Start typing, then use the up and down arrows to select an option from the list. # Financial Accounting

Learn the toughest concepts covered in your Financial Accounting class with step-by-step video tutorials and practice problems.

8. Long Lived Assets

# Depreciation: Straight Line

1

#### concept

Introduction to Depreciation 11m
Play a video:
2

#### concept

Straight Line Depreciation 6m
Play a video:
Alright so let's see how we're going to calculate our depreciation expense per period in the straight line method. So remember we've got our three variables cost useful life and residual value. We're gonna be dealing with this in all the different depreciation methods. Okay so let's see how it works here, notice we've got cost minus residual value in our numerator. So what we call this cost minus residual value. Well this is called the depreciate ble base. Okay appreciable base because this is what we are going to depreciate. Think about it. We've got the cost, what we paid for it minus the residual value. What's gonna what we think it's worth at the end? So everything in between the cost minus the residual value. Well that's what we're gonna depreciate. So after we do this depreciation we're gonna be left with the residual value. Okay so cost minus residual value divided by the useful life and pretty much all the time. We're gonna be talking about years of of useful life. Okay so this is going to tell us the depreciation expense per period. Okay so the nice thing about the nice thing about um straight line depreciation, that makes it so easy is that every year every period we're gonna have the same amount of depreciation expense. So that's why it's a little easier. Let's go ahead and jump into an example. So I can show you what I mean on january 1st. Let me keep that on the screen on january 1st year, one, johnson and johnson and johnson company purchased a delivery truck for \$42,000 the company estimated a useful life of five years and a residual value of \$2000. What would be the entry to record depreciation when preparing the december 31st year one? So notice it's been a year, right? We bought it on january 1st announced december 31st. So the entry to record depreciation and the netbook value. So we'll get to net book value in a minute. But let's start, let's start here with our depreciation expense per year. And how much depreciation we're gonna take the first year. So let's use our formula. We've got cost minus residual value over useful life. So the depreciation expense, I'll put D. E. P. Expense per year. Which also means the first year. What's the depreciation expense? Well it's gonna be the same amount. So depreciation expense per year. Well that's gonna be our cost of 42,000 minus a residual value of 2000. Right? That's what they told us in the problem. 42,000 minus 2000. And what's our useful life? five years. Right? So we think it's gonna be useful for five years. So let's go ahead and find out our depreciation per year. So notice 42,000 -2000. That's 40,000, right? That is our depreciate ble base, as we said above. So the total amount of depreciation. We're going to take over the five years is the 40,000 that depreciate ble base. So we divide it by five and we're gonna get 8000 per year in depreciation, right? So that's why this is so simple. We've already got our depreciation for every year for the next five years. Alright so our entry our journal entry, every time we record depreciation expense we're gonna make this entry no matter what um no matter what method we're using straight line or the other methods we're gonna deal with later. We're going to debit depreciation expense for the amount 8000 here. And it's a debit right? Because it's an expense. So we debit our expenses and what's going to be our credit are credit is accumulated depreciation. So remember that this accumulated depreciation, accumulated depreciation. And I'm gonna just put D. E. P. Accumulated depreciation is a contra asset, right? So this is lowering that net book value. Right? So now let's calculate net book value. Remember we have our asset of the truck which has a debit balance and then the accumulated depreciation is going to have a credit balance lowering this netbook value. So this netbook value, we call it N. B. V. For netbook value is our cost minus accumulated depreciation. Okay that's how we calculate our net book value. And this netbook value. That's generally what we show on our balance sheet on our financial statement will show the net value of the truck. Okay so let's go ahead and calculate this. So after one year after we've depreciated it for one year. Well our cost was 42,000 minus accumulated depreciation. Well, it's only been one year. So we've only accumulated one year of depreciation, which is 8000. And Our Net Book Value is the 42000 -8000. We've got a 34,000 net book value. Okay, so just to reiterate how we might see this on a balance sheet here, um I'm trying to get out of the way so you can see behind me, doesn't seem to be working. So I'll try and stay out of the way and I'll do it here on the side. All right. So what we've got, we would show our assets, just like we do on any balance sheet, right? We would have our cash, we would have our accounts receivable inventory, whatever assets we have, right? And would show their balance, and then we might get to our fixed assets and we'd say something like truck, and we would show 42,000 right? The cost of the truck. And then we'd say something like less accumulated depreciation, which I'm just gonna say a prayer a slash D for accumulated depreciation. And we would say less accumulated depreciation, which at this point is 8000 and then we would show the netbook value here of 34,000 troops. Make it fit on the screen there. I'm balancing between staying out of the way, since I can't get out of the way for some reason right now. Alright, So we would show the Netbook value just alongside all of our assets there. So notice we're showing the historical cost, we're leaving the truck the value of the truck that we paid for at its historical cost, but then we lower it with this accumulated depreciation over its life. Okay, so let's pause here, and on the next page, we're gonna continue this example and kind of follow the whole life of this asset. Alright, let's go ahead and do that now.
3

