Horngren’s Financial & Managerial Accounting, 7th edition by Miller-Nobles so...
Depreciation
1. So far...we have learned how to analyse business transactions, record these in T-Accounts, prepare a trial balance, income stmt and balance sheet. We have also been introduced to the concept of accrual accounting vs cash accounting (accounts receivable and accounts payable) We have been accounting for transactions as they occur, however during the accounting period other changes take place End of Period Adjustments
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3. The income stmt reports earnings for a specific time period (1qtr, 1yr etc) The balance sheet reports the assets, liabilities and owners equity on a specific date (as at 31 Dec 20xx) Therefore to follow the matching principle, accounts in the trial balance must be adjusted before financial statements are prepared. The matching principle
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5. Current vs Non Current Assets Balance Sheet Current Assets: Within the financial year: Cash - Expected to produce revenue Accounts receivable - Can be used to meet short term / day to day obligations Prepaid Insurance - Generally can be liquidated (converted to cash within 1 yr) Inventories Non Current Assets: (Fixed Assets) Office Furniture - Tend to remain in the business for a longer period of time Motor Vehicles - Indirectly generate income Buildings - Can not be liquidated instantly for cash Land - Suject to depreciation Total Assets = Current + Non Current Assets
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9. Non-current assets such as vehicles, equipment etc cannot be included as expenses in an income statement because they are not used up in one reporting period. A delivery van for example will be useful to a company for a number of years, during which time it helps the company earn revenues by delivering goods. Under accrual accounting, revenue for a reporting period must be Matched with the relevant expenses for that period. Depreciation is the process of allocating (or writing off) the cost of a non-current asset over its useful life . What is Depreciation?
10. An assets useful life is the period of time that asset is expected to help produce revenues. Depreciation is the recognition of a decline in value of an asset due to wear and tear. Depreciation is an expense account. When depreciation is recognized as an adjusting entry at the end of the accounting period, an expense is charged – a debit entry is made to depreciation expense. Where does the credit entry go? Adjusting Entries - Depreciation
11. Under the ‘historical cost’ principle, assets are recorded at their actual cost. (regardless of whether the firm got a good buy or over paid for them.) When we made an adjustment for pre-paid insurance, the asset accounts were credited to show that they had been consumed. However assets that are expected to provide future benefits for more than 1 yr require a different approach. The business must maintain a record of the actual cost of an asset. The credit side of the adjusting entry therefore goes to an asset – contra account called ‘Accumulated Depreciation’ Accumulated Depreciation
12. The depreciation adjusting entry is: DR Depreciation Expense (P/L) CR Accumulated Depreciation (B/S – contra asset account) Accumulated depreciation is also known as Provision for depreciation Accumulated Depreciation cont.. Balance Sheet Income Statement Assets: Expenses: Delivery Equipment 3,600 Depreciation Expense 100 less: Accumulated depreciation (100) Net Book Value 3,500
15. If a company's accounting year ends on December 31, but the purchase of the asset was 1 July, what will the depreciation schedule look like? What is the cash outlay? How will the company report the depreciation expense on the company's income statement? Why is depreciation expense regarded as a non-cash expense? Depreciation Example cont.