Depreciation Accounting Flashcards

Question 1

In accounting, what does the term depreciation actually mean for a long-lived asset?

Accepted Answer

Depreciation is the systematic allocation of the cost of a tangible long-lived asset over the periods that benefit from its use. It matches part of the asset's cost to the revenues it helps produce, rather than expensing the full purchase price at once. It is a noncash expense.

Question 2

Which kinds of assets should a business depreciate, and which should it not depreciate?

Accepted Answer

Assets with a finite useful life that are used in operations, such as buildings, machinery, vehicles, and equipment, are depreciated. Land is not depreciated because it is generally treated as having an unlimited useful life. Inventory is not depreciated either because it is sold rather than used over time.

Question 3

How is the depreciable base of an asset calculated before any depreciation method is applied?

Accepted Answer

The depreciable base is the asset's cost minus its salvage value, also called residual value. Salvage value is the estimated amount the company expects to receive when it disposes of the asset at the end of its useful life. Cost includes freight and installation.

Question 4

Why does useful life matter in depreciation, and what does the term actually measure?

Accepted Answer

Useful life is the period over which an asset is expected to be available for use by the entity, or the number of units it is expected to produce. It is an estimate based on management's judgment. A shorter useful life produces larger annual depreciation expense.

Question 5

What is the difference between depreciation expense and accumulated depreciation?

Accepted Answer

Depreciation expense is the amount recorded for a single accounting period and appears on the income statement. Accumulated depreciation is the running total of all depreciation recorded for an asset since it was acquired, and it appears on the balance sheet as a contra asset account reducing the asset's cost.

Question 6

How is the carrying amount of a depreciable asset determined at any point in time?

Accepted Answer

Carrying amount, also called book value, is the asset's original cost minus accumulated depreciation. It is not the same as market value, which may be higher or lower. Carrying amount at the end of the useful life should equal the estimated salvage value, assuming the estimates hold.

Question 7

Why does depreciation reduce reported profit even though no cash leaves the business in that period?

Accepted Answer

Depreciation reduces reported profit because accounting matches the cost of an asset with the revenue it helps earn over time. The cash outflow occurred when the asset was bought, and the journal entry for depreciation debits an expense and credits accumulated depreciation, not cash. Depreciation itself does not change cash.

Question 8

How does amortization differ from depreciation in accounting?

Accepted Answer

Amortization is the systematic allocation of the cost of an intangible asset, such as a patent with a finite life, over its useful life. Depreciation applies to tangible assets such as buildings and machinery. The same allocation logic applies to both, though the two terms refer to different asset types.

Question 9

How is depreciation calculated under the straight-line method?

Accepted Answer

Under the straight-line method, the depreciable base is spread evenly across the useful life. Annual depreciation equals cost minus salvage value, divided by the number of years of useful life. For example, an asset costing 10,000 with 1,000 salvage and a five-year life produces 1,800 of depreciation each year.

Question 10

How does the units of production method link depreciation to actual use?

Accepted Answer

The units of production method allocates the depreciable base in proportion to actual output in each period. Depreciation per unit equals the depreciable base divided by total expected units over the asset's life, and that rate is multiplied by units produced in the period. A busy year records more depreciation than a slow year.

Question 11

How is depreciation computed under the double declining balance method?

Accepted Answer

Double declining balance applies a rate equal to twice the straight-line rate to the asset's beginning carrying amount each year. Salvage value is not subtracted in the calculation, but depreciation stops once carrying amount reaches salvage value. Because the rate applies to a shrinking balance, depreciation is highest in the early years.

Question 12

How does the sum-of-the-years digits method determine each year's depreciation fraction?

Accepted Answer

Each year's fraction uses the remaining useful life in the numerator and the sum of all years' digits in the denominator. For a five-year life, the sum is 15, so year one uses 5/15, year two uses 4/15. The fraction is applied to the depreciable base, which is cost minus salvage value.

Question 13

Which depreciation method produces the same expense each year, and which produces the most expense early?

Accepted Answer

Straight-line produces the same expense each year, while accelerated methods such as double declining balance and sum-of-the-years digits produce more expense in early years and less later. Total depreciation over the asset's life is the same under every method, so the choice affects timing rather than the total.

Question 14

What factors should guide a company when it chooses a depreciation method for an asset?

