Changes in Depreciation Estimate

A depreciation estimate is calculated based on the chosen method of depreciation, and on estimates of an assets useful life and salvage value.

Of course both useful life and salvage value cannot be known at the time and it is often the case than one or the other or both need to be revised during the lifetime of an asset. Factors such as a change in how an asset is used, unexpected wear and tear, technological advancement, and changes in market conditions, may indicate that the salvage value or useful life of an asset has changed.

In addition, the chosen method of depreciation may no longer be appropriate. The pattern of usage of the asset may change to such an extent that an alternative method of depreciation may need to be used.

When there is an indication that a change in depreciation method, salvage value, or estimated useful life is necessary, then the business should revise its depreciation estimates accordingly.

Changes in Depreciation Estimate Example

Suppose for example, a business originally purchased an asset for 120,000, and at the time decided to use the straight line method of depreciation, with an estimated useful life of 10 years and salvage value of zero.

The depreciation estimate when purchased is calculated as follows:

Depreciation estimate = (Cost - Salvage Value) / Useful Life
Depreciation estimate = (120,000 - 0) / 10
Depreciation estimate = 12,000 per year

The depreciation estimate journal each year would be as follows:

Original Depreciation Estimate Journal
Account Debit Credit
Depreciation expense 12,000
Accumulated depreciation 12,000

Asset Useful Life Changes

As time passes, the asset is depreciated at this rate and after 4 years the accumulated depreciation on the asset is 12,000 x 4 = 48,000. At this stage, at the start of the fifth year, the business decides that although the straight line method of depreciation is still appropriate, the asset has a remaining useful life of 8 years, and due to a change in market conditions, has an estimated salvage value of 16,000.

Both the useful life and salvage value estimates have changed and so the depreciation asset for the future remaining years needs to change.

At the start of the fifth year, the asset is in the books of the business at cost less accumulated depreciation, referred to as the net book value or NBV.

Net Book Value = Cost - Accumulated depreciation
Net Book Value = 120,000 - 48,000
Net Book Value = 72,000

This net book value of 72,000 needs to be depreciated over the remaining useful life of the asset, taking into account the revised salvage value. The revised depreciation estimate is calculated as follows:

Depreciation estimate = (Cost - Salvage Value) / Useful Life
Depreciation estimate = (72,000 - 16,000) / 8
Depreciation estimate = 7,000

Notice that the remaining net book value has been substituted for the cost in the depreciation formula. The depreciation estimate is now 7,000 per year.

The depreciation estimate journal each year would be as follows:

Revised Depreciation Estimate Journal
Account Debit Credit
Depreciation expense 7,000
Accumulated depreciation 7,000

The revised depreciation estimate only applies to the remaining years, no adjustment is made to the past 4 years.

Asset Depreciation Summary

A summary of the depreciation estimates for the asset over its lifetime are set out in the table below.

Summary of Asset Depreciation
Year Opening Depreciation Ending
Year 1 120,000 12,000 108,000
Year 2 108,000 12,000 96,000
Year 3 96,000 12,000 84,000
Year 4 84,000 12,000 72,000
Estimates revised
Year 5 (1) 72,000 7,000 65,000
Year 6 (2) 65,000 7,000 58,000
Year 7 (3) 58,000 7,000 51,000
Year 8 (4) 51,000 7,000 44,000
Year 9 (5) 44,000 7,000 37,000
Year 10 (6) 37,000 7,000 30,000
Year 11 (7) 30,000 7,000 23,000
Year 12 (8) 23,000 7,000 16,000
Summary 120,000 104,000 16,000

The table shows that the original depreciation estimate of 12,000 continues for the first 4 years and is then revised to 7,000 for a further 8 years. After this period of time, the total depreciation is 104,000 and the net book value of the asset is 16,000, which is the estimated salvage value of the asset.

Changes in Depreciation Estimate April 26th, 2017Team

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