Challenging Issues Under
Long-Lived Depreciable Assets –
A Closer Look
Some factors determining the estimated useful life of assets might include:
a. prior experience the company
b. industry norms
c. anticipated technological advancements
d. the way the asset will be used
e. anticipated company growth
An important point that needs to be made during the discussion of this question is that companies are considering the useful life of the asset and not the life of the asset. Companies rarely, if ever, intend to use any asset until it is literally worthless. Usually, the estimated useful life is somewhat shorter than the actual life.
The definition of residual value or (what is left over( implies that the asset will be scrapped or traded-in for a newer asset once its estimated life is over. In trying to estimate an asset(s residual value, a company actually tries to look into the future and determine what the company will receive for an asset when it is disposed of or traded in on a new purchase. If the company believes there will be a market for the used asset, the company might find out what used assets, like the one being depreciated, are selling for today. That amount could be used as a starting point in the development of the estimate of its asset(s residual value.
If a large piece of machinery is expected to be totally obsolete when the company is finished using it, the estimated residual value may be based on how much the company could expect to get from the scrap metal in the asset. Expected technological advances may lead management to anticipate that machinery may become nothing more than scrap metal well before the asset actually wears out. In this case, the residual value may be estimated as a dollar amount per ton that the company can expect to get when the machinery is replaced.
The first alternative starts with a depreciable base of $24,000 to allocate over the estimated useful life of 6 years. The cost is allocated to expense at the rate of $4,000 per year. The second case starts with a depreciable base of $25,000 allocated over 4 years. This scenario allocates the depreciable amount at a rate of $6,250 per year. Because the expense is higher, the net income is lower.
However, the second scenario calls for depreciation expense to be recorded for only 4 years. After that, net income is not impacted by depreciation related to this asset. The second scenario would record more depreciation expense per year, but only 4 years of net income will be affected.
Units-of-production may be established for each item in the following manner: a.
Long-distance truck - based on mileage or based on number of hours of engine time b. Commercial airliner - based on number of hours of engine running time or based on number of air miles flown a. Milling machine - based on number of parts produced or based on number of machine hours used b. Cruise ship - based on number of engine hours
Students may come up with some other useful measurements.
Answers may vary but some suggestions might include:
a. Furniture and fixtures
c. Office machinery
e. Automotive equipment
The book value is computed by subtracting the accumulated depreciation from the original cost. The book value at the end of three years for each scenario is as follows:
Decision 1:Book Value = [$40,000 ( ($9,000 x 3)] = $13,000 Decision 2:Book Value = [$40,000 ( ($7,200 x 3)] = $18,400 Decision 3:Book Value = [$40,000 ( ($9,500 x 3)] = $11,500 Decision 4:Book Value = [$40,000 ( ($7,600 x 3)] = $17,200
This question is designed as a review for your students about the meaning of retained earnings and how yearly net income (or loss) will affect...
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