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Depreciation Sample Assignment

DEPRECIATION

Worked Example 5.1: Depreciation charge included in the carrying amount of another asset

Point Impossible Ltd constructs and sells boats. In making a boat an electronic sander was used. The cost of the electric sander is $9000 and it is expected to have a useful life of 500 hours, and no residual value. During the financial year the sander was used for 50 hours on the boat.

Required

Provide the journal entry to account for the depreciation of the electric sander.

Worked Example 5.2: Determination of useful life

Assume that a business has an item of plant with the following characteristics:

  • The plant should continue to produce output in its current manner for the next 12 years.
  • Demand for the output of the plant is expected to be maintained for the next seven years, after which time the demand will fall to such a low level that it will not be viable to produce the goods.
  • A more technically advanced machine will probably be available in five years and the firm believes that it will need to switch to the new plant in order to remain competitive.

Required

Determine the period of time that should be used in the depreciation calculation.

Worked Example 5.3: A review of alternative depreciation methods

Noosa Ltd acquires an asset for $25 000. It is expected to have a residual value of $5000 in five years’ time—its expected useful life to the entity.

Required

Calculate each period’s depreciation, using:

  1. the straight-line method
  2. the sum-of-digits method
  3. the declining-balance method
  4. units-of-production method

Worked Example 5.4: A components approach to depreciation

At the beginning of the financial period, De Lange Limited acquired an aircraft for use in its travel business. The aircraft cost $3 569 000. De Lange Limited’s maintenance and engineering department have provided the accounting department with the following list of component parts and useful lives.

Useful life (years)

Component cost ($)

Airframe

15

1 830 000

Engines

10

1 324 000

Interior fixtures and fittings

5

415 000

3569 000

These components and lives are consistent with those previously used, and with what is currently used within the industry.

Required

Assuming that the individual components of the aircraft are depreciated on a straight-line basis over their useful lives, and they will have no residual value, prepare the journal entries necessary to account for the depreciation expense at the end of the 12-month reporting period.

Worked Example 5.5: A further consideration of depreciable life

  1. Ochillupo Ltd purchases a canning machine from a major supplier holding a clearance sale. The machine will start to be used in two years’ time, when Ochillupo Ltd plans to expand the current business to include a fruit-canning operation. The machine costs $150 000 at the sale, a saving of $50 000 on its recommended retail price. The machine will be kept in storage until it is needed. It is reported to have a useful life of 10 years if operating at full capacity.
  2. Ochillupo Ltd recently purchased some new commercial vehicles at a cost of $220 000. The documentation that came with the vehicles boasts that the useful economic life of these vehicles when they are worked hard is approximately 150 000 km. Given the size of the orchard in which the vehicles are to be used, management estimates that it will take approximately 15 years to reach this level of usage. A new model vehicle with exceptional advantages over the current model is expected on the market within five years. The company will probably update its vehicles when this new model is released.
  3. An asset purchased six years ago for $100 000 had an estimated useful life of seven years and accordingly will be fully written off at the end of the next financial year. The asset is being carried in the accounts as follows:

$

Cost

100 000

less Accumulated depreciation

(85 716)

14 284

A review by Ochillupo Ltd indicates that the machine can be used effectively within the business for a further five years. It has been established that the carrying amount of the asset is a good approximation of the recoverable amount of that asset.

Required

Worked Example 5.6: Disposal of a depreciable asset

Sandon Point Ltd acquires an item of machinery on 1 July 2012 for a cost of $100 000. When the asset is acquired, it is considered to have a useful life for the entity of five years. After this time, the machine will have no residual value. It is believed that the pattern of economic benefits would best be reflected by applying the sum-of-digits method of depreciation. However, contrary to expectations, on 1 July 2014 the asset is sold for $70 000.

