 Hello, and welcome to this session. This is Professor Farhad. In this session, we would look at partial year depreciation. This session implies that you understand what depreciation is. If not, please look in this playlist to find out what is depreciation is about. This topic is covered in an introductory accounting course also on the CPA exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is what you need to subscribe. I have 1600 plus accounting, auditing, finance and tax lecture. This is a list of all the courses that I cover, including a lot of CPA questions. If you like my lectures, please click on the like button, share them, put them in playlists, subscribe if you haven't subscribed yet, and please connect with me on Instagram. If my lectures help you, it means they might help others. So please share the wealth. Also, if you're looking for supplementary material, you could visit my website, farhadlectures.com for additional supplementary material, especially if you're studying for your CPA exam. Now, on the prior session, we looked at the three depreciation method that we use, which is the straight line units of production and the double declining balance. Now, the only partial year I'm going to illustrate is the straight line, whatever applies to the straight line applies to the other two methods as well. So the rules are the same. And if you remember, we looked at an asset with the cost of 10,000, salvage value of 1,000, depreciable cost of 9,000, a five-year asset with 36,000 inspectors choose. And let me go ahead and review the straight line method under the straight line method to compute depreciation will take cost minus salvage value divided by useful life if we're looking for a full year of depreciation. And the amount will be 1,800 debit depreciation expense credit accumulated depreciation. So this is what we did in the prior session basically showed you how to compute depreciation on a straight line basis units of production and the double declining balance. In this session, I'm going to be looking at the partial year depreciation. So what is the concept, what's the idea of a partial year depreciation in the prior example or in the prior session. Although I did not tell you this, we assumed that we bought the asset. January 1st. Okay, now let me tell you something. Most businesses are closed January 1st. So no one buys their asset January 1st companies by their asset throughout the year. And also, it's not only they buy their asset, they sell their asset throughout the year. What does that mean? It means in the year that we purchase the asset and in the year that we sell the asset, we can only take a partial depreciation. So when a plant asset is purchased or sold, when a plant asset is purchased or sold during the year, depreciation is calculated for the fraction of the year the asset is owned. So we cannot take depreciation for the full year. We have only take the depreciation for the amount that we own the asset. So the best way to illustrate this, this is the idea behind it is to look at an example. Let's go back and look at the same numbers that we were working with an asset with a cost of 10,000 salvage value of 1000. The only difference here is we're going to buy the asset on a different date. So we're going to buy the asset October 1st 2018. So if you're saying October 1st, if this is a full year, October 1st someplace here. So you're going to take the depreciation for October, November and December. So you're going to take the depreciation for October, November, and December, December. So you're going to take the depreciation for for only three months. So the question is, how do you compute the depreciation expense for 2018? Well, it's going to be a partial year depreciation. It's going to be very similar to the full year, but we have to prorate the amount. So let's take a look at how we do the computation. First, we do the computation for the full year, assuming we're using the straight line, the cost minus the salvage divided by five years. Then we'll take this amount and multiply it. If you remember, this amount was 1800. We multiply it by the fraction of the year that we own the asset. And we own the asset for 312 of a year. We own the asset for year one, October, November and December. Therefore, multiplied by 312, and the entry is debit depreciation expense for 50 credit accumulated depreciation expense for 50 for the year of 2018. So this is what we have to do. Also, when do we have to deal with partial year depreciation or change or we have to deal with this formula is when we have a change in estimate. Okay. So remember, depreciation itself is an estimate. What do I mean by this? When we book depreciation, we estimate the life of the asset. We estimate the salvage value. Now, the cost should not be an estimate. The cost should be an actual number, an objective number. So we estimate the salvage value. We estimate also the useful life. Those two are estimate, predicted or estimate. So what happened is over the life of the asset, new information might surface and as that new information surfaces, you know, in the light of this new information, we might have to change either the salvage value or the useful life. We might have bought an asset and initially we thought it's going to serve us eight