Depreciation for productivity

1. Introduction: Welcome to depreciation. That easy way to learn depreciation for counting. I'm Eric night and I'm honored to be your instructor for this course. I'm a CPA, experienced and financial accounting, but I now focus exclusively on education and training. I hope to bring that experience in the field and my love for education together for you. After completing this course, you'll be able to breeze through accounting depreciation calculations and apply these techniques to a business. You'll be left with tools to complete the job using Excel. Excel is accounting is most popular software tool. We're going to learn depreciation and short direct lectures. These lectures will use real-world example. This is an acid examples. We're going to see what assets are and which ones aren't. Appreciate it. We're gonna get an understanding of the relationship between the balance sheet and income statement with depreciation applied. We're gonna see how to calculate depreciation using the most commonly implemented methods. We're going to get these explanations, calculate it using Excel. We're going to get bonus lesson on advanced topics as well as templates that you can take full. If you are a beginning level of counting student wants to develop a better understanding of depreciation in your perfect. Also bookkeepers are entrepreneurs didn't need depreciation for their business venture, will find this course an excellent resource. Students should already have a basic understanding of the accounting cycle before beginning of this course. Thank you for joining me today. Please let me know if you have any additional questions. 2. Assets Defined: Welcome back to this course on depreciation. Now before we jump into depreciation methods and doing all kinds of calculations to come up with the depreciation expense. First, we need to understand the idea of an asset. What is an asset? And more importantly, which assets are we going to depreciate? So let's go ahead and get a better understanding of the idea of assets. Here and less than one. We're going to start out by learning about what an asset is. Before we get into all the calculations that are necessary to depreciation is crucial to get a feel for what assets really are. Because assets, at least certain assets, are going to be what gets depreciated. Simply stated, an asset is what the manager needs to do his or her job. So what kind of resources, what kinds of things they are neat. So if you look at some example industries, let's look at a restaurant. It's going to need stove, friars of tables and chairs, silverware. Those are the typical types of resources, also known as assets on. A manager's going to need to do the job that needs to be done. Looking at different industry. Let's look at the airline. They need airplanes. That's a big asset that they're going to need on their balance sheet. Looking at a factory, well, factories need equipment and machinery, buildings. Those are the types of resources managers need in a factory to accomplish their goals. But not all assets are the same. There are several categories of asset that you'll find in the balance sheet. One category of asset is a current asset. One way to know a current asset is if it's going to turn into cash in a relatively short period of time. Obviously then cash is going to be a current asset. But another example of a current asset would be inventory. Usually a business buys inventory to sell and turn into cash within a year. That's a good indication that you have a current asset. Another example of a current asset or another way to know if you have a current asset is if you're going to use the resource up within a year, within a short period of time. So take something like office supplies. Office supplies are usually purchased and they're going to be used within a year. So that's a good indication that that's going to be a current asset for you. Another category of asset is the long lived asset. A long lived asset, It's going to be used for more than a year, usually for a pretty long period of time, say ten years. Here's an example of a long-lived asset for former. The former might need attractor and that tractor is probably going to be used for many, many years. So the situation with the current asset is that since it's going to be used up within a year, within a short period of time, then when it's purchased and put as an asset and when it's used up in expensed, it's not gonna be a big problem for us because it's getting expensed are used up. And the same time period in which is being purchased and put on the books, at least within a relatively close time period. Like I said, usually about a year. But the long lived asset has a different situation. The tractor is going to be used for many years. So the time that is purchased, the year in which is purchased, it's not going to be the same year in which it's used all the way up. That means we're going to have to spread that asset usage out over multiple years. So in this case we estimate ten years. Spreading it out over ten years means that we're going to expense it over ten years. We're going to depreciate it. That's where depreciation comes in. It's like we're whittling it down a little at a time over a ten-year period. And depreciation is the mechanism in which we use to do that. I guess the last thing I want to leave you with is to be careful of the use of depreciation by the rest of the world. The rest of the world uses depreciation to mean what something is worth right now, the value would buy by four on the street or buy it for on the market. That fair market value is not accounting depreciation. And you need to make sure you kind of forget about that and focus on what we mean by depreciation in accounting. That accounting depreciation that I just explained to you is what we want to make sure we focus on. If you confuse accounting depreciation with the fair market value are what something's worth on the street, then you're going to have a harder time understanding depreciation. But now that we've gotten this far and we've got a good basis for understanding some of our terms. We're ready to move forward. 3. Depreciation on the Financial Statements: Welcome back. In this lesson, depreciation, we're going to begin by looking at the financial statements and how the assets end up on the financial statements, how they're represented in both the balance sheet and the income statement. We're going to then look at how depreciation works on the income statement and the balance sheet together to give us a value for the asset that we have along with the depreciation, will learn later on how to do the calculations for depreciation. Right now, we're just interested in learning how they are represented on the financial statements for business. Let's learn about depreciation by looking at two of the most important financial statements that we have in accounting. On the left here we have the balance sheet, and then next to it we have the income statement for the company called Cool beans called the balance sheet, provides us with a snapshot of a business. What are the assets worth as of that day of January 31st? The assets are on the left side. And then on the right side we have the liabilities, meaning what the business owed, obligations they had and then they equity, which was the ownership of the business. Notice how the assets equals liabilities plus equity, hence, the balance sheet. On the other side, we have the income statement. The income statement provides us ultimately with the profit of business made. And accounting, we don't call it profit, we call it net income. And we look at the