Required

Worked Example 5.7: Sale proceeds deferred

Assume the same information provided for Sandon Point Limited in Worked Example 5.6 but this time the sale proceeds of $70 000 will be received in two years’ time on 30 June 2016. The applicable interest rate is 8 per cent.

Required

Provide the journal entries necessary to account for the sale of the asset.

End-of-chapter exercises

Fistral Ltd acquires a blank-making machine—blanks are the inner foam core of a surfboard—for the following amounts:

  • Initial price paid to the supplier on 1 July 2013: $70 000
  • Cost to deliver the machine to the site: $5 000
  • Amount paid to an engineer to make the machine work: $35 000

The engineer completes her work on 31 December 2013.

It is expected that the benefits from the blank-making machine will be derived uniformly over 10 years and that the machine will have no residual value.

On 1 July 2014, an additional component is acquired at a cost of $60 000 and is attached to the blank-making machine acquired on 1 July 2013. Although this does not extend the life of the blank-making machine, it makes the machine more efficient. The additional component is expected to have a useful life of 20 years, and to be able to be used on other machines when the useful life of the existing blank-making machine is over. At the end of 20 years the component will have no residual value.

Required

Determine the total depreciation expense for the blank-making machine and attachment for the year ended 30 June 2015. LO 5.1, 5.2, 5.3, 5.4

Solution to end-of-chapter exercise

As the additional component can continue to be used beyond the life of the blank-making machine, the two items should be depreciated independently. As the benefits are expected to be derived uniformly, it is appropriate to use the straight-line method of depreciation.

The depreciable amount of the blank-making machine should include the initial cost, delivery cost and the amount paid to the engineer—that is, the costs necessary to get the machine into a usable state. This gives a total cost of $110 000. One year’s depreciation of this, assuming no residual and a life of 10 years, is $11 000.

The depreciation expense of the additional component will be its cost allocated over 20 years. This gives an amount of $3000. Hence the total depreciation expense for the year to 30 June 2015 is $14 000.

Review questions

1 Does depreciation reflect a change in the market value of an asset? LO 5.1

2 Define ‘useful life’ in terms of the decision to depreciate an asset. LO 5.2, 5.3

3 What effect does depreciation have on the statement of comprehensive income and the statement of financial position? LO 5.2

4 An item of plant is acquired at a direct cost of $110 000. It requires installation and modifications amounting to $20 000 and $10 000, respectively, before it is efficiently operational. It is expected to have a useful life of six years, at which point it will have a residual value of $15 000.

Required

Provide the depreciation entries for the first two years using:

  1. the sum-of-digits method
  2. the declining-balance method
  3. the straight-line method. LO 5.3, 5.4

5 What is the difference between amortisation and depreciation? LO 5.1

6 You have been appointed the accountant of a new organisation that is preparing its first set of financial statements. In determining the depreciation for the first year, what sorts of information would you need? LO 5.3, 5.4, 5.5

7 You are the accountant for a manufacturing company and have decided to review the depreciation expenses being recognised. Your review has caused the depreciation charges for a number of factory machines to increase significantly. In response to this change a number of the factory managers are angry at you as they believe that they have put in place maintenance schedules that will extend the workable lives of the assets for a number of years and hence should have led to a reduction in the depreciation expenses being recognised. How would you justify your proposed increases in depreciation expenses? LO 5.1, 5.2, 5.7

8 The financial statements of ABC Ltd indicate that the directors did not depreciate their buildings on the basis that an increase in the value of the associated land was not treated as revenue. Is this a valid argument? LO 5.1, 5.2

9 Staunton Ltd acquires a new tractor for its pineapple farm. The tractor is expected to be operational for a period of 18 years, although a more economical version, which Staunton Ltd’s competitors will probably acquire, will be available in six years. It is envisaged that Staunton Ltd will close down in 15 years, as its existing lease will expire.

