Difficulty: Intermediate | Prerequisites: PPE Acquisition and Classification notes; familiarity with straight-line, sum-of-the-years'-digits, declining-balance, and units-of-production depreciation formulas.
Once an asset is on the books, three things will happen to it over its life: it gets depreciated, management may revise the estimates behind that depreciation, and eventually the asset is sold, scrapped, or otherwise disposed of. This topic covers the journal entries for all three and how they interact. You need to know the depreciation methods themselves before starting here; the lecture assumes that knowledge.
Depreciation allocates cost to expense over the asset's useful life. When you sell or dispose of PPE, update depreciation to the disposal date, then remove the asset and accumulated depreciation and recognise any gain or loss. Changes in depreciation method or estimates are applied prospectively (going forward only, no restating prior periods).
Depreciation
A systematic and rational method of allocating the cost of a tangible long-lived asset to expense over its useful life. It is a cost allocation process, not a valuation process.
Think of it as spreading the cost of the asset across the periods that benefit from it.
Residual value (salvage value)
The estimated amount the company expects to receive when it disposes of the asset at the end of its useful life.
Depreciable base
Cost minus residual value. This is the total amount that will be depreciated over the asset's life.
Straight-line depreciation
(Cost minus residual value) divided by useful life. Produces equal depreciation expense each period.
Sum-of-the-years'-digits (SYD)
An accelerated method. Each year's fraction = remaining years of life / sum of the years' digits. Produces higher expense in early years.
Declining balance (double-declining balance, DDB)
An accelerated method. Each year's expense = (2 / useful life) x beginning book value. Residual value is not subtracted before applying the rate, but you stop depreciating once book value reaches the residual value.
Units of production
An output-based method. Depreciation per unit = depreciable base / total estimated output. Annual expense = depreciation per unit x actual units produced that year.
Accumulated depreciation
A contra-asset account that holds the total depreciation taken on an asset since acquisition. It is credited each period (not the asset account itself) so the original cost remains visible on the balance sheet.
Net book value (carrying value)
Cost minus accumulated depreciation. This is what appears on the balance sheet. It does not equal fair value.
Gain or loss on disposal
The difference between the proceeds received and the asset's net book value at the date of disposal. Proceeds > book value = gain. Proceeds < book value = loss.
Prospective application
When a change in depreciation method or estimate is applied going forward from the date of the change, without restating prior periods.
GAAP allows any systematic and rational depreciation method. The three families are:
Uniform: Straight-line
Accelerated: Sum-of-the-years'-digits, declining balance (typically double-declining)
Output-based: Units of production
Each period:
Dr. Depreciation Expense
Cr. Accumulated Depreciation
We credit accumulated depreciation (the contra-asset) rather than the asset account itself. This preserves the original cost on the balance sheet, which is useful information.
PPE appears on the balance sheet as:
Equipment (at cost): $X
Less: Accumulated Depreciation: ($Y)
Net book value: $X - $Y
Depreciation is a cost allocation process. It does not track the actual decline in market value. A truck that cost $50,000 with a 5-year life and $5,000 residual has a book value of $41,000 after one year of straight-line depreciation [($50,000 - $5,000) / 5 = $9,000 per year], but its resale value on the open market might be quite different.
When an asset is sold, scrapped, or otherwise removed, follow three steps.
If depreciation was last recorded at year-end and the disposal occurs mid-year, record depreciation expense for the partial period (e.g. 6 months of a full year's amount).
Gain or loss = Proceeds received minus net book value at the date of disposal.
Debit Accumulated Depreciation (full amount), debit Cash (proceeds), credit the Asset (at original cost), and debit Loss or credit Gain as needed.
Facts:
Office equipment purchased 1 February 2016 for $32,000
Estimated useful life: 5 years; residual value: $2,000
Straight-line depreciation: ($32,000 - $2,000) / 5 = $6,000 per year
Sold 1 July 2020 for $8,000
Depreciation last updated 31 December 2019
Step 1: Record depreciation for 1 January to 1 July 2020 (6 months):
Dr. Depreciation Expense $3,000
Cr. Accumulated Depreciation $3,000
Accumulated depreciation to date: Feb 2016 to Dec 2019 = 3 years and 11 months. Annual depreciation is $6,000. Through Dec 2019: $6,000 x (47/12) = $23,500 (or calculate by period). Plus the $3,000 for Jan to June 2020 = $26,500 total.
More precisely: Feb 2016 to Jul 2020 = 4 years and 5 months = 53 months. Monthly depreciation = $6,000 / 12 = $500. Total accumulated depreciation = $500 x 53 = $26,500.
Steps 2 and 3: Proceeds ($8,000) minus book value ($32,000 - $26,500 = $5,500) = gain of $2,500.
Dr. Cash $8,000
Dr. Accumulated Depreciation $26,500
Cr. Equipment $32,000
Cr. Gain on Sale $2,500
Switching from one depreciation method to another (e.g. SYD to straight-line, or DDB to straight-line).
Switching from accelerated to straight-line is relatively common
Switching from straight-line to accelerated is uncommon (though GAAP permits it)
Applied prospectively: calculate the remaining depreciable base (current book value minus residual value) and spread it over the remaining useful life using the new method
No restatement of prior periods
Revising the useful life or residual value (e.g. management now expects the asset to last 6 years instead of 8).