period of time that was made with so this was the profit they made during the month of January. Okay, so let's say that the managers of cool beings have decided that they want to buy a new coffee trailer. Maybe they want to offer mobile coffee services. So they bought this trailer back on January first, $11 thousand. And at this point, it's not reflected that they bought this trailer and the financial statements, the balance sheet or the income statement. So let's look at how we would accomplish this. Now first I'm going to show you the incorrect way to do it so we can maybe make a comparison. So let's, let's see how that would look. What I've done is I added a line in the income statement and I put trailer expense there. Now this is incorrect. To make sure you know it's incorrect. I even added a big red X there for you. Why is it incorrect to do this? Well, there's an important reason you see the income statement is only supposed to show expenses that were used up during the month of January. They expect to use a trailer for many, many years. So wouldn't make sense to put the entire trailer as an expense for just that one month. Some things work. I mean, take paper cups as part of supply expense. I mean, a paper cup gets used up immediately. So whenever it's used up completely in January, which happens all the time, it goes into an expense there. The trailer, however, is completely different. It's going to be used for many, many months. So it wouldn't work this way. So I'll put things back the way they were. Let's see how we should actually do this. Thinking about it, the trailers or resource, Right? The resource is something that the managers can use to make money for the business for years to come. So as a resource, it should be included as an asset. So it should actually be in that asset section around this property plant and equipment, since it is equipment to their barn to use. Since they took a loan out to get the trailer, they didn't pay cash for it. Then it's going to also show that a liability and the liability section of the balance sheet two. Here we see the trailer added into property, plant and equipment. We see the new loan for the trailer, and we see the assets and liabilities still equal each other. So one of the concepts that we need to remember is that the trailer is put on the books at the historical cost. It will remain at that value as long as the trailers owned by the business. However, as the trailer is used up a little at a time, then we're going to do what we call depreciation. Depreciation has two kinds of accounts. There's the depreciation expense. Then they have something called the accumulated depreciation. So this depreciation expense is the little bit that we deemed was used up for accounting purposes. And each month in this case, we're going to first look at January. Okay. So let's set the financial statements to include the accumulated depreciation account and the depreciation expense. For purposes of this course, the scope of this course, we only need to see the asset side for this reason, we're going to go ahead and hide the other side of the balance sheet for now. What we're gonna do is add the accumulated depreciation and we'll add the depreciation expense. And so now we have the balance sheet and the income statement with those two new accounts in there so we can do the depreciation. The depreciation has been calculated already for us to be $1000. We're going to learn how to do the calculation later in this course. But each period, each month, we're going to have a depreciation expense of $1000. So we'll put that here and we can see how that reduces our profit. And then we can see the accumulated depreciation here. Now, this is a negative amount because the accumulated depreciation works together with the asset that is attached to to give us a net, also known as a book value. So the trailers book value is the trailer itself minus the accumulated depreciation. Looking at our next month of February, we see we have another month of depreciation and our accumulated depreciation continues to climb each month. How we calculate this will be in future slides. 4. Journal Entry: Welcome back to this course on depreciation. I'm excited that you are here with me today. In this lesson, what we're going to focus on is a journal entry. You may have learned about journal entries in the past. Basically, a journal entry puts transactional information in the financial statements. You can say you're putting him on the books and that's exactly what you're doing with the journal entry. So this is a very important part of the accountant's job. But we're going to focus on the specific journal entry for use with depreciation. Little refresher from our previous lessons, we saw that the depreciation ended up affecting are impacting the financial statements, including the income statement, the balance sheet. So we had the depreciation expense on the income statement. And what that represents this just the expense that happened in that period. In this case, the period was the month of February. Then we had the accumulated depreciation. Accumulated depreciation is on the balance sheet and it represents all the depreciation that's accumulated since we acquired the asset. We acquired the trailer several months ago, and the depreciation that's accumulated so far is $2 thousand. So we can see that book value as being the trailer minus the accumulated depreciation. And book value is there for $9 thousand. We haven't talked about how we can calculate the depreciation expense yet, that's for some future lessons. But for now, we want to figure out how these amounts ended up on the financial statements and the way that happened using a journal entry, using our debits and credits. We'll start by looking at the journal. The journal is where I'm going to put the journal entries is a typical journal. You see you have a date column. The journal entries are always done chronologically, a short account description. So like accumulated depreciation, depreciation expense, account number, and then a debit and credit column. Now some rules for journal entries, you need to have at least one debit and at least one credit. So you would need at least two accounts. For every journal entry. You can have more than one debit, more than one credit, but the journal entry must end the end equal to debits and credits. If I have two debits and one credit and they have to equal when you add up the debits and credits. Now, this is not going to be really an issue for appreciation, as we will only need one account for the debit and one account for the credit will need two accounts total. The depreciation work is usually accomplished at the end of the month. This is the time when the accountants do what they call adjusting entries, meaning that they do like kinda like ketchup work. So this is February, so we'll do 228. And then we're going to want to always do our debit amount first. Since we're doing depreciation expense and accumulated depreciation, we want to go with the account is gonna be debited with that one on top. So the expenses are increased through debits, depreciation expense. The account number 4,030, and the debit amount is a thousand. By debiting the expense, this increases the expense. Then the next account is the asset account, or in our case, the contra asset account, called accumulated depreciation. Account number as 1052. And the amount is again 4 thousand. We see the debits equal the credits. Finally, most most of these journal entries have a short description on the bottom of what occurred. So we might put something like monthly depreciation for the trailer. Just kinda