Accepted Answer

The method should reflect the pattern in which the asset's economic benefits are expected to be consumed. An asset that wears evenly may suit straight-line, while one whose output varies may suit units of production. Management should apply the chosen method consistently, and any change must be justified and disclosed.

Question 15

What is the effect of using an accelerated method on reported profit in the first year of an asset's life?

Accepted Answer

An accelerated method records higher depreciation expense in the first year, so reported profit is lower in that year than it would be under straight-line, all else equal. Later years reverse this pattern. The total expense over the asset's life is unchanged, so the difference is one of timing.

Question 16

What is the double declining balance rate for an asset with a five-year life?

Accepted Answer

The straight-line rate for a five-year life is 20 percent, so the double declining balance rate is 40 percent of beginning carrying amount each year. In year one, an asset costing 10,000 records 4,000 of depreciation. In year two, the balance is 6,000, so depreciation is 2,400.

Question 17

What journal entry records depreciation expense for a period?

Accepted Answer

The entry debits depreciation expense, which appears on the income statement, and credits accumulated depreciation, which is a contra asset account on the balance sheet. Cash is not involved. The entry is usually recorded at the end of each accounting period, often through an adjusting entry.

Question 18

Why is accumulated depreciation used instead of crediting the asset account directly?

Accepted Answer

Keeping the asset at original cost in its own account preserves a clear record of what was paid. The accumulated depreciation account shows how much of that cost has been allocated so far. Together they let readers see both the historical cost and the remaining carrying amount on the balance sheet.

Question 19

What is a contra asset account, and how does accumulated depreciation fit that definition?

Accepted Answer

A contra asset account carries a credit balance and reduces the related asset account on the balance sheet. Accumulated depreciation has a normal credit balance and is subtracted from the cost of property, plant, and equipment. Its presence does not change the asset's original cost, which remains visible.

Question 20

What appears on the balance sheet for a depreciable asset, and how is it presented?

Accepted Answer

A depreciable asset is typically shown within property, plant, and equipment at its original cost, with accumulated depreciation subtracted beneath it to arrive at net book value. Presentation can vary, but the cost and accumulated depreciation are usually disclosed either on the face of the statement or in the notes.

Question 21

Where does depreciation go when the asset is used in manufacturing rather than in administration?

Accepted Answer

Depreciation on production equipment is typically included in the cost of manufactured goods as factory overhead, and it reaches the income statement as cost of goods sold when the goods are sold. Depreciation on administrative assets, such as office equipment, is usually reported as an operating expense in the period incurred.

Question 22

Why is an adjusting entry needed at period end for depreciation?

Accepted Answer

An adjusting entry is needed because depreciation is an estimate of the cost used up during the period, and that use is not recorded by a transaction with an outside party. Without the adjustment, expenses would be understated, profit overstated, and the asset's carrying amount overstated on the balance sheet.

Question 23

What happens to the depreciation expense account at the end of the accounting period?

Accepted Answer

The depreciation expense account is a temporary account, so its balance is closed at period end. Closing moves the balance into equity, leaving the account at zero for the next period. Accumulated depreciation, by contrast, is a permanent account that keeps growing until the asset is disposed of.

Question 24

What is a fixed asset register, and why does it support depreciation records?

Accepted Answer

A fixed asset register is a subsidiary record listing each long-lived asset with its acquisition date, cost, useful life, salvage value, method, and accumulated depreciation. It supports the general ledger balances and lets the accounting team recalculate and verify depreciation for each asset. Reconciling the register to the ledger is a common control.

Question 25

How is depreciation calculated for an asset purchased partway through a fiscal year?

Accepted Answer

Depreciation for a partial year is usually prorated by the fraction of the year the asset was in service. For example, a machine with an annual straight-line charge of 3,000 placed in service three months before year end would record 750 of depreciation in that year.

Question 26

What is a change in accounting estimate, and how is it applied to depreciation?

Accepted Answer

A change in accounting estimate revises a figure such as useful life or salvage value based on new information. It is applied prospectively, so the remaining carrying amount is depreciated over the revised remaining life, and prior periods are not restated. The change is a revision of judgment, not a correction of an error.

Question 27

What is the accounting for an error in prior-period depreciation?

Accepted Answer

An error in prior-period depreciation, such as using the wrong cost or omitting an entry, is a correction of an error rather than a change in estimate. It is generally corrected by restating the prior periods presented, with any remaining effect adjusted to opening retained earnings.