Also applied prospectively
Take the current book value, subtract the (possibly revised) residual value, and depreciate over the new remaining life
Equipment purchased 1 January 2018 for $80,000, residual $5,000, 8-year life. Company switches from SYD to straight-line on 1 January 2020.
SYD depreciation for 2018 and 2019:
Sum of digits for 8 years = 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1 = 36
2018: (8/36) x $75,000 = $16,667
2019: (7/36) x $75,000 = $14,583
Total through 2019: $31,250
Book value at 1 January 2020: $80,000 - $31,250 = $48,750
Switching to straight-line from 1 January 2020 with 6 years remaining:
New annual depreciation = ($48,750 - $5,000) / 6 = $7,292
Depreciation expense for 2021 = $7,292
Equipment cost $24,000, straight-line over 10 years, no residual value. At the beginning of year 7, management revises the total useful life to 14 years (still no residual).
Depreciation years 1 to 6: $24,000 / 10 = $2,400/year, total = $14,400
Book value at start of year 7: $24,000 - $14,400 = $9,600
Remaining life: 14 - 6 = 8 years
New annual depreciation: $9,600 / 8 = $1,200
Book value after year 7: $9,600 - $1,200 = $8,400
Students often think net book value represents what the asset is worth. It does not. Book value is cost minus accumulated depreciation; fair value is what the asset could sell for.
When disposing of an asset mid-year, students forget to record the partial-year depreciation before removing the asset. Always update depreciation to the disposal date first.
Students sometimes restate prior years when changing a depreciation method or estimate. Both are applied prospectively under GAAP, meaning you only change going forward.
With DDB, students subtract residual value before applying the rate. DDB applies the rate to beginning book value without subtracting residual, but you stop once book value equals the residual.
⚠️ Disposal problems nearly always require a partial-year depreciation entry before the disposal entry. Missing this step means the accumulated depreciation and gain/loss will both be wrong.
⚠️ Change-in-method problems require you to compute depreciation under the old method for the years before the switch, then switch to the new method using the book value at the switch date.
⚠️ Know the difference between a change in method and a change in estimate. Both are prospective, but the calculation differs.
⚠️ For DDB-to-straight-line switches, remember that the DDB calculation ignores residual value, but the straight-line calculation after the switch uses it.
True or false: The depreciation journal entry debits the asset account. (False. It debits Depreciation Expense and credits Accumulated Depreciation.)
Fill in the blank: Gain on disposal = ______ minus ______. (Proceeds; net book value)
True or false: When an asset's useful life estimate changes, you must go back and restate prior periods. (False. The change is applied prospectively.)
Fill in the blank: Net book value = ______ minus ______. (Cost; accumulated depreciation)
True or false: Under double-declining balance, you subtract the residual value before applying the depreciation rate. (False. You apply the rate to beginning book value, but stop depreciating when book value reaches the residual.)
Q: Equipment costing $80,000 with a residual value of $5,000 and a 10-year life is purchased on 1 January 2016. On 1 July 2020, it is disposed of for $54,000. Depreciation was last updated on 31 December 2019. Using straight-line, what are the journal entries?
A: Annual depreciation = ($80,000 - $5,000) / 10 = $7,500. Partial-year depreciation for Jan to Jun 2020 = $7,500 x 6/12 = $3,750.
Entry 1 (update depreciation): Dr. Depreciation Expense $3,750; Cr. Accumulated Depreciation $3,750.
Accumulated depreciation through 1 July 2020 = $7,500 x 4 + $3,750 = $33,750. Book value = $80,000 - $33,750 = $46,250.
Entry 2 (disposal): Dr. Cash $54,000; Dr. Accumulated Depreciation $33,750; Cr. Equipment $80,000; Cr. Gain on Disposal $7,750.
Q: Equipment cost $24,000, straight-line over 10 years, no residual. At the start of year 7, total useful life is revised to 14 years. What is depreciation expense in year 7?
A: Book value at start of year 7 = $24,000 - (6 x $2,400) = $9,600. Remaining life = 14 - 6 = 8 years. New depreciation = $9,600 / 8 = $1,200.
Q: A company's PPE account goes from $200,000 (beginning) to $110,000 (end). Accumulated depreciation goes from $85,000 to $90,000. Depreciation expense was $20,000 and equipment was sold at a loss of $10,000. What were the proceeds from the sale?
A: Equipment disposed of = $200,000 - $110,000 = $90,000 (at cost). Accumulated depreciation removed = $85,000 + $20,000 - $90,000 = $15,000. Book value of equipment sold = $90,000 - $15,000 = $75,000. Proceeds = $75,000 - $10,000 (loss) = $65,000.
Depreciation feeds directly into disposal calculations (you need accumulated depreciation to find book value) and into impairment testing (the carrying value being tested is cost minus accumulated depreciation). Changes in estimates also affect future depreciation on assets held for sale. The capitalised interest from the previous topic becomes part of the depreciable base here.
depreciation, straight-line, sum-of-years-digits, SYD, double-declining balance, DDB, units of production, accumulated depreciation, net book value, carrying value, disposal of PPE, gain on sale, loss on sale, asset disposal journal entry, change in depreciation method, change in estimate, prospective application, depreciable base, residual value, salvage value, contra-asset, ACCT MIS 3200, Chapter 11, LO 11-1, LO 11-2, LO 11-5, LO 11-6