reviewing this one more time. We have the expense. Expenses are increased with debits. We have the accumulated depreciation which brings down the book value of the trailer, which is an asset. So to reduce the asset, we use a credit, debits equal the credits. This occurred on February 28th, the end of the month. So we're all good. So we've learned a lot so far. Below what assets are, which assets need depreciation. We learned what depreciation is and why we do it. And then we even learned the journal entries for getting depreciation and accumulate depreciation onto the financial statements. But we haven't talked about how to calculate the amount that needs to be depreciated. And that's what's coming up and the remainder of this course. So that's something for us to look forward to. 5. Depreciation Methods: Welcome back to this course on depreciation. In this lesson, we're going to look at the different options that we have to choose from when determining how we're going to go about calculating depreciation. To start to get an, a good understanding of the calculations that are involved with depreciation for the different methods that we're going to look at. There are some key terms that we really need to focus on and get under our belt. The first one is called the cost or the historical cost of the asset. They call it historical cost because that's how much they paid for it when it was originally purchased. That amount plus any amounts that are needed to get the asset ready for its intended use would be what we would put on our books as the cost for that asset. If you purchased, let's say a new delivery truck? Well, that delivery truck needed to have your logo put on it and GPS system installed? Well, those costs would be included as part of the historical cost of the asset. One thing to remember about historical cost is this is an actual costs. We know what it is. It's not something that's estimated or guessed. Another important term that's used in depreciation is salvage value. Salvage value is basically what the management estimates the asset will be worth at the end of its useful life, meaning about the time when they're done with the asset, what will be the value? Now, of course, this is going to have to be estimated. There's other terms that are used for salvage value or residual value or trade-in value means the same. That just says, this is what we think it will be worth. The asset will be worth at the end of the useful life. Useful life is another term that we need to use. It's basically an estimated amount of time that the management thinks they're going to use that asset. So we have four basic depreciation calculations that we can use. These options are available for management to choose from depending on which one they think is going to best fit that asset. We're going to go through each of these individually, but just a brief overview, the straight-line method, declining balance method, some of the year's digits method and the activity method. Now these numbers were calculated and advanced and we'll look at how we would go about calculating straight line depreciation in a future lesson. But what we want to do is just give you some example numbers. So let's say we calculated a straight-line depreciation and the depreciation expense came to $2 thousand. Now you'll see that that $2 thousand is gonna be the same every period. That is the straight-line depreciation method and how it works. You'll notice that the accumulated depreciation just as that 2000's and accumulated over time. The straight line method is known for being one of the simpler methods to calculate, and it's also pretty straightforward. It's very frequently used. Looking at the declining balance method, you'll notice that in the early years, more depreciation is taken in the later years, but ultimately the same amount of accumulated depreciation was taken. The straight line method gave us 10 thousand accumulate depreciation will get the same with any other method we use, including the declining balance method. Again, this is called an accelerated depreciation method because more depreciation is taken the early years and less later on. Accelerated methods are sometimes popular with managers because a lot of times when they get a new piece of equipment, a new asset or some sort, they use it a lot more in the early years. And then as it gets older, they use it a little bit less. So that's why an accelerated method is often in favor. It is more complicated to calculate this method. So that's one of the drawbacks. The sum of the year's digits depreciation method is another method for accelerated depreciation. Again, you notice that there's more depreciation taken early years and less taken later on. It's not necessarily better or worse than the declining balance method is just another option they have. And then finally, we have the depreciation is based on activity. In other words, how much we use the asset, not the time that we have the asset, is what we use for calculating the depreciation. Example. Let's say we have a delivery truck and whatever mileage we put on the delivery truck is going to be used to calculate the depreciation. If we drive very little, very little depreciation is taken. If we drive a lot more and more depreciation is taken. This situation we see we drove a lot in the early years and less later on, but it doesn't have to be that way. It just really depends on how many miles you drove. If you drive very little in the early years, then you would have less depreciation in the early years. However, one thing that needs to be pointed out is that the accumulated depreciation still ends up being the same. In other words, we depreciate based on the miles driven, but it still can only add up to that $10 thousand, which is the cost minus the salvage value. So this chart is just another way for us to look at the different methods and compare them. The blue line is the straight line method and you see that it's the same amount every year, then we have to accelerated depreciation methods, the declining balance method, which is the orange line and the gray line, which is the sum of the year's digits. Those both have more depreciation taken early and less later on. Then finally, the activity method just really depends on how much activity that asset is used. It could be the number of miles driven or number of hours we used. The machine really doesn't matter, but what matters is how much we use it. And then another thing to point out is that no matter which method we use, they all end up providing us with the same amount of accumulated depreciation in the end. The biggest difference is just really about the timing. So now that we've got a pretty good understanding of how the different methods compare with each other. We can go ahead and start looking at each one individually and how we would actually go about doing the calculations. 