Question 28

What happens to depreciation when an asset is impaired?

Accepted Answer

After an impairment loss, the asset's carrying amount is written down to a lower measured value, and future depreciation is calculated on that new amount over the remaining useful life. Impairment is recorded as a separate loss, not as depreciation expense.

Question 29

How is gain or loss on disposal determined when a depreciated asset is sold?

Accepted Answer

The gain or loss equals the cash or fair value received minus the asset's carrying amount at the date of sale. Carrying amount is cost minus accumulated depreciation through the sale date, so depreciation must be recorded up to that date first. A sale price above carrying amount produces a gain.

Question 30

What entries are needed when a fully depreciated asset is still in use?

Accepted Answer

No depreciation entry is needed once the carrying amount has reached salvage value, even if the asset remains in use. The cost and accumulated depreciation remain on the books until the asset is retired or disposed of. Management should also review whether the estimates still hold.

Question 31

How is an asset retired with no proceeds recorded?

Accepted Answer

Retirement with no proceeds removes the asset's cost and its accumulated depreciation from the books. Any remaining carrying amount is recorded as a loss on disposal. For a fully depreciated asset, both accounts are removed at equal amounts, so no gain or loss arises.

Question 32

Should depreciation continue for an asset that is temporarily sitting idle?

Accepted Answer

Depreciation generally continues while an asset is idle, because the expense is based on the asset's expected service over its useful life rather than on whether it is operating in a given period. Units of production is the exception, since no output means no depreciation.

Question 33

How does depreciation appear in the operating section of the statement of cash flows under the indirect method?

Accepted Answer

Under the indirect method, depreciation is added back to net income because it is a noncash expense that reduced net income without reducing cash. The add-back appears in the operating activities section, and it offsets the expense recorded on the income statement. Capital spending itself is reported in the investing section.

Question 34

How can heavily depreciated assets affect the interpretation of a company's balance sheet?

Accepted Answer

Assets that are largely depreciated have small carrying amounts relative to their original cost, so the balance sheet may understate the current cost of the productive capacity in use. Ratios based on book values, such as asset turnover, can look high for older firms.

Question 35

What is EBITDA, and why does it exclude depreciation?

Accepted Answer

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It excludes depreciation because depreciation is a noncash allocation tied to past capital spending, which makes operating results easier to compare across firms. It is a non-GAAP measure, so it does not replace operating cash flow or net income in analysis.

Question 36

How do analysts compare depreciation with capital expenditures over time?

Accepted Answer

Analysts compare capital expenditures with depreciation to judge whether a company is investing enough to maintain and grow its asset base. Spending well above depreciation suggests growth investment, while spending well below it may signal aging assets or underinvestment. The comparison is informal, since depreciation is based on historical cost.

Question 37

What does the ratio of accumulated depreciation to gross cost indicate about an asset base?

Accepted Answer

The ratio of accumulated depreciation to gross cost shows what share of the asset base has already been used up. A high ratio suggests older assets that may need replacement. The ratio is a rough indicator, since it depends on the depreciation methods and useful lives chosen.

Question 38

Why might two companies with identical assets report different depreciation expense?

Accepted Answer

Two companies can report different depreciation for the same asset because they may use different methods, estimated useful lives, or salvage values. Differences in cost capitalization policies, such as which costs are added to the asset, also matter. Comparing firms therefore requires reading the accounting policy notes.

Question 39

How does depreciation influence a company's return on assets over the life of an asset?

Accepted Answer

Depreciation lowers net income, which reduces the numerator of return on assets. Because carrying amounts also fall over time, the denominator shrinks as assets age, which can offset part of that effect. The overall pattern depends on method, timing of asset purchases, and the company's reinvestment.

Question 40

What should a student check first when reviewing a depreciation schedule for accuracy?

Accepted Answer

Start by confirming the depreciable base, meaning cost minus salvage value. Then check the useful life and method, and confirm that the ending carrying amount equals salvage value at the end of the schedule. Finally, verify that accumulated depreciation ties to the general ledger.

Depreciation Accounting Flashcards

1Core Concepts of Depreciation

2Depreciation Calculation Methods

3Journal Entries and Ledger Records

4Partial Periods, Changes, and Disposals

5Statement Effects and Analysis

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