Required

Determine the number of periods over which the tractor should be depreciated. LO 5.1, 5.3

10 What could motivate management to use one method of depreciation in preference to another? LO 5.3, 5.4

11 How is the gain or loss on the disposal of a non-current asset determined? LO 5.8

12 Winkipop Ltd acquires an item of machinery on 1 July 2011 for a total acquisition cost of $90 000. The life of the asset is assessed as being six years, after which time Winkipop Ltd expects to be able to dispose of the asset for $10 000. It is expected that the benefits will be generated in a pattern that is best reflected by the sum-of-digits depreciation approach. On 1 July 2014, owing to unforeseen circumstances, the machinery is exchanged for a motor vehicle. The motor vehicle is two years old, originally cost $30 000 and has a market value of $20 000.

Required

Provide the journal entry to record the disposal of the machinery on 1 July 2014. LO 5.4, 5.8

13 What considerations would you take into account when deciding to use one depreciation method, for example the straight-line method, in preference to another? LO 5.3, 5.4

14 If a company depreciates its property, plant and equipment, what are the associated disclosure requirements? LO 5.9

15 Can an organisation switch depreciation methods from one financial period to the next? LO 5.7

16 On 1 July 2013, Bells Beach Tourist Operations acquired an aircraft that can be used for taking wealthy surfers to remote surfing destinations with lovely waves and limited crowds. The aircraft cost $12 000 000. An engineer’s analysis commissioned by the company determined that the aircraft could be broken down into the following components: airframe, engines and fittings. The airframe comprised 55 per cent of the cost, while the engines were 40 per cent of the cost, with the fittings comprising 5 per cent of the cost.

The airframe is estimated to have a useful life of 15 years. At the end of its useful life it will have an estimated scrap value of $150 000. The engines have an estimated useful life of 20 000 hours, while fixtures and fittings are expected to have a useful life of 5 years. Both the engines and fixtures and fittings are expected to have no residual value at the end of their useful lives. During the first year the aircraft was operating for 2920 hours.

Required

Prepare all journal entries necessary to account for the acquisition of the aircraft, and its depreciation, for the year ending 30 June 2014. LO 5.4, 5.5

17 Assume you are the accountant for an organisation and that the managing director queries you about an item of machinery that is shown in the financial statements at a cost of $200 000 less accumulated depreciation of $60 000. He tells you that you need to recognise more depreciation for the asset as he is convinced that the fair value of the machinery at reporting date is only $110 000. How would you respond to his query? LO 5.1, 5.7

Challenging questions

18 Is depreciation an allocation process or a valuation process? Provide reasons for your answer. LO 5.1, 5.2

19 At the beginning of 2011 Lorne Ltd acquired an item of machinery at a cost of $100000. At the time it was expected that the machinery would have a useful life of 10 years and a residual value of $10 000. Until the end of the 2013 financial year the depreciation expense was recognised on a straight-line basis. At the beginning of the 2014 financial year the remaining useful life was reassessed as being 11 years and the residual value was reassessed at $14 000.

Required

Calculate the depreciation expense for the 2011, 2013 and 2014 financial years. LO 5.3, 5.4, 5.7

20 Anglesea Ltd constructed a building in 2010 for a cost of $960 000. The building was expected to have a useful life of 25 years after which time it would be demolished at an expected demolition cost of $100 000. Being on the coast, the building was subject to wild winds at times. At the end of the 2014 financial year the roof of the building was blown away and a replacement was constructed at a cost of $200 000. It was predicted that by replacing the building’s roof its expected useful life would be extended a further 25 years after the end of the 2014 financial year.

Required

Calculate the depreciation cost for the 2013, 2014 and 2015 financial years. LO 5.7

21 Lonsdale Ltd has a machine that makes one type of fin for surfboards. The machine was acquired in 2012 at a cost of $20 000 and it is expected that the machine will be able to produce approximately 2000 fins before it would need to be replaced. It is not expected to have any residual value. At the beginning of the 2015 financial year an attachment for the machine is acquired at a cost of $5000 which feeds the sheets of fibreglass into the fin-making machine. The attachment is expected to have a life of five years and can be utilised on other machines if required. The attachment will act to extend the useful life of the fin-making machine so that after 2015 the fin-making machine is expected to be able to produce a further 1000 fins in total. The numbers of fins produced in 2012, 2013, 2014 and 2015 were 400, 600, 500 and 800, respectively.

