 Hello and welcome to the session in which we would look at a depreciation problem that deals with the four most depreciation method, which are straight line, the activity method, double declining method and the sums of year digit. This type of exercise could appear in your intermediate accounting course or on the CPA exam in a form of a CPA multiple choice or even a CPA exam simulation. Let's go ahead and get started at a corporation purchase a new equipment for its assembly process on September 1st 20 X one. So it's very important to look at the date September 1st. The cost of the machine was 107. Okay, I would say cost 107 cost 107. The company estimated that the company that the equipment would have a salvage value of 7000 salvage value. Immediately you would need to meet me making notes of those. The life of this equipment is five years and the working hours are estimated at 20,000 hours and the year end is December 31st. So why is the date important? Why is the date important? The date is extremely important in this exercise because because the the equipment was not purchased on January 1st and usually that's not the case. So on the exam day you have to be very careful of when the equipment was purchased and when does when is year end? Well, if the equipment was purchased September 1st and the year end is December 31st. It means for the first year you only can take a partial depreciation. Why is that important? Because you might know, you might know the answer for a full year depreciation, but if that's not the question, then your answer will be incorrect. So the first thing what's interesting or what's unique about this problem is the year end. The year end is December 31st. The company purchased September 1st. So if the year end was September 30th, let's assume the year end for this company is September 30th, then that's a totally different computation. So it will be computing the depreciation for one month. The first thing you want to compute is what is the depreciable amount? What is the depreciable amount? Is the maximum amount you can depreciate for this asset? Well, how do we compute the depreciable amount? Second ago I had cost and salvage. Well, you will take the cost minus the salvage. So we have the cost of 107 minus the salvage of a 7 will give us depreciable cost of 100,000. So you might be asked what is the depreciable cost or you may not be asked. That's pretty very simple concept. But the point is you need to know how to come up with the depreciable cost, which is the cost of the asset minus the salvage. What's the salvage? How much you can get for this asset once it's been used after five years? Once the service life has ended five years. Well, you cannot depreciate this amount. Why? Because you're going to, the assumption is you are going to get this salvage value. You're going to get this $7000. So this is the depreciable cost. You cannot depreciate the asset yet. Let's start by computing the straight line depreciation for 20x1. Before we compute the year one straight line depreciation, welcome. You are most likely here as a student or a CPA candidate looking for some help for some additional clarification. You have arrived. Please visit my website, farhatlectures.com for additional resources, whether you are taking a CPA exam course or a regular accounting course. My resources for your accounting courses are broken down by chapter. So it's very easy to follow your actual course and each chapter is broken down by topics, giving you multiple choice resources such as lectures, through faults and exercises. My CPA material is aligned with your backer, Roger, Gleam, Wiley, Miles and major CPA review courses. I give you access to 1500 previously released AI CPA released questions with the original format. Connect with me on Insta LinkedIn. If you have not check out my LinkedIn recommendation. Like this recording on YouTube, subscribe. Connect with me on Instagram, Facebook, Twitter, Reddit and join me on my group me account CPA exam support group. So let's compute the straight line. What's the formula? The formula is cost, cost minus salvage value. Cost minus salvage value gives us 100,000, which is the depreciable amount and we'll divide this amount by five. And that's going to give us $20,000. Is this the answer for year one? No. Why not? Because for year one, we purchase the asset in September. Therefore, we have to prorate the September, October, November and December month only take only those four months. Therefore, we multiply the full year by 412. Therefore, for year one, for the straight line depreciation, we take $666.67 for year one depreciation. Now, don't forget the entry is debit depreciation expense for the amount and credit accumulated depreciation for that same amount. Remember, depreciation expense is a non-cash expense. And this is relevant when you are preparing the incomes, the cash flow statement where you will need to add back non-cash expenses. Let's take a look at the activity method. Assuming the machine usage was 1000 hour. Well, what's the machine usage 1000 hours? Remember, the total machine usage was $20,000. So what we have to do is we have to find our depreciation per hour now using the activity. We're