6. Straight Line Depreciation: Welcome back to our course in depreciation. In this lesson, what we're gonna do is start to learn how to do the calculation in order to learn how to determine what amount needs to be depreciated during the period. We're going to start out with the straight line depreciation method. It's the simplest and most straightforward. Let's go ahead and look at that. The overall calculation or formula that we're going to need for doing straight-line depreciation. It looks like this. We take the cost, which is how much we paid for the asset, any other costs and get it ready for its intended use. So for example, if we bought a truck for our business and we had to put a GPS system onto track it. And then we also have to put lettering on for advertising. All those things would be included in the total cost of the truck. Subtract from that the salvage value, which is what we think the drop is going to be worth at the end of its useful life. The useful life is how long management thinks they're going to be able to use that asset. So those are the different variables in this calculation. But if we do this, we will get the depreciation expense for each year. Also want to introduce you to the rate of depreciation. Or the rate of depreciation is one over the number of years they useful life that we are expecting to use the asset. So for example, if we expect to use the truck for ten years than the rate of depreciation under the straight line method is 10%, one over ten years. We won't do too much with this and this lesson, but it's going to be useful in the future lessons. Okay, let's go ahead and use a spreadsheet in Excel and just show how he would depreciate an asset, will fill out these gray cells here. That's important that we get the starting information. So first we need to know when we acquire the asset and we're going to say, we acquired on the first of the year and we'll just do like the year 2010, just to make it easy to follow and the cost will put 11 thousand for our cost and a 1004 salvage value. When you take your cost minus salvage value, that gives us what we call the appreciable value. So that gives a $10 thousand depreciable value. Then the estimated life is gonna be ten years. And all of these numbers are pretty easy to follow along with our first example. So using our formula, we see that the cost of 1 thousand or 11 thousand minus 7 thousand salvage value, divide it by ten years, gives us $1000 a year. When we look at our spreadsheet, we can see how that would be, that would be applied over the entire useful life of the asset. So now that we've seen the calculation for depreciation expense, let's apply it over the length of time of the asset. So since we bought the asset for the entire year of 2010, we're going to depreciate it over the next ten years. The depreciation expense was calculated and because it's straight-line method, it's the same amount every year. That's one of the key elements of the straight line method. Then we have the accumulated depreciation and that's just going to be an accumulation or buildup of the depreciation expense over time. And it will continue to build up until it gets to what they call the depreciable cost. Depreciable value, which is the cost minus the salvage value. Once it gets to that depreciable value, then it no longer builds up. And sometimes students ask me what if they keep it longer? And the answer is, well, they keep it 1112 or even longer than that. It just stays on the books. You don't have to do anything else. We don't do any additional appreciation. If they eventually decided to sell it or somehow scrap it, then there's a whole nother process that we would, we would go through, which is something outside of the course that we're doing. Another thing that I get asked as well, what if we don't buy it on the first of the year? And I can understand that we're gonna have to look at that as a partial year depreciation, will do that in another lesson. 7. Straight Line Depreciation: Partial Year: Hello and welcome back to our course on depreciation. Now we've already covered the straight-line depreciation method. As you recall, that's the method where the same amount is depreciated as an expense each period. However, there was one question that came up along the way and that was what happens if you have a partial period depreciation. Like, for example, you have an asset that was put into operations in the middle of the year, so you don't want to depreciate an entire 12 months. Let's see how you would handle that. There are several options that we can go with to do this type of a calculation. The convention we're going to use is called the nearest whole month convention that's very popular one. In this situation, we, if the asset is acquired on or before the 15th of the month, we depreciate the entire month. If we acquire it after the 15th, then we depreciate beginning on the first of the next month. So if we were using this method for May of 2010, if we bought the asset anywhere between first to the 15th, we would treat the entire asset as being purchased on the 1st of May, and we would depreciate for that entire month after the 15th, we would then treat it as if it was purchased June 1st and we would appreciate for the entire month of June. So looking at a year, if we purchased the asset somewhere in the beginning of May, before the 15th, then we would see there would be eight months that we would want to depreciate for that first for that first year. If it was purchased after that, perhaps in the end of May. Okay. Then we would see that we would start with June and we would only have seven months to depreciate. So that's how this method works. And then we just do a fraction of the year based on the date in which it was acquired. So first, let's see what happens if we were to buy or acquire the asset and the beginning of the month, let's say May 5th. Well, we would include the entire month of May, May through December 12th or eight out of 12 months. So that's eight twelfths of the entire year. 812, $1000 of depreciation is $667. Then for the next nine years, we go through and we do an entire year of $1000. When we get to the very last year, we only need to depreciate four twelfths. We want to have ten years total, eight twelfths to first-year. So that leaves us for 12, So last year. And we can see that we did this correctly because it all adds up to $10 thousand total as our depreciation that's accumulated. Well, what about if we purchased the asset after the 15th? Well, then we treat it as if we purchased it on the next month. In this case, June 1st. June 1st to the end of the year is seven months. So we have seven months of depreciation the first year. And that leaves us at the end of the useful life of the asset with five months leftover. So that last year we only depreciate five months. Now we know if we've done it correctly because our accumulated depreciation is still adds up to $10 thousand total. So now we see what we'll do if we have an asset that's purchased in the middle of the year. Probably more typical in a real-world scenario, anyhow. So from here on out, we're going to look at some different types of depreciation calculations. We've learned straight line. There's some other options that are out. 8. Declining Balance Method: Hello and thank you for coming back to our course on depreciation. Now, we've talked about in previous lessons that there are multiple ways to calculate depreciation. We looked at the method that uses the straight line depreciation, where every month or every period we do depreciation, it's gonna be the exact same amount as the other periods that we did abbreviation for. However, there are other options that we have. So we're going to see our first glimpse at another option called the declining balance method. As you might recall, management has multiple options to choose from when deciding on depreciation method. We've talked about the straight line method. Now we're looking at declining balance method in RV. Do the declining balance method, we first need to get the rate of depreciation. So all you do is take one divided by the estimated useful life. So if our estimated useful life is five years, we take one divided by five, we get 20%. And as you recall from the straight line method, we use that every year. And the declining balance method, we're going to take that rate of depreciation, but we're going to