 Hello and welcome to the session in which we would look at depreciation revision. What is the big idea? The big idea is can you revise your depreciation? Can you do it? Can you use go from the straight line to the double declining method that the sums of years digit? And the answer is yes. How about can you change the estimated useful life of the asset? Yes. Can you change the residual value of the asset? Yes. Methods, life and residual value are estimates, are estimate figures that are inherent part of the accounting process. In accounting, we estimate many things. We estimate that expense, we estimate warranty, we estimate losses. That's a part of accounting. So the good news about depreciation revision is it's handled prospectively. And what does it mean it's handled prospectively? So if we do change from the straight line to the double declining method, we don't have to go back and change the prior year. We just we treat this prospectively. Prospectively means this period. So we're going to change this period and future period. Retrospectively, if it says retro, it means we have to go back to prior period, which is more challenging. So simply put, what you need to know is depreciation changes or depreciation revisions are handled prospectively. So no changes to previous period. And this is easy. This is simple versus going back and changing prior period. The best way to illustrate this concept is to actually work an example. Before work an example, I would like to remind you that this topic is covered in intermediate accounting as well as the CPA exam. Whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website farhatlectures.com. I don't replace your CPA review course. I'm a useful addition to your CPA review course. I can help you understand the material better. I can go slower. I teach you the theory behind the concept. By doing so, I can add 10 to 15 points to your CPA exam score. 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So let's take a look at an example to illustrate this concept. Adam Company purchased a machine for $1 million in $20,000, which was estimated to have a useful life of 10 years with the residual value of $20,000. Depreciation has been recorded for seven years on a straight line basis. In year eight, Adam determined that the total estimated life should be 15 years and the residual value is 10. So basically what we did is we extended the life of the asset and we reduce its residual value. So let's take a look what happened for the first seven years. For the first seven years, we had a machine, a piece of equipment, for $1 million and $20,000. We deduct the salvage value. We come up to the depreciable base of a million. We divide the million by 10. We're going to have $100,000 of annual depreciation. Therefore, we took this depreciation over a seven-year period by debiting depreciation expense $100,000, credited accumulated depreciation for $100,000. In total, we depreciated the asset $700,000. Now, starting in year eight, we revised the depreciation. So this is what the piece of equipment looks like. This is what the machine looks like, or piece of equipment at year seven, the balance sheet year seven. We have the machine $1 million and $20,000 minus accumulated depreciation. We have a net book value of $320,000. Now, what do we do with the new depreciation numbers? Well, we're going to look at the new asset, the new book value as the new asset minus the new salvage value gives us the new depreciable base. Now, we are depreciating an asset that has a depreciable base of $310,000 over the remaining eight years because we have year eight, nine, 10 remaining from the old life, $810,000 plus the new five years. So we have eight years remaining with the new life. If we divide $310,000 over eight years, now we have a depreciation amount of $38,750. Now, we're going to be debiting depreciation expense $38,750 in crediting depreciation expense $38,750. So this is the new depreciation amount. So notice what happened. Our depreciation amount went from $100,000, our depreciation expense, we cut it in more than half. By extending the life of the asset and reducing its residual value, what we did actually reducing the residual value did not help. Really, what really helped is extending the life of the asset reduced our depreciation expense. Now, is this allowed? And the answer as long as it's reasonable, what you are doing is reasonable. There's a business sense. You have a justification to do it. That's fine. However, if you do this to cook the books like what waste management did, the company waste management, hopefully you all heard of this company waste management. When management announced it was it has the largest three statement in history when they admitted to cooking the books and they cook the books by doing shenanigans like this for $1.7 billion. And what if they did is they made unsupported changes in depreciation estimate. So what waste management did to increase their profit, what they did is they reduced their depreciation expense. And how did they reduce their depreciation expense? They started to extend the life of their asset, of their trucks, of their vehicles, of their equipment, and they started to inflate the residual value. Here we reduced our residual value. They started to inflate residual value by doing so they reduced their expenses. And in turn, they increased their profit. So this is one of the main things they did is they played with depreciation. So again, depreciation is allowed, depreciation revision is allowed as long as it's supported. It's reasonable. It's not done to cook the books. The best way to learn depreciation, depreciation revision is now to go to my website and work some multiple choice questions. That's the best way to learn it. At the end of this recording, I'm going to remind you again to take a look at my website farhatlectures.com. I don't replace your CPA review course. Once again, I don't do that. Keep it. I work along your CPA review course. I'm going to help you do better by understanding the material better. You will do better on your review course, which in turn you will do better on the exam itself. The CPA exam is a one is a lifetime investment. Don't shortchange yourself. Give it a try for one month. If it's helping you, it's helping you with your accounting courses. You keep it. If it's not, you cancel. That's your maximum loss. Your potential gain is passing. The CPA exam is worth it. Study hard. Good luck. And of course, stay safe.