not using time. Now we're assuming we are depreciating this machine, this equipment through its activity. The more activities it has, the more is the depreciation. So what's the depreciation per one hour? Well, we take cost minus salvage value, which is 100,000, which is the depreciable cost, the depreciable base, and we'll divide this by 20,000 hours. Notice we are using hours in the denominator. Why? Because we are assuming the activity is driving the depreciation, which make more sense. If you use the asset more, you're supposed to depreciate it more. Therefore, we get to this answer, which is $5 per hour. It means for every hour we use this asset for any particular year, we should depreciate this asset for five hours. For X1, we used 1000 hour. $5 times 1000 will give us 5000 of depreciation. And this is the depreciation for year one under the activity method. Now again, the entry is the same. The entry is the same for depreciation regardless of the method, hopefully you notice. Now let's compute depreciation using the sums of year's digit and the double declining balance, which are considered accelerated method. What is the sums of year's digit? You will take the life of the asset five and you go one plus two plus three plus four plus five. And that's going to be your denominator, which is equal to 15 sums of the year's digit for five years. It's 15. And in the numerator, you will always have the remaining life of the assets. You will take the remaining life of the asset divided by 15 multiplied by the depreciable cost. So for year one, the depreciable cost is 100,000 starting September 1st. The remaining life is five years, five divided by 15 will give us 33,333.33 rounded. Now, for year one, remember, we purchase the asset when we purchase the asset September 1st. Therefore, we have to take this amount multiplied by 412. And that's going to give us 11,110 rounding, which is 109.999, 11,110 rounding. So you have to prorate it. Now, for year two, how much is left in year two? Well, what's left for the life of the asset is four years plus 412. Sorry, four years and 812 of a year because the first four month already been used, depreciated. Therefore, in the next year, in the year two, X2, the numerator will be 4.66 divided by 15. Why 4.66? Because in the numerator is the remaining life. The remaining life for this asset starting year X2 is four years and 812 of a month. So that's why it's that ratio. In year three, it's going to be 3.66 all the way until the last, last year, which is point will be 0.66, which is 812 of a month. Now, this is the sums of year's digit. The double declining balance is a little bit different. In the double declining balance, the first thing you do is you find what's called the double declining rate, which is taken one divided by life, one divided by five, multiply by two. Remember, one divided by five is the straight line, straight line rate, which is 20%. 20% times two is 40%. We call this the double declining rate, and this does not change. This does not change. Now, how do we use this double declining rate? We'll take the book value of the asset. Remember, now we are using a different number, not the depreciable cost. For the double declining balance, you will take the book value multiplied by the rate. The book value for year one, what's 107, the cost of the asset minus accumulated depreciation, accumulated depreciation starting in year one is zero. Therefore, the cost of 107 minus accumulated depreciation of zero equal to 107. So this is my book value for year one. And this is the book value at the beginning of the year, by the way, not at the end at the beginning of the year times the rate will give us 42,800. Is this the answer? No. Multiply the answer by 412, which will give us $14,266.66. Let's compute year two. Year two is the cost of the asset minus accumulated depreciation, which is so far we took 14,266 times 40%. So the book value is 92,733 times 40%, which will give us accumulated depreciation of 37,093. Now for year three, it's going to be 107 minus 14,266.66 minus 37,093.33. This is going to be the book value and we'll multiply this by 40%. Hopefully you notice that under the sums of year's digit and the double declining balance, the amount of depreciation for year one was much larger than the depreciation that we took for the straight line, which is the straight line was 6,000, right? The straight line was 6,000 and the activity method was 5,000, way larger. And that's what it's called accelerated method. Now bear in mind, if you computed the depreciation for the full five years, remember, you don't depreciate the salvage value in any of the method. So you will have a remaining salvage value always of 7,000. Now, although in the double declining balance, you think you are going to because you are using 107, but you don't. You don't depreciate the salvage value. This is only the formula. What should you do now? Work MCQs through faults. Look at additional lectures and resources. Accounting CPA is an important aspect of your professional life. Don't shortchange yourself. Don't invest in yourself. It's going to pay you dividend down the road. It's worth it. Good luck. Study hard. And of course, stay safe.