change it. One way we can change is by doubling it. So if the declining balance method is doubled, then we're calling that the double-declining balance. That's the most common method of declining balance methods. And all it is is taking two because it's double. So 20% is changed to 40%. However, it doesn't have to be at double-declining balance. It could be any multiplier. Another common one would be 150%. So instead of taking two times the rate of depreciation, we would take 1.5 times rate of depreciation. So instead of 40%, 30 percent. However, because the double declining balance method is by far the most common method used of the declining balance methods. We're going to stick with that. Let's look at an example. Let's take some equipment. Say the cost of equipment 120 thousand. Now salvage value is what managers think it's gonna be worth at the end of its useful life. Useful life is how long managers think I'm going to use it. And we need to know the multiplier. In this case, we're going to use double the rate of depreciation because again, that's the most common one. So let's go ahead and do the example using Excel. So I'm going to start out the data choir and we're gonna do the entire year. So we'll start with the beginning of the year and let's just do 2020. The cost we said was 120 thousand and the salvage value is 20 thousand. We estimated the life was five years and we're going to use double-declining balance. So two times, that'll be our multiplier. So I'm gonna go ahead and put our years. And to start with, I went ahead and put five years in because it's a five-year useful life. The beginning value of the book value will be the cost of the asset because we haven't had any depreciation yet. Remember the book value is taking the cost minus the accumulated depreciation. Since it's brand new, there has been no depreciation. So a 120 thousand. Then we're going to multiply that by the depreciation rate, which we said was 40%. We calculated that by taking one divided by five and then multiplying it by the multiplier two. Alright? This means that our depreciation expense is 48 thousand. So this will be the depreciation expense for the year. Accumulated depreciation is going to be all depreciation we ever, we've ever taken well, it's only been one year, so this is the first year. The book value takes the cost minus the accumulated depreciation. So that leaves us at 72 thousand. Now that ending book value rolls into our next year's beginning book value. Alright, and we said that depreciation rate was 40%. We're going to use that same depreciation rate every year. However, we're not going to have the same depreciation every year. If you recall, straight line depreciation used the same rate every year, but that rate was applied to the same number as applied towards the depreciable cost, which was the same. Now we're going to apply that 40% to the book value every year, which is going to be different. It's going to, the book value is going to reduce every year. So then our depreciation expense is going to change. As you can see, the declining balance method, which you'll notice is that more depreciation is taken early and less is taken later on. Now we just add last year's depreciation, accumulated appreciation to this year's new depreciation that we added. And we get 76,800. The book value takes the 121,120 thousand minus 276,800 accumulated, and we have 43,200. So then next year, same thing. Again, 40% every year. That gives us 17 thousand to a 0. Add those two up, and we have 94000080. Our book value is 120 thousand minus 94 thousand zeros 0, and we get our new book value as 2500920. So that 25,920 becomes two years beginning book value of 25,920. Now things get a little tricky here. You see, as you might recall, we can never have a book value dips below the salvage value or book value can never go below that salvage value of $20 thousand no matter what method we use. So if we use 40% here, Let's see what happens. 40% equals 10,368. Now here's the problem. If we use the depreciation of 10,368 and we add it to our depreciation. We see our book value is going to be the 120 thousand minus the accumulated depreciation. It goes below the 20 thousand and that can't happen. So instead of using 40%, we're going to have to cut our depreciation expense off. And where we need to get it to where our book value just ends at 20 thousand and doesn't dip below it. We can only take 5,920. So if we take that, what we plus the 9094000000, we have 100 thousand as our accumulated depreciation. Our book value at the end of the year ends up being 20 thousand. So a couple of things to note. First of all, you'll notice that we only did four out of five years. And that's something that you'll commonly see with the declining balance method. Another thing you should notice is that you take a lot of depreciation in the beginning and much less at the end. So that's an overview of the declining balance method. There are some other things that we need to talk about related to it. Maybe a few more examples and then we'll also look at the other methods and future lessons. 9. Declining Balance Method: Partial Year: Welcome back to the depreciation course and we're going to continue on with the declining balance method that we've already been discussing. However, now we're going to look at how we go about calculating if we were to acquire the asset in the middle of the period, in the middle of the year, for example. And therefore need to only depreciate the asset partially for that first year. We're going to use the same example, except for the date of purchase. So we're going to use the same numbers that we did before, only instead of January 1st as the date of purchase, we're going to use May 16th. Okay. So let's go ahead and start this by looking at where we left off with our last example. In our last example, as you recall, we purchased the asset on January 1st. We took the beginning book value of the asset, which is the cost of the asset minus the depreciation that's accumulated times the depreciation rate. And we've got the rate by taking one divided by the useful life, one divided by five, which is 20% and doubling it. We went through that and a lot more detail in our last example. And so every year we just took whatever the book value was, the beginning of that year and multiply it by the depreciation rate until we get to the last year. Now when you get to the last year, you can't take a full 40%. And the reason is because we can only depreciate down to the salvage value and taking a full 40% would have been too much. Now, we're going to look at an example where we purchased the asset in the middle of the year. We're going to use May 16th as our date. So when we do May 16th, we're going to use what's called the nearest whole month convention. And the nearest whole month convention, what you do is if you buy an asset between the first and the 15th, you treat the asset is being purchased at the beginning of the month. After the 15th, you treat it as if it was purchased the next month. So in the 16th, we're going to treat it as if it was purchased in June. June is the six-month let's look at a breakdown of the months as we count them down. We see that June is the six month starting with January, we get down to June as the sixth month is to treat it as if it was purchased the beginning of June. We're going to depreciate the entire month of June down to December, and that means we have seven months of depreciation. So now we see that instead of having the asset for 1212 months, we're only going to have the asset for 712 months. That means we're going to have a partial year for that first year