years. Then what we find out this asset could last 10 years, or this asset could last only five years. Or when we bought this asset, we thought the salvage value will be 1000. Now we find out the salvage value is higher or the salvage value is zero. So both of these figures are estimate. So what do we have to do when we haven't changed an estimate, we have to change our computation of the depreciation. So how do we come? What do we do? Well, the good thing is we don't have to go back and change any prior period. So a change in estimate for the appreciation is called, you don't have to know this for financial accounting, it's called a prospective change. It means you don't have to go back and change anything in the past. It's not retrospective. It's a prospective. And the best way to illustrate this is to actually work an example. So let's take a look at this example where the machinery from the previous example, which is 10,000 cost, assuming we have already 3,600 of accumulated depreciation. It means when we make the change to anything, the book value was 6,400, the cost minus accumulated depreciation. At that time, it's determined that the machinery will have remaining useful life of four years. Well, let's, well, four years, they have a remaining life of four years. Really, what does that mean? Remember, we were depreciating the asset for 1,800. So we already depreciated the asset 1,800 plus 1,800 is 3,600. So after two years, remember, the asset has a cost of five years initially. Okay, two years later, it should have had only three years left, but we find out now we should add a year. So we extended the life of the asset and the estimated salvage value used to be 1,000. Now we can only get 4,400. So how do we compute the new depreciation? Remember, the new depreciation was 1,800 per year. Okay, which I showed you at the beginning right here, right here. The full year depreciation is 1,800. Now we change the life and we change the salvage value. So we increase the life by 1,000 and we reduce the salvage value. What we do is this. The book value of the asset becomes the new asset. So we just basically treat this as a new asset. We have a new asset with a book value of 6,400 minus the new salvage value divided by the new life. So 6,400 is the book value. This is the new asset. So basically once we revise the life or the salvage value or both, we have basically a new asset. And this new asset has a book value of 6,400. Then we deduct the new salvage value. We deduct the new life and our depreciation expense becomes 1,500. So basically a change in estimate is treated prospectively. We don't have to go back to the prior year and change the 1,800. That's gone. That's basically done. That's basically done. One more minor topic we're going to talk about here. Again, it's covered much, much more in details in intermediate accounting as a permanent decline in the fair value of an asset. So when we have an asset impairment, what is an asset impairment? You bought an asset. And for one reason or another for change in technology, change in regulatory environment, something happened, something happened and the asset that you bought. So let's just work with a computer. That's a simple example. You bought a computer and you paid $3,000 for it. Six months later, technology advanced very quickly and the computer that you bought, now it's worth $1,000. Just you thought when you paid for it, you paid $3,000. I'm sorry, you made a mistake. There was a permanent decrease in its utility. Why? Because another company manufactured a better, faster, more efficient computer. So your computer is worthless. This is called asset impairment. It's a permanent decline. And basically put your computer went down in value and it's never going to recover because it's not worth that much anymore. So what you have to do, you have to write down the asset, bring down the asset. So if you bought an asset and initially it has a $500 market value and now it's $750, it went down by $50. So what you have to do is you have to journalize an impairment. Now again, if you want to learn a little bit more about this topic, go to my intermediate accounting because this is basically an intermediate accounting topic rather than financial accounting. So what you have to do is you have to debit impairment loss. You have to book a loss of $50, the difference between the book value and the fair market value. Sorry, we said this is the book value and now it's worth the fair market value. The rules are a little bit more specific, but for financial accounting students, you just have to know that the difference that the value went down of $50, you debit the loss and you credit accumulated depreciation. Basically, you lost $50 of value that you cannot recover from that asset. And this is basically what I'm going to cover in this session. Please, if you like this recording, click on the like button, share it, put it in playlist. And don't forget to visit my website for additional resources, whether you are an accounting students or a CPA candidate looking to supplement to get that extra seven to 10 points on your exam to pass the CPA exam and move on with your life. Study hard. Good luck and please stay safe. In the next session, we would look at revenue versus capital expenditure. Stay safe.