Principles of Financial Accounting: Plant Assets and Intangibles - Revision of Depreciation Estimates

Revision of Depreciation Estimates

Revision of depreciation estimates is a process in financial accounting where a company updates its depreciation method or rate to reflect changes in the asset's useful life, salvage value, or other factors that affect its depreciation. This is important because it ensures that the company's financial statements accurately reflect the asset's value and the expenses associated with its use. For example, if a company buys a piece of equipment for $50,000 with a useful life of 5 years and a salvage value of $10,000, and it decides to revise the useful life to 7 years, it will need to update its depreciation method to reflect the change.

Key Concepts & Formulas

• Depreciation Method: A method used to calculate the depreciation of an asset, such as straight-line, units-of-production, or double-declining balance.
  • Example: A company uses the straight-line method to depreciate an asset with a useful life of 5 years. The annual depreciation expense would be $10,000 ($50,000 / 5 years).
• Useful Life: The estimated number of years an asset will be used by the company.
  • Example: A company estimates that a piece of equipment will have a useful life of 7 years, which is longer than the original estimate of 5 years.
• Salvage Value: The estimated value of an asset at the end of its useful life.
  • Example: A company estimates that a piece of equipment will have a salvage value of $20,000, which is higher than the original estimate of $10,000.
• Depreciation Rate: The rate at which an asset is depreciated, calculated as the annual depreciation expense divided by the asset's cost.
  • Example: A company calculates a depreciation rate of 20% per year for an asset with a cost of $50,000.
• Accumulated Depreciation: The total amount of depreciation expense recorded by a company over the life of an asset.
  • Example: A company records $20,000 in accumulated depreciation for an asset with a cost of $50,000 and a useful life of 5 years.
• Asset Revaluation: The process of updating the carrying value of an asset to reflect changes in its market value.
  • Example: A company revalues an asset from $50,000 to $60,000, resulting in a gain of $10,000.

Journal Entry Examples

1. Revision of Depreciation Method

Dr. Depreciation Expense $5,000 Cr. Accumulated Depreciation $5,000

Explanation: The company is revising its depreciation method to reflect a change in the useful life of the asset. The depreciation expense is increased by $5,000 to reflect the additional depreciation over the revised useful life.

1. Revision of Useful Life

Dr. Depreciation Expense $5,000 Cr. Accumulated Depreciation $5,000

Explanation: The company is revising its useful life estimate for the asset, resulting in an increase in the depreciation expense. The accumulated depreciation account is credited to reflect the additional depreciation over the revised useful life.

Common Mistakes

1. Mistake: Failing to update the depreciation method or rate when revising the useful life or salvage value of an asset.
   • Correction: Always update the depreciation method or rate to reflect changes in the asset's useful life or salvage value.
2. Mistake: Confusing the depreciation expense with the accumulated depreciation account.
   • Correction: Remember that the depreciation expense is recorded as a debit to expense, while the accumulated depreciation account is credited to reflect the total depreciation expense over the life of the asset.
3. Mistake: Failing to revalue an asset when its market value changes.
   • Correction: Always revalue an asset when its market value changes to reflect the change in its carrying value.

Exam Tips

1. Tip: Remember that a revision of depreciation estimates requires an update to the depreciation method or rate to reflect changes in the asset's useful life or salvage value.
2. Tip: Be careful when revising the useful life or salvage value of an asset, as this can result in a change in the depreciation expense.
3. Tip: Always revalue an asset when its market value changes to reflect the change in its carrying value.

Quick Practice

1. A company revises its depreciation method to reflect a change in the useful life of an asset. The new depreciation rate is 15% per year. What is the adjusting entry for the first year?

Dr. Depreciation Expense $7,500 Cr. Accumulated Depreciation $7,500

Explanation: The company is revising its depreciation method to reflect a change in the useful life of the asset. The depreciation expense is increased by $7,500 to reflect the additional depreciation over the revised useful life.

1. A company revises its useful life estimate for an asset from 5 years to 7 years. The asset has a cost of $50,000 and a salvage value of $10,000. What is the adjusting entry for the first year?

Dr. Depreciation Expense $5,000 Cr. Accumulated Depreciation $5,000

Explanation: The company is revising its useful life estimate for the asset, resulting in an increase in the depreciation expense. The accumulated depreciation account is credited to reflect the additional depreciation over the revised useful life.

Last-Minute Cram Sheet

1. Depreciation expense is recorded as a debit to expense.
2. Accumulated depreciation is credited to reflect the total depreciation expense over the life of the asset.
3. Revision of depreciation estimates requires an update to the depreciation method or rate to reflect changes in the asset's useful life or salvage value.
4. Asset revaluation is the process of updating the carrying value of an asset to reflect changes in its market value.
5. Dividends are NOT an expense – they go directly to retained earnings.
6. The straight-line method of depreciation is calculated as annual depreciation expense = (cost – salvage value) / useful life.
7. The units-of-production method of depreciation is calculated as annual depreciation expense = (cost – salvage value) / total units produced.
8. The double-declining balance method of depreciation is calculated as annual depreciation expense = 2 x (cost – accumulated depreciation) / useful life.
9. Depreciation expense is not the same as accumulated depreciation.
10. Revision of depreciation estimates requires an update to the depreciation method or rate to reflect changes in the asset's useful life or salvage value.