and every year after that will be treated as it was before. In other words, we'll just take whatever the book value is. So that means seven out of 12. So we're going to multiply 48 thousand times seven out of 12 months. So when we multiply 48 thousand times seven-twelfths, we get 28 thousand. And so now our book value is gonna be higher. But then our book value of the next year is used as the starting point. And we just take 40%. We don't have to worry about taking the partial year from that point on. When we get to the final year. And we can't take the full 40%. Because if we did that, we would end up depreciating it down below 20 thousand. So the most we can take is 13,120, and that gets us down to $20 thousand as our final book value. Using this method, we're able to depreciate assets that are purchased in the middle of the year, which is probably what happens most of the time. Notice it's very similar to what we did last time in a sense that we just took whatever the book value was, the beginning of the year and multiply by 40%. And notice that the end, we had the same kind of situation where we did not need to take an entire 40% and we ended up depreciating it down to book value before the end of the useful life, which is very common, something we see often with the declining balance method. So now that we've got the declining balance method down, we're going to move on to other methods that we need to look at. 10. Sum-of-the-years Digit Method: Welcome back to our depreciation course. And just to let you know, the declining balance method is not the only option. If you want to do another method for an accelerated depreciation, you can use the sum of the years digits. That's what we're going to focus on in this lesson. Ultimately will cover four different methods. We're now on the third of four methods, will cover the last method, a future lecture. For this example, we're going to use the same information to depreciate the equipment that we used in previous lessons. The cost of the equipment being a 120 thousand, the salvage value being 20 thousand, and the useful life being estimated at five years. The cost of the equipment is obviously what was paid for the equipment and the cost to get it available and ready for its intended use. The salvage value being what management estimates the equipment will be worth at the end of its useful life. The useful life being an estimate of how long management thinks will use the equipment in our business. Let's start to learn how to do this calculation and depreciation by using a spreadsheet. So we'll start by putting the information in that we already are familiar with. We know that the cost is a 120 thousand and we know the salvage value is 20 thousand and the estimated useful life is five years. The date acquired, we're gonna put it at January first of 2020. By doing a full years of depreciation, it makes it a lot simpler for us to learn. One thing we need to figure out is what it means by the sum of the year's digits. So let's go ahead and look at how we would go about getting that calculation. To figure out how we calculate the sum of your digits, we'll use ten as a starting place. So some of the year's digits, we just take every year and we add up that number for the total number of years that we expect to have for the useful life. So in this case we have ten years, So we do one plus two plus three plus four plus five plus six plus seven plus eight plus nine plus ten. When we add those up, we get 55. Now in our example we only had five years. So when you use five years, you see that adding up one plus two plus three plus four plus five equals 15, That's gonna be the sum of your digits. So going back to our spreadsheet, I went ahead and put the sum of the year's digits as 15. And I input the years 20232024 because it's five-years estimated useful life. Next thing I did was I went ahead and put the years remaining. So we start out with five years remaining, 4321. And then now we need to look at the depreciable base. So the depreciation base is going to be the cost minus the salvage value, or 120 thousand minus 20 thousand. We see that depreciable base is the same amount every year. We're gonna do is we're gonna multiply that by the fraction that we develop using the sum of the year's digits. So every year we take the 100 thousand and we multiply it by the number of years remaining divided by the sum of the year's digits. So the first year is five fifteenths seconds, 432115. And then what we get from that application is our depreciation expense for that year. So for the first year we have a 100 thousand times five fifteenths and we get 33,333. The next year, a 100 thousand times four fifteenths, we get $26,667. And we see each year we're going to do the same thing, use the same depreciation base, multiply it by a fraction, that fraction gets smaller every year. For that reason, some of the fifth digit is another version of an accelerated depreciation method, meaning you get more depreciation expense in the early years and less than later years. When we look at the accumulated depreciation, we see that is calculated the same way as in the past. You just take whatever the accumulated depreciation is and then you add future years depreciation expense. Now we're going to depreciate it all the way down to the salvage value. So as you notice, the accumulated depreciation can only go up to 100 thousand. When you have accumulate depreciation of 100 thousand, that means your final book value that you're going to have is going to be 20 thousand. So we're not put the book value and we can see how it, after the first year depreciation, the book value continues to be reduced by the total of the accumulated depreciation until it gets all the way down to 20 thousand. I've said it before. We can never depreciate beyond the salvage value, so it can never go below 20 thousand. So what we've seen in this lesson is that some of the year's digits is another form of accelerated depreciation. We also see that the depreciation cannot again go below the book value being the salvage value. And we used an example where we did a full year of depreciation. So what we need to do is look at another example where we do just a partial year depreciation. 11. SYD method for Partial Year: So we just went through an example where we implemented the sum of the year's digits depreciation method for an entire year, meaning we purchased the asset on January one. However, often, that's not the case. So in this lesson, we're going to consider how we would go about using some of the year's digits and a partial year situation. We're going to use the same information as we use for the previous example. Meaning the cost of the equipment is still a 120 thousand. Salvage value is 20 thousand, useful life is five years, and the purchase date is now going to be May 16th, 2020. Let's begin by just looking at what it looks like when we do a sum of the year's digits calculation for an entire year, we see that since the date acquired was January 1st, we take the depreciation base times the fraction. We talked about how to derive that fraction and the previous lesson, how will this change if we change the date acquired from January first to May 16th? Remember, we're going to use the mid month convention. We've talked about this before. It's basically just says, if you purchase the asset anywhere from the beginning of the month to the 15th, you treat it as if the entire month. So if we bought this anywhere from May 1st to May 15th, we will just treat this as if it was purchased on May 1st. In this case, we bought it on the 16th. So we treat it as if it was purchased the