Introduction to Financial Accounting Chapter 7.ppt

* With the straight-line method, we allocate an equal amount of the allocation base to each year of the asset’s service life. The allocation base is the asset’s cost minus its estimated residual value. We simply divide the allocation base by the number of years in the asset’s life. * Straight-line and declining-balance methods measure depreciation based on time. In an activity-based method we allocate an asset’s cost based on its use. For example, we could measure the service life of a machine in terms of its output (units, pounds, barrels). Under this method, we first compute the average depreciation rate per unit by dividing the allocation base (cost minus residual value) by the number of units expected to be produced. We then multiply this per unit rate by the number of units of activity each period. We allocate natural resources to expense through a process known as depletion. The process of recording depletion expense for natural resources is nearly identical to the activity-based method of recording depreciation. * The declining-balance method is an accelerated depreciation method. Declining-balance depreciation will be higher than straight-line depreciation in earlier years, but lower in later years. However, both declining-balance and straight-line will result in the same total depreciation over the asset’s service life. The depreciation rate we use under the declining-balance method is a multiple of the straight-line rate, such as 125%, 150%, or 200% of the straight-line rate. The most common declining-balance rate is 200%, which we refer to as the double-declining-balance method since the rate is double the straight-line rate. * * Despite their lack of physical substance, intangible assets can be very valuable indeed. Companies can either (1) purchase intangible assets like patents, copyrights, trademarks, or franchise rights from other entities or (2) create intangible assets internally by developing a new product or process and obtaining a pro