old estimate minus the salvage value. Cool, let's see this all. In an example here on january 1st year one abc company purchased a machine for $65,000. So january 1st year one, they purchased it for 65,000. And they made some estimates on that day estimated a five year useful life and $5000 salvage value now on july 1st year too. So july 1st year too, so noticed they were already depreciating it for a while for all of year one and some of year two, they were depreciating it on those old estimates. So on july 1st year to the company reevaluated its estimated life for the machine to six years from that date. Okay, so it's not six total years from when they bought it. It's six additional years from that date. On july 1st year too. The company uses the straight line method for depreciation, calculate depreciation expense for year two with the netbook value of the machine on the uh, on December, year too. Okay, so let's go through the steps of how we're gonna do this. The first thing we need to do is calculate all the accumulated depreciation. We've taken up to this point, right? Because we had some depreciation in year one, and some depreciation during year two as well. So what we're trying to get to is this remaining depreciated value. Okay, so let's start here with the accumulated depreciation. And that's gonna be, let's look at Year one's depreciation expense. Well, what we're gonna need to do is our straight line formula, right? Depreciation expense per year. And I'm gonna put old on this, because this is the old estimates when we did this. Okay, so let's see what that is depreciation expense per year while we bought it for 65,000, And we had a $5,000 salvage value. And how long was the useful life? five years? So 65,000 -5000, and we're gonna divide that by five. That's 12,000 per year in depreciation from the original estimates, right? So during year one, well, we would have taken 12,000 in depreciation, write a full year's depreciation. What about in year 2? Using the old estimates all the way up to July one. So this is year two. And I'm gonna put up to July one Up to July one. Right? And that's when we changed our estimates. Well, it would have been 12,000 for the whole year, right? 12,000 would have been the whole year. But we have to do our partial year depreciation because we didn't get a whole year's worth before we changed our estimate, how much of the year had passed. Well, it was January, February March, April May June, we're talking about half the year, right? Six out of the 12 months. So this would have been 6000 in depreciation That we took in year two up to July one using the old estimates. Alright, so what was our accumulated depreciation? Well, that was the 12,000 plus the 6000. We're talking about 18,000 in accumulated depreciation, up to july 1st year to. Alright, so now we're ready to say, well, how much is left to depreciate at this point? So now we're on july 1st and we're changing our estimates, right? So how much is left to depreciate at this point? Will the remaining depreciated value? So I'm just gonna put remaining here the remaining depreciated value. Well, that's gonna be what we paid for it. The 65,000 minus the accumulated depreciation we took so far of 18,000 minus the 5000 of salvage value. Right. We didn't change our estimate for salvage value. So that's gonna stay the same. So let's see how much remaining we have 65 minus 18 minus five. What we've got 42,000 left in remaining depreciated value. So that's the amount that we want to depreciate over the rest of the life? Okay, so how much is the rest of the life? What we're ready to uh we want to calculate the rest of the depreciation for year two, Right? So let's leave that on the screen up there, actually. So you see the question. So notice we had 42,000 left to depreciate before we get to our 5000 salvage value at this point. And now it told us that there's going to be 66 years from this date. So from july 1st till the asset is fully depreciated, we think it has six more years of useful life. So what we wanna do is take that remaining depreciated value and divided by the six years that we still have going forward, Right? So it's not six years from when we bought it. It's six years from this date, july 1st year too. So we're gonna depreciate it for the next six years. So we'll have 7000 per year in depreciation going forward, notice our original estimate was 12,000 per year. We did that for a year and a half. And then we said, actually it's gonna last us a lot longer than we than we first expected. So that's why this depreciation is going down and there's also less depreciation value. So we're gonna take less per year. Cool. So let's keep going forward here. Let's calculate the entire depression? Or let's calculate, sorry, the depreciation expense for the second half of the year, and then we'll be able to calculate the full year's depreciation. We already took, remember from the first half of year two, we already took some depreciation. Now we're gonna look for the other half of year two, how much depreciation we take? Well, that's that 42,000 Divided by the six years, right. That would be 7000 per year. But this isn't a full year we're talking about in year two, right? We're talking about just the second half of the year, from july through december 31st, So 7000 per year times those six months, Right, july august september october november december those six months. Well, we need to depreciate it for that half of the year, and that's gonna be 3500 in depreciation, right? Half of a full year's depreciation, using our new estimates. Alright, so now we've got our value for the second half of the year. We took 6000 with the old estimates from the first half of the year. And now with our new estimates, the second half of the year is going to use this 3500 and depreciation. So we can calculate our total depreciation expense in year two, and it's gonna be the total of those two numbers. Right? It's going to equal the 6000 that we took in the first half of the year. So I'll say January through July plus, sorry, that's January through June. And then we took 3500 for July through December. Right, so our total depreciation in year two is going to be 9500 in total depreciation. Okay, So the last thing is to calculate the net book value at the end of year two. Well, we are netbook value. Remember that's just our cost minus accumulated depreciation. Our cost, we bought it for 65,000. That never changed. We paid 65,000 for it. And then our accumulated depreciation. Right? How much depreciation have we taken? Let me get out of the way. And I'm gonna do a little t account behind me here. So, accumulated depreciation in year one. So in year one we took 12,000 of depreciation in year one, with our old estimates, right? So that would go into our accumulated depreciation account and then in year two we took the 6000 plus the 3500. We took this 9500 for the whole year of year two, And that's the addition of those two calculations the 6000 plus the 3500. Cool, so this is our total accumulated depreciation 21,500. So, if we take out our accumulated depreciation, this will get us to our net book value 65,000 -21 500 and it gets us to 43,500. Alright, so our net book value is 43,500 after those two years. So notice when we change the estimate, we only change our calculations going forward everything that we did in the past. Well, it stays as such. All right. Why don't we try some practice problems with these changes in estimate?

2

Problem

Problem

Roller Coaster Tycoons purchased a concession stand for $360,000. Initially, the concession stand was depreciated straight-line over a ten year useful life with no residual value. After six years in use, RCT assessed that the concession stand would be useful for only two more years. What is depreciation expense in year 7?

A

$18,000

B

$36,000

C

$54,000

D

$72,000

E

$90,000

3

Problem

Problem

Changing Minds Company purchased a building for $480,000 and depreciated on a straight-line basis over 40 years, estimating a residual value of $60,000. The company depreciated the building for twenty years and then estimated that the building would only remain useful for another twelve years. At this time, the company also re-evaluated the residual value at $30,000. What will be depreciation expense in year 21?