Chapter 5
The Accounting Cycle: Adjustments
118
ASSETS
$10,000
Net Book Value
$8,000
- $2,000
Less
PPE
(ORIGINAL COST)
PROPERTY, PLANT &
EQUIPMENT (PPE)
ACCUMULATED
DEPRECIATION
Balance
$8,000
______________
FIGURE 5.17
The contra asset account behaves in a manner opposite to the way a regular asset account behaves.
Recall that an asset account will increase with a debit and decrease with a credit.The contra asset
account (accumulated depreciation) will increase with a credit and decrease with a debit. Figure
5.18 illustrates the T-accounts for property, plant and equipment and accumulated depreciation.
+
-
-
+
PROPERTY, PLANT AND EQUIPMENT
ACCUMULATED DEPRECIATION
INCREASE (DR)
DECREASE (DR)
DECREASE (CR)
INCREASE (CR)
______________
FIGURE 5.18
Calculation of Depreciation
There are a number of ways to calculate depreciation for the period. We are going to use a simple
method called straight-line depreciation.
Straight-line depreciation
is a method to allocate the
cost of the asset evenly over the life of the asset. The calculation for straight-line depreciation is
shown below.
Straight-Line Depreciation =
Cost of Asset – Residual Value
Useful Life
There are three parts of this calculation that must be explained.
1. The cost of the asset is the original purchase price of the asset.This is the value shown on the
balance sheet in the asset account.
2.
Residual value
is the estimated value of the asset at the end of its useful life. By subtracting the
residual value from the original cost of the asset, we determine the cost that will be allocated over
the life of the asset. It is possible for an asset to have a residual value of $0, meaning the asset will
be fully depreciated and worthless at the end of its useful life.
3. The useful life is how long the asset is expected to be used by the business. Like residual value,
this is also an estimate.The useful life can be expressed in years or months, depending on how
often depreciation will be recorded.
For example, suppose a machine was purchased on January 1, 2016 for $10,000. The machine is
expected to last for five years, and after five years the machine is expected to have a residual value
of $1,000.The calculation for yearly depreciation under the straight-line method is shown below.
