 Hello and welcome to this session in which we would look at an example that deals with depreciation expense. Since I mentioned an example, it means somehow in the prior session or sessions we explained the topic. Indeed in the prior session we looked at the different depreciation method which are the straight line, the activity method, sums of year's digit and the double declining balance. So you have to have a good understanding of this method before you work this example. Now what is special about this example or what's unique about this example? What is special about this example is the fact that Tesla, the company that purchased the asset, purchased the asset on September 1st, year one. So when I illustrate the concept of depreciation method I kept everything simple and we assumed that we purchased the asset January 1st. That's not really true in the real world. Companies buy asset at different time during the year. Therefore, as an accounting student or a CPA candidate you need to be familiar with buying asset throughout the year and how much depreciation to book. So in this example we would assume the asset was purchased on September 1st. 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 am a useful addition to your CPA review course. I'm a useful addition to your classroom, to your accounting courses. I explain the material differently. I go a little bit slower than your typical CPA review course. I give you more example, more resources to help you understand the material. Your risk is one month of subscription. Your potential gain is actually passing the exam. And if not for anything take a look at my website to find out how well or not well your university doing on the CPA exam. This is my course catalogue, my accounting course catalogue. I have taxation, governmental accounting, intermediate, managerial, audit, so on and so forth. My resources will include lectures, multiple choice practice questions. My CPA supplemental resources are aligned with your Becker, Roger, Gleam and Wiley. Therefore, you can go easily back and forth between my material and your CPA review course. I also give you access to 1500 plus a previously released AI CPA questions with detailed solution. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other, connect with me on Instagram, Facebook, Twitter and Reddit. So let's start to work with this example. Tesla purchased a new robot for its manufacturing process on September 1st. The cost of this machine was 300,000. Now on the CPA exam or on the actual exam in the classroom, they're not going to highlight the date. They're not going to underline or bold September 1st. You have to be careful. When was the machine purchase? The salvage value was 48,000. Tesla estimated the life of the robot to be five years and its production capacity are estimated to be at 42,000 units. So we have the cost, we have the salvage value, we have the production capacity and we have the life. We have everything that you need to start the book, the depreciation, starting with the straight line method, the most straightforward, easy, most commonly used for financial accounting and reporting. The way we compute the straight line method is we take the cost 300,000 minus the salvage value. Remember, this is called the depreciable base and we'll divide the depreciable base by the life and the depreciation per year is 50,400. True. However, remember, this asset was purchased on September 1st. What does that mean? It means for the first year we compute the full depreciation, then we multiply it by September, October, November and December, which is 4 out of 12 months. As a result, for the first year, we are only going to take depreciation of 16,500. Let's book the depreciation entry. We're going to have a depreciation expense 16,500 credit accumulated depreciation 16,500 and our accumulated depreciation now is 16,800. For year two, we're going to have the asset for the full year. The reason why we only had 16,800 for year one, it's because think about it from a graphical perspective. If this was year one, we purchased the asset in September. Well, if we purchase the asset in September, it means we're only going to take the depreciation for the four month, September, October, November and December. For year two, we're going to have the asset the full year. Therefore, we are going to depreciate the asset for the full year, which is 50,400. Now accumulated depreciation is 67,200. This is the total accumulated depreciation. The entry will be 50,400. However, from a T account perspective, accumulated depreciation at 16,800. Now we added to it 50,400. So this is where the 67,200 comes from. It's the total, not the entry. For year three, we had the asset for the full year. Again, 50,400. Same entry, debit depreciation expense 50,400. Credit accumulated depreciation 50,400. Add 50,400 to accumulated depreciation. Now the total is 17,600. Year four full year, year five full year, and year six. So notice what happened is although the asset is four, five years, it's going to go into year six because we're going to depreciate in year six, eight out of 12 months. Remember, we have to depreciate the asset for the full five years. So in year one, we only took four months. In year six, we're going to take the remaining eight. And as a result, the full depreciation will be 252,000, which is the depreciable base. This is the depreciable base 252,000. This is how much we're going to depreciate. And our accumulated depreciation is 252,000. Indeed, we cannot depreciate the salvage value. So this is the straight line method. One thing I want to make sure, you know, a few things I want to point out to, the total expense is 252. Accumulated depreciation and total 252, okay, over a period of six years. Let's take a look at the activity method. Under the activity method, first we have to find the activity rate. We'll take the asset 300,000 minus salvage value divided by the total of unit produced or hours or whatever that unit is, which is unit produced. So our activity rate is $6 per unit. Simply put, for every one unit we produce, we're going to depreciate this asset for $6. So let's assume for year one, we produced 1,000 units. Well, at $6, the annual expense is $6,000. Therefore, we debit depreciation expense credit, accumulated depreciation for $6,000. Therefore, accumulated depreciation is $6,000. Now, what is the year two? What is the ends? What is the year two? Well, depending on how many units we produced, depending on how many units we produced, if we produced 3,000 units, it will be times 6. And then we will compute the depreciation that way. It will be 18,000. If we produce 30,000 units, it will be 180,000, depending on the activity level, depending on the activity level. Bear in mind that the total activity level should be 42,000 units, 42,000 units. This should be unit, not hours, 42,000 units. So if we completed the 42,000 unit in year three, that's it. We will stop depreciating this asset. So the activity method is based on activity, not based on time. So although I have a period of five years, but in year two, we might use the asset so much and use all the units and this way depreciate the asset. Simply put, the maximum you will depreciate, the