next month. We're going to treat it as if it was purchased June. That's the sixth month, seven months remaining in the year. So if we look at how we're going to allocate that amount between the different years. If we're in the mid month well, and 2020, we have seven months remaining, June through December, seven months. So 33,333 times seven-twelfths is going to give us how much depreciation will take and the year 2020. However, the rest of that, 33,333, it needs to go into 2021. So you'll notice that we're going to multiply that 33,333 times five-twelfths. Then we have the next year's depreciation expense of 26,667, and we'll begin that in 20217 months remaining in that year. So you notice in 2021 we have a full year of depreciation. Some of it coming from the 33,333, some of it coming from the 26,667. So each year 2021 through 2024, we have full years of depreciation. The depreciation expense carries over into two different years. When we get to the last year, 20 Twenty-five, we only have five twelfths of the month. We covered seven-twelfths of the 40032000024. That means five-twelfths spills over into 2025. Looking at our calculation, we now see that if we take the 33,333 in 2020 times seven-twelfths, we get the depreciation expense for that year. Now in the next year, that 33,333 only has five-twelfths of a year left. And then the 26,667 can begin. This calculation is carried through 2021 through 2024. And then in 2025, we just have five-twelfths of that 6,667 left to get us through five full years. Ultimately, we can see there are book value ends up being $20 thousand. Our accumulated depreciation still is only a 100 thousand. Nothing has changed at the end as far as the total amounts. It's just that the amount that was taken as depreciation expense in each year has shifted because we didn't buy it at the beginning of the year. We bought the asset in the middle of the year. So now we've seen the sum of the year digit calculation for a full year if we were to purchase an asset on January 1st. And we've also seen how we would accomplish middle of the year purchase of an asset. Now it can move on and look at another depreciation method that we can utilize. 12. Activity method: Another option in depreciation methods is a little bit different from the other methods we can use in. This one is known as the activity method. Let's go ahead and look at how that is utilized. As we stated earlier, there are four basic methods that management has to choose from. Activity method is gonna be the last of the board that we discussed. Basically, the activity method is how much an asset is going to be used. Not based on the amount of time we're using the asset, but how much activity that asset will be used for. So say for example, we buy a new delivery van and we're going to use it for 200 thousand miles. Then we're going to see how many miles we use that van each year and then use that as the basis for depreciation. Let's say we have a shrimper who buys a new motor for the boat. How many hours did that shrimp or use that motor out of the total number of hours, he thinks he's going to use it over its useful life. It's also called the units of production method. The equipment might be for making barrels of oil and we see how many barrels of oil we make each year. Or two, cut boards out of rough cut lumber or produce Kansas soda or t-shirts that we wanted to print, whatever the product may be. We're just going to look at the equipment and then how much we use it as opposed to the amount of time that we used it. So the way we're gonna do this is by first calculating the depreciation rate. So the depreciable cost is just the cost minus the salvage value. Then divide that by how much estimated usage will have out of the life of the asset, then we'll figure out the depreciation expense for the year by taking that rate that we calculated above and multiplying it by the actual usage of the acid that year. So in our example, we have equipment that costs a 120 thousand. Salvage value is 20 thousand, and we think we're going to use this machine for 10 thousand hours. So to do the calculation, we just take the 120 thousand minus 20 thousand divided by 10 thousand machine hours, we get $10 per machine hour. So every time we use the machine, for every hour we use a machine. We have $10 of depreciation. So for example, let's say in the first year we use the machine, only 500 machine hours. We calculated the rate at $10 per machine hour. So that means $10 per machine hour times 500 machine hours. And that first-year, what we'll do is have $5 thousand in depreciation. If we use it more or less than the next year, we'll have more or less depreciation. We're not going to base the depreciation on the amount of time, usually equipment, but the amount of activity with which we use that equipment. Let's look further at this using our Excel spreadsheet on this problem. So let's go ahead and start with putting the information into the top portion of our spreadsheet. So in our first year, we used the machine 500 hours. We need to calculate the depreciation rate, which we did earlier. And what we did was we took the cost minus the salvage value, 120 thousand minus 20 thousand equals a 100 thousand and divide it by the estimated usage, which was 10 thousand machine hours. That gives us an amount of $10 of depreciation per machine hour, 500 machine hours in the first year times $10 is our rate, means that we're going to have depreciation in the first year, One thousand dollars. Accumulated depreciation is calculated by just taking how much depreciation we've had over the life of the equipment. So the next year we used equipment less than 2021, we only used 400 hours. We then multiply that by the rate of $10 and we get a depreciation expense of 4 thousand. Accumulated depreciation is now 9 thousand because we added last year and this year's depreciation expense. The total usage is going to be tallied up because we can never go above the 10 thousand, which is our estimated maximum amount of usage. We see in 2022 that we are now using that equipment little bit more. Maybe our production is getting bigger and so we now use One machine hours times $10. We have more depreciation expense in 2022 because we used it more in 2023, we've really ramped up production. We used 8 thousand machine hours. That's the most we've ever used. So now we're going to have the most depreciation expense that we ever had because it's the most usage we've ever had in 2024. Let's say we use the equipment for, let's say, 500 machine hours. But notice our annual usage is stopped at 100 and that's because we can't use more than the estimated usage that we set up in the beginning of 10 thousand. In other words, we fully depreciate this asset and it looks like five years based on how much activity we use the machine for. If we continue to use the machine, that's fine. But it's been fully depreciated so we can no longer take any more depreciation on this machine. So the activity method is all about usage. Not really about how much time we've had the machine, but how much we use it in the time that we had it. We won't run into any problems such as mid-year partial depreciation because that's not really relevant. It's just relevant as to how much activity we use the machine for, rather than how much time we've had the machine. 