Required

Calculate the depreciation expense for the fin-making machine and attachment for each of the years from 2012 to 2015 and discuss whether the expense would be included as part of the cost of inventory. LO 5.3, 5.4

22 Wastewater Limited acquired an item of plant on 1 July 2012 for $3 660 000. When the item of plant was acquired, it was initially assessed as having a life of 10 000 hours. During the reporting period ending 30 June 2013 the plant was operated for 3000 hours.

At 1 July 2013 the plant had a remaining useful life of 7000 hours. On 1 July 2013 the plant underwent a major upgrade costing $234 600. Management believes that this upgrade will add a further 2000 hours of operating time to the plant’s life. During the reporting period ended 30 June 2014 the plant was operated for 4000 hours.

On 1 July 2014 the plant underwent a further major upgrade, the cost of which amounted to $344 00, and this added a further 3100 hours’ operating time to its life. During the reporting period ending 30 June 2015 the plant was operated for 3800 hours.

Required

Prepare all the journal entries that Wastewater Limited would prepare for the years ending 30 June 2013, 30 June 2014 and 30 June 2015 to account for the acquisition, subsequent expenditure and depreciation on the asset. LO 5.2, 5.3, 5.4, 5.7

23 On 1 July 2011 Sprintfast Couriers, which has a year-end of 30 June, purchased a delivery truck for use in its courier operations at a cost of $65 000. At the end of the truck’s useful life it is expected to have a residual value of $5000. During its six-year useful life, Sprintfast Couriers Limited expected the truck to be driven 246 000 kilometres.

Required

Calculate the annual depreciation charge for each of the six years of the truck’s life using the following methods: LO 5.4

  1. the straight-line method
  2. the sum-of-digits method
  3. the declining-balance method
  4. the units-of-production method using kilometres as the basis of use and assuming the following usage:

Year

Kilometres

2012

28 000

2013

34 000

2014

42 000

2015

55 000

2016

68 000

2017

19 000

246 000

24 On 1 July 2011, Bear Island Ltd acquires a computer for an initial cost of $50 000. To make the computer more efficient in the workplace, a number of hardware modifications are necessary before installation. These modifications cost $40 000. The computer is ready for use on 1 January 2012. The computer is expected to be used by the entity for a period of five years, after which time it will be scrapped. On 1 July 2013, a high-speed disk drive is acquired at a cost of $20 000. This disk drive will work only on the existing computer.

Required

Determine the total depreciation expense for the computer and disk drive for the year ended 30 June 2014, using the straight-line method, and provide the required journal entries. LO 5.2, 5.3, 5.4

25 Gazza Ltd acquires a machine for a cost of $29 000. It is expected that the machine will continue to be operational for seven years, during which time it is expected to run for 35 000 hours. The estimated residual value of the machine is $7000 at the end of its useful life.

Required

Calculate the depreciation charge for each of the first three years, using the following methods:

  1. the straight-line method
  2. the sum-of-digits method
  3. the declining-balance method, using a 33 per cent rate
  4. the units-of-production method, based on hours of operation, given that operating times are as follows:

year 1

6000 hours

year 2

7000 hours

year 3

5500 hours LO 5.4

26 First Point Ltd acquires an item of machinery on 1 July 2011 for a cost of $250 000. When the asset is acquired, it is considered to have a useful life for the entity of six years. After this time, the machine will have no residual value. It is believed that the pattern of economic benefits would best be reflected by applying the sum-of-digits method of depreciation. However, contrary to expectations, on 1 July 2014 the asset is sold for $110 000. The amount is to be received as follows: $60 000 on 30 June 2015 and $50 000 on 30 June 2016. The applicable interest rate is 6 per cent.

