Question

(Depreciation Computation—Addition, Change in Estimate) In 1990, Herman Moore Company completed the construction of a building at a cost of $2,000,000andfirstoccupieditinJanuary1991.Itwasestimatedthatthebuildingwillhaveausefullifeof40yearsandasalvagevalueof$60,000 at the end of that time.

Early in 2001, an addition to the building was constructed at a cost of $500,000.Atthattime,itwasestimatedthattheremaininglifeofthebuildingwouldbe,asoriginallyestimated,anadditional30yearsandthattheadditionwouldhavealifeof30yearsandasalvagevalueof$20,000.

In 2019, it is determined that the probable life of the building and addition will extend to the end of 2050, or 20 years beyond the original estimate.

Instructions

1. Using the straight-line method, compute the annual depreciation that would have been charged from 1991 through 2000.
2. Compute the annual depreciation that would have been charged from 2001 through 2018.
3. Prepare the entry, if necessary, to adjust the account balances because of the revision of the estimated life in 2019.
4. Compute the annual depreciation to be charged, beginning with 2019.

Short answer

Answer

1. Depreciation = $48,500
2. Depreciation = $64,500
3. No entry required
4. Depreciation = $24,188

Step-by-step solution

Meaning of Depreciation

The term "depreciation" refers to the process of diminishing the book value of fixed assets over time.Shrinkage is calculated using the cost of the assets used in the company rather than the market worth of the assets.

(a) Computing depreciation

Computation of annual depreciation charged from 1991 through 2000

$\begin{array}{rcl}\text{Depreciation}& =& \frac{\text{Cost} \text{of}\text{building}-\text{Salvage}\text{value}}{\text{Useful}\text{life}}\\ & =& \frac{\$2,000,000-\$60,000}{40}\\ & =& \$48,500\end{array}$

(b) Computing annual depreciation 

Computation of annual depreciation charged from 2001 through 2018

$\begin{array}{rcl}\text{Depreciation}& =& \left(\frac{\text{Building}\text{cost}-\text{Salvage}\text{value}}{\text{Estimated}\text{life}}\right)+\left(\frac{\text{Addition}-\text{Salvage}\text{value}}{\text{Estimated}\text{life}}\right)\\ & =& \left(\frac{\$2,000,000-\$60,000}{40}\right)+\left(\frac{\$500,000-\$20,000}{30}\right)\\ & =& \$48,5000+16,000\\ & =& \$64,500\end{array}$

(c) Explaining the journal entry 

In 2019, 28 years will have passed, and the useful life will be prolonged by another 20 years.

A change in depreciation is a change in estimate, and changes in estimates are recognized prospectively under accounting rules.

As a result, future changes in depreciation methodologies are accounted for.

As a result, no adjustment to the account balances would be necessary.

The adjustment would be made prospectively by computing a new annual depreciation.

(d) Computing annual depreciation 

Revised annual depreciation
Building
Book value	$642,000
Salvage value	60,000
	582,000
Remaining useful life	32 years
Annual depreciation	$ 18,188
Addition
Book value	$ 212,000
Less: Salvage value	20,000
	192,000
Remaining useful life	32 years
Annual depreciation	$ 6,000
Annual depreciation expense building ($18,188 + $6,000)	$24,188

Working notes:

Calculation of Book value of building

$\begin{array}{rcl}\text{Book}\text{value}& =& \text{Buiding}\text{cost}-\left(\text{Annual}\text{depreciation}\times \text{Total}\text{year}\text{depreciation}\text{applied}\right)\\ & =& \$2,000,000-\left(\$48,500\times 28\right)\\ & =& \$2,000,000-\$1,358,000\\ & =& \$642,000\\ & & \end{array}$

Calculation of annual depreciation of building

$\begin{array}{rcl}\text{Depreciation}& =& \frac{\text{Book}\text{value}-\text{Salvage}\text{value}}{\text{Estimated}\text{life}}\\ & =& \frac{\$642,000-\$60,000}{32}\\ & =& \frac{\$582,000}{32}\\ & =& \$18,188\end{array}$

Calculation of Book value of Addition

$\begin{array}{rcl}\text{Book}\text{value}& =& \text{Additional}\text{cost}-\left(\text{Annual}\text{depreciation}\times \text{Total}\text{year}\text{depreciation}\text{applied}\right)\\ & =& \$500,000-\left(\$16,000\times 18\right)\\ & =& \$500,000-\$288,000\\ & =& \$212,000\end{array}$

Calculation of annual depreciation of addition

$\begin{array}{rcl}\text{Depreciation}& =& \frac{\text{Book}\text{value}-\text{Salvage}\text{value}}{\text{Estimated}\text{life}}\\ & =& \frac{\$212,000-\$20,000}{32}\\ & =& \frac{\$192,000}{32}\\ & =& \$6,000\end{array}$