Types
What is the most commonly used method of depreciation that spreads an asset's cost evenly over its useful life?
Straight-line method
What is the formula to calculate annual depreciation using the straight-line method?
(Cost of Asset - Salvage Value) / Useful Life
Why might a company choose the straight-line method of depreciation for office furniture?
Because the asset’s value decreases evenly over time, and the company wants consistent depreciation expenses each year?
On which financial statement is depreciation expense recorded, and how does it affect the company's profitability?
What is the income statement, where depreciation expense is subtracted from revenue to reduce net income.
Depreciation is a process used to increase the value of an asset over time.
False, depreciation is used to allocate the cost of an asset over its useful life, decreasing its book value over time.
Which depreciation method results in higher depreciation expenses in the earlier years and lower expenses in later years?
Declining balance method
An asset costs $12,000, has a salvage value of $2,000, and a useful life of 6 years. Using the straight-line method, what is the annual depreciation expense?
$1,666.67(Calculation: (12,000 - 2,000) / 6)
A company purchases a delivery truck for $25,000 and plans to use it for 5 years with a $5,000 salvage value. What is the likely reason they would use the declining balance method instead of straight-line depreciation?"
Because the truck will lose value more quickly in the first few years as it is used more heavily, and the company wants to match higher depreciation with higher usage early on?
How does depreciation affect the balance sheet?
depreciation is recorded as accumulated depreciation, a contra asset, reducing the book value of the asset on the balance sheet.
The straight-line method of depreciation results in higher depreciation expenses in the earlier years of an asset's life.
False, the straight-line method results in equal depreciation expenses each year over the asset's useful life.
This depreciation method is based on how much an asset is used or produced, rather than the passage of time. Name this method.
Units of Production Method
What is the formula to calculate depreciation using the declining balance method?
(Book Value at Beginning of Year) x (Depreciation Rate)
A construction company owns equipment that is used on a per-project basis. Which depreciation method would they likely use to account for wear and tear on the machinery?
The units of production method, since depreciation depends on the amount of work the equipment does, rather than just time?
If a company records depreciation using the straight-line method, how does this impact the company’s return on assets ratio?
depreciation increases accumulated depreciation, reducing the asset's book value and thus lowering the return on assets ratio in the short term.
Depreciation is recorded as a non-cash expense, meaning it does not directly affect a company’s cash flow.
True, depreciation is a non-cash expense, so it reduces taxable income but does not impact cash flow directly.
What is the name of the depreciation method where the depreciation rate remains constant but is applied to the declining book value of the asset each year?
Double-declining balance method.
Using the double-declining balance method, how do you calculate the depreciation expense for the first year
2 x (1 / Useful Life) x Cost of Asset? (Double the straight-line rate applied to the asset’s initial cost)
If a business buys a piece of machinery that costs $50,000, has a salvage value of $10,000, and is expected to last 10 years, how might this depreciation calculation impact the business’s tax situation?
Depreciation reduces taxable income, lowering the company’s tax burden each year by deducting the depreciation expense from profits.
A company has a large amount of depreciation expense. How might this affect the company’s cash flow statement?
depreciation is a non-cash expense, so it is added back to operating cash flow in the cash flow statement, increasing cash flow.
A business can choose to use different depreciation methods for different types of assets.
True, businesses can apply different depreciation methods based on the asset type or how they expect the asset to be used over time.
This method is particularly useful for assets like machinery or vehicles, where depreciation is based on mileage or hours of operation. Identify this method.
Units of production method
If an asset’s cost is $15,000, its estimated salvage value is $1,500, and it has a useful life of 5 years, how do you calculate the depreciation expense for each unit produced using the units of production method?
(Cost - Salvage Value) / Total Estimated Units of Production? (Then multiply by actual units produced in a given period)
A company operates in a country with tax laws that allow accelerated depreciation. What is the benefit of using the double-declining balance method in this situation?
It allows the company to deduct a higher depreciation expense in the early years, reducing its taxable income and improving cash flow in the short term.
What happens to the company’s net income and total assets if depreciation is increased in a given period, assuming all other factors remain the same?
Net income decreases because depreciation is an expense, but total assets decrease more slowly due to the accumulated depreciation offsetting the asset's value.
Increasing depreciation in a given period will always lead to a higher net income.
False, increasing depreciation expense reduces net income since depreciation is an expense that lowers profit.