Required

Calculate the profit on disposal of the asset and provide the appropriate journal entries in the books of First Point Ltd to record the disposal and the subsequent receipts of cash. LO 5.8

27 Brisbane Ltd purchased a property 10 years ago for $3 000 000. Included in this amount is $350 000 that relates to buildings constructed on the land. A recent valuation has shown that the property is now valued at $5 400 000. The valuer has suggested that the location of the property and the quality of the soil are such that it is unlikely that the value will ever drop below the initial cost of acquisition. The buildings on the property are of a general nature.

Required

Describe the appropriate depreciation treatment. LO 5.1, 5.2, 5.6

28 On 1 July 2012 Long Boards Ltd acquired a printing machine at a cost of $120 000. At acquisition the machine had an expected useful life of 12 000 machine hours and was expected to be in operation for four years, after which it would have no residual value. Actual machine hours were 3000 in the year ended 30 June 2013 and 3400 in the year ended 30 June 2014. On 1 July 2014 the machine was sold for $50 000.

Required

  1. Prepare journal entries to record depreciation of the printing machine for each of the years ended 30 June 2013 and 30 June 2014 using the straight-line method. State the carrying amount of the machine at the end of each period. Prepare the journal entry to record the sale of the machine on 1 July 2014.
  2. Prepare journal entries to record depreciation of the printing machine for each of the years ended 30 June 2013 and 30 June 2014 using the declining-balance method with a depreciation rate of 40 per cent. State the carrying amount of the machine at the end of each period. Prepare the journal entry to record the sale of the machine on 1 July 2014.
  3. Prepare journal entries to record depreciation of the printing machine for each of the years ended 30 June 2013 and 30 June 2014 using the sum-of-digits method. State the carrying amount of the machine at the end of each period. Prepare the journal entry to record the sale of the machine on 1 July 2014.
  4. Prepare journal entries to record depreciation of the printing machine for each of the years ended 30 June 2013 and 30 June 2014 using the production basis. State the carrying amount of the machine at the end of each period. Prepare the journal entry to record the sale of the machine on 1 July 2014. LO 5.3, 5.4, 5.8,

29 Malibu Ltd acquired a building on 1 July 2007 at a cost of $800 000. The useful life of the building was estimated as 20 years with no residual value. Malibu Ltd used the straight-line method of depreciation. On 30 June 2013 the estimate of the remaining useful life of the building was revised to 15 years.

Required

Prepare journal entries for depreciation of the building for the years ended 30 June 2012, 2013 and 2014, and state the carrying amount of the building at the end of each of the three reporting periods. LO 5.6

30 Read the article below in Financial Accounting in the News 5.2 entitled ‘Doing it tough? Let them watch pay TV’ by Lisa Murray, which appeared in The Sydney Morning Herald on 4 August 2006, and provide a reason to justify Austar’s change in depreciation policy. LO 5.7

31 Read the article below in Financial Accounting in the News 5.3 entitled ‘Councils’ lack of debt hides financial trouble’ by Ross Gittins, economics editor of The Sydney Morning Herald, and explain why councils might want to base depreciation expenses on the historical costs of non-current assets rather than on their fair values. LO 5.2, 5.3

32 Possoes Ltd acquired an aeroplane in 2012 for $75 million. Possoes does not revalue its assets, but instead measures its aeroplanes at cost less accumulated depreciation. If the cost of the same type of aeroplane increases to $110 million over the next three years, and assuming that the organisation distributes all of its profits to shareholders (in the form of dividends) then does the practice of basing depreciation on historical cost create any possible problems for the organisation? If, by contrast, the organisation periodically revalues its assets to fair value would this have acted to alleviate such problems? LO 5.1, 5.2

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