maximum is 252,000 because the salvage value is 48, unless you change your estimate. Now, we're going to talk about changing estimate in the next session, but that's beyond the scope of this lesson. The third method is the sums of years digit. The first thing we have to do is to find the denominator. If we're looking at an asset with five years, we're going to take five, plus four, plus three, plus two, plus one, and that's going to be our denominator. The denominator will always stay the same. It's 15. What's in the numerator? In the numerator is the amount remaining as of the beginning of the year. So let's take a look at this computation. We'll take the depreciable base, which is cost minus accumulated depreciation times five divided by 15 is the remaining five years. The annual expense, the full annual expense is 84,000. True, that's the full annual expense. However, we purchased this asset in September. What we have to do, we have to prorate it, multiply it by 412. Why 412? September, October, November, and December. Therefore, for year one, we're only going to take 28,000 of depreciation expense. Therefore, we'd have a depreciation expense 28,000. We credit accumulated depreciation 28,000. The entry does not change. The journal entry is pretty straightforward. Now, what do we have to know? We have to know that after year one ended, after year one ended, we still have, because four divided by 12, if you take four divided by 12, and I want you to do that, just to kind of see where the remaining coming from, four divided by 12, that's going to give you 0.3333. So this is how much we took of depreciation from the life of the asset, 0.333 of a year. What's left of that 0.333 is 0.6667. Now, this is rounding. We're going to have an issue here in rounding. I just want to let you know. But the point is, the remaining life of this asset, after year one, it's going to be four plus 0.667 again rounding. So when we go to year two, we're going to take 252,000. And in the numerator, again, what goes in the numerator? The remaining life of the asset, as of the beginning of the year, is four years and 0.666, which is four years and eight months, four years and eight months, eight divided by 12, which is 4.667 divided by 15. Now we take full depreciation. Again, these numbers are rounded. At the end, we're going to be a little bit off, but the point is it's rounded. So the depreciation for year two is 78,406, 78,406. Now our accumulated depreciation is 106406. Year three, 252 multiplied. We still have three years 0.667 divided by 15. That's going to be our depreciation expense. Year four, year five, and we're going to have year six. And the reason we're going to have year six is because we're going to have a year six. We're going to have 0.667 remaining, 0.667, which is the remaining eight months multiplied by the depreciable base. It's going to give us 11,205. When we compute all, when we add up all the expense, it's going to add up to 252, $29. And this is a large rounding, but I'm not going to sit down and fix it. I mean, try to make it perfect because this is 0.33 and 0.66. It will take a little bit of time. So I just going to let you know that it's rounding, but the point is remain valid, that you can only depreciate 252,000. This is just basically a large rounding error. Okay. So again, at the end of the day, we will depreciate only 252, which is the depreciable base. Let's take a look at the double declining balance. Under the double declining balance will take one divided by life times two to find the double declining grade, which happens to be 40%. Now the double declining balance, if you will start with your book value at the beginning of the year, not the depreciable base book value. The reason I kept it here is to make a point. It's different. So we're going to take the book value 300,000 year one times the rate. It's going to give us 120,000. That's 120,000, assuming we purchased the asset January 1st. Well, we purchased the asset September 1st. Therefore, we're only going to take 412, which is 0.333 of that, which is 40,000. So year one, it's 40,000. We debit depreciation expense, credit accumulated depreciation. Now for year two, you have to be careful. It's going to be the book value. The book value after year one is 300,000 minus 40. So the big value is 260. Therefore, I'm going to start with 260 times 40%. That's going to give me 104. That's going to be my depreciation expense for year two, 104 and 104. Now my depreciation, my accumulated depreciation is 144. Now I'll take 300,000 minus 144 to come up with my book value. And that happens to be 156. 156 times 40%. That's going to give me 62,400. Again, I'm going to add my accumulated depreciation to the prior year and come up with 206,400. Now let's take a look at year four. Year four, we're going to have book value of 93,600. Again, we're going to multiply the book value by 40%, our double declining rate. And as a result, we're going to have 37,440 of depreciation expense. Again, what's going to happen is we're going to take 300,000 minus 243,840. And that's going to give us a new book value of 56,160. Now if we take 56,160 multiplied by 40%, so let's say 56,160 multiplied by 40%, that's going to give us 22,464. Well, guess what? We can't take this depreciation. Why not? Because the book value as of right now is, this is year five, is 56,160. If we take an additional 22,464, that's going to drop us below 48. So what's going to happen is we cannot go below 48,000. What is that 48,000? That's the salvage value. Well, if that's the case, the only thing we can take is 8,160. So that's going to be a plug the last year. Sometime it may arrive earlier. So the only depreciation we can take for year five is 81,60. And as a result, then we add up all the depreciation. And as a result, just like all the other ones, the total is 252,000. However, we took the depreciation in different years, the depreciation amount in different years. So on all the depreciation method, one thing I wanted to see is the total for all five years is 252. That's the total for all five years. That does not change. We take the depreciation in different years. For the straight line, it's always the same. Every year is the same, except if it's a prorated. The double declining balance in the sums of years digit, we took more upfront, we took more depreciation early on in the life of the asset. So this is what I want you to see. But at the end, it evens out over a five-year period or over six-year period. At the end of the day, I'm going to remind you the best way to learn this is to work multiple choice and additional questions on my website, farhatlectures.com. That's what you should do next. At the end of this recording, I'm going to remind you again, whether you are an accounting student or a CPA candidate, to take a look at my website, farhatlectures.com. Again, I don't replace your CPA review course. You need your CPA review course. I don't replace your accounting course. I'm just a useful addition. I can help you along your CPA review course, along your accounting course to help you do better. Your investment in your accounting career is worth it. Don't shortchange yourself. 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