#### example

Straight Line Method Through Life of Asset 5m
Play a video:
Alright, so let's continue with that example. And let's follow this truck through its entire useful life. Alright, so I've summarized our data here, we've got the cost of the truck, the residual value and the estimated useful life. Okay, so those are three main numbers that we need to know to do our depreciation entries. And let's go ahead and start here on january 1st year one, we purchased the truck at this point, there's no depreciation, right? We just bought it, no time has passed, no depreciation expense, no accumulated depreciation. Right? So our net book value. Well remember net book value is the cost minus accumulated depreciation. So all it is is just the cost at this point. But I'm gonna write out the formula, so cost minus accumulated depreciation of zero. Well, that gets us to our net book value of 42,000, right? So if right now we are going to show a balance sheet, it would show a value of 42,000 for the truck. Cool. So now time has started to pass, a year has passed, just like just like in our example above. And now we have depreciation expense, right? We calculated it as 8000 per year and this is what's so nice, it's gonna be 8000 every year here for the straight line depreciation method, right? So now our accumulated depreciation it was zero And now we added 8000 to it for the first year and we're at 8000 total accumulated depreciation. So our net book value is gonna start decreasing, right? We've started taking depreciation And now our net book value is 34,000, just like we saw in the example above. Cool, so now let's keep going through the rest of the useful life the next four years to get through the entire five year useful life. So year to another 8000 depreciation expense. And now our accumulated depreciation is the 8000 from last year plus another 8000 gets us to a total 16,000 and accumulated depreciation. And that's gonna keep lowering our net book value, 42000 -16000. That's going to equal 26,000 here. Right? So let's go another year. Guess what? The depreciation expense is 8000 again, right? Straight line method keeps it easy like that. So now we've got 16,000 previous accumulated depreciation And now we're gonna add another 8000 to it. Right? So now notice 24,000. This makes sense, right? It's been three years and 8000 times three is 24,000. We've taken three years of depreciation. So accumulated depreciation is 24,000, cost minus our accumulated depreciation of 24,000. Well, that gets us to our net book value of 18,000. So when we show our year three balance sheet, it's gonna show the truck with a netbook value of 18,000. So let's keep going another 8000 in year four for depreciation expense and that brings our accumulated depreciation Up to 32,000 and our net book value? 42,000 in cost minus 32,000 and accumulated, gets us to 10,000 as under our net book value. And finally year five. Remember we had a five year useful life and we're finally in that fifth year. So we take our last 8000 of depreciation expense and check this part out, 32,000 plus 8000. Our accumulated depreciation is 40,000. Remember when I talked about the depreciation base? Our depreciation base was the numerator in our equation, the cost minus residual value. So our cost of 42,000 minus our residual value of 2000 is 40,000. Right? And that after the five years we we've taken all of that depreciation base over the five year life? So here are total accumulated depreciation that we've taken over. The life is 40,000. So it all works out here. And guess what's left in our net book value. The 42,000 minus the 40,000 in depreciation accumulated depreciation Gets us to our residual value of 2000. So now all that's left is the residual value. What we expected it to be worth at the end of its useful life? Now, I've got a interesting question, what happens if the truck isn't isn't done being used? Right? We estimated it would last five years. Remember? It's just an estimate? Well what if it lasts six years? What if we go on into the six years? How much depreciation expense are we gonna take in year six? Do you think it's the 2000 and residual value? No, we actually don't take any depreciation. There's no depreciation in year six. We've already fully depreciated this asset all the way to its residual value. Okay, so there's gonna be no more depreciation. Even if we go into year seven and year eight, we're not gonna take any more depreciation are accumulated. Depreciation is going to stay at the 40,000 total and our net book value will stay at 2000. Remember? This is what we're expecting to be able to sell it, sell it for when we're done using it. So once we finally sell it we'll we'll have entries to deal with that and we'll talk about that in a later lesson. But for now I just wanted to point out that once we fully depreciate the asset, we don't keep depreciating, there's no more 8000. We couldn't take another 8000 in year six, we don't get rid of the residual value. That's what we expect it to be worth still. So that's what we want to leave it at that value on on our balance sheet. Cool. So now that you kind of see the full effect of the straight line depreciation method? Why don't you guys try some practice problems and work with this formula yourself? Alright, let's do that. Now
4
Problem

ABC Company purchased a new machine on January 1, Year 1 for \$44,000. The company expects the machine to last ten years. The company thinks it could sell the scrap metal from the machine for \$4,000 at the end of its useful life. If the company uses the straight-line method for depreciation, what will be the net book value of the machine on December 31, Year 4?

5
Problem

DBQ Company purchased a machine on January 1, Year 1 for \$60,000. The company estimated a five year useful life and \$8,000 residual value. If the company uses the straight-line method for depreciation, what will be the amount of accumulated depreciation on December 31, Year 2? 