13. Comparison: Welcome back to the course. In this lesson, what we're going to do is look at the various methods that we've already gone over and do a comparison on some graphs too. So you can kind of get an idea of how they differ from each other and the implications of using one versus another one. There were four options that we spoke about and how to calculate each of these. These are the methods that management has to choose from when deciding on which depreciation they want to use. There's the straight line declining balance method, some of the ear digit method, and the activity method, we're comparing these methods, which we'll see is that one of the methods, the straight line method, will have the same amount of depreciation every period. This method is known for being the simplest to calculate and the simplest to implement. There are other methods that offer accelerated depreciation, meaning they can take more depreciation in the early years than in later years. Oftentimes when we buy new equipment or new asset, we tend to use it more when it's new. These two methods include the declining balance method and the sum of the year digit method. They live with more complicated to calculate final method that we talked about. What's the activity method? Now, this method was based on how much we use the asset had nothing to do with the amount of time, but how much we use it. So in years where we use the asset more, Let's say we had a delivery truck and we drove it more. In early years. We would take more depreciation because we drove it more in years where we drove it last week would take less depreciation no matter what method we choose though. In the end, they all equal the same amount of accumulated depreciation. It's just really about the timing of how we spread that depreciation expense over the life of the asset. Ultimately, they all get to the same accumulated depreciation. 14. More Declining Balance Method Considerations: Come back to our course. In this lesson, we are going to go into an advanced topic where we do an adjustment to the declining balance method to see how that might be able to meet some of the needs of management when they're looking at calculating depreciation. Let's look at how this would work. So looking at an example of using the declining balance method in a spreadsheet, I have the entire calculation presented. However, we're going to walk through each little piece bit by bit so we understand what's going on here. As you can tell, it is more complicated than the declining balance method. But you'll also notice that the final accumulated depreciation gets us to an exactly 80 thousand, which is the cost minus the salvage value, and that's exactly what you want. It also does it end the ten years that we want happen? We also show that we can do a partial year calculation if we acquire the asset and the middle of the period in the middle of the year. So starting with we acquire the asset July first 2010, and the cost is 83 thousand, salvage value of 3 thousand. That means the depreciable value is 80 thousand. That's what we want our total accumulated depreciation to be for this asset. In the long run, we're gonna do the double declining balance method. So that's why the declining balance of multipliers to that's the most common. So looking at the declining balance method by itself, what you'll notice is that the first year we took one divided by ten, which is 10% times two. So that's, that's how the declining balance method works. We multiply that by the book value. Well, beginning of the year, the book value is just the cost because we haven't done any depreciation. And so we get the depreciation expense. It would have been 20% of a 3 thousand, which is 16,600. However, because it was purchased July 1st, we're only going to take half a year's depreciation. That gives us 8300. The first year we calculate a 300 far depreciation expense. And then from then on, we are going to take the beginning book value and we're going to multiply it by that 20%. The problem with the declining balance method is at the end of ten years, we don't usually get to that 80 thousand as our final accumulated depreciation, you can see we only get to 72,974. So that means we would have had to do adjustments. Usually what we have to deal with declining balance method is either take a little bit more or a little bit less depreciation in that last year, or sometimes depreciate for a couple of more years or couple fewer years to get the depreciation to work out. You're kinda making it fit the straight line test as a way to fix that. So what we wanna do is we want to figure out the straight line depreciation for the assets current book value. In other words, what would the assets depreciation beef if we started doing a straight-line depreciation from that point on. So what you see is every year, we'll take the beginning book value and we'll subtract from the salvage value. And we'll divide by how many years are left. So in the first year we have ten years left, so we divide by 10. Second year we have nine, we divide by nine. So we get a different straight line amount every year. If you recall, the straight-line depreciation method usually has the same amount of depreciation every year, but we're not doing the straight line depreciation method. We're doing the straight line test. Straight line test says, if we did a straight line from this point forward, what would the depreciation expense b. So then we do the switch test. So the switch test says, compare the straight line amount that we would have to the depreciation expense from the double-declining or from the declining balance method and see which one's higher. And if the declining balance method is higher than depreciation from that will be used. When we get to the year 2016, we noticed that the straight line amount is more than the depreciation expense if we had done the declining balance method. So we use that amount, it turns out to be $5,369. Once we start using that amount, we're going to continue to use it from that point forward. When we do that, as you'll notice, it gets down to 80 thousand final accumulated depreciation. The depreciation that we show on the left where we have the double-declining balance method. It's not really our final depreciation expense because we haven't compared it to the straight line method yet. Once we do that, we can see if it is higher than we're going to continue to use the depreciation expense from the declining balance method. Or we might switch over and start using the straight line amount. Once that occurs, then we just continue using the same amount. So that's how we get to the 80 thousand with our final accumulated depreciation. And we have our declining balance method work out for us in the sense that we were able to accomplish depreciation and the useful life of ten years. And we ended up with the amount that we wanted to for our final book value. That final book value would be the $3 thousand because we have 83 thousand cost minus 8 thousand accumulate depreciation gives us a $3 thousand book value at the end. That equals the salvage value. That's where we wanna be. 15. Conclusion: Thank you for joining me on this journey to learn to calculate and apply depreciation and accounting. I've thoroughly enjoyed developing this course for you. I only hope is as useful for you as I hope. In our journey, we discussed which assets are depreciated. We discussed the various methods most often used to calculate depreciation. We discussed the impact of depreciation on the financial statements. These lessons were then explained using the examples in presented to you using Excel, which is the most powerful spreadsheet use in business today. Finally, we have a project that you will use to apply all of your knowledge using Excel templates and using example assets. Whatever your journey in business, I wish the best for you. Please remember to provide feedback and comments. I would love to hear from you.