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Case Study: Depreciation

Case Study: Depreciation

Author: Evan McLaughlin

In this tutorial, the student will learn about depreciation in a case study. 

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"Case Study: Depreciation"

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Hey everyone, and welcome to our video today, Case Study Depreciation. So what's today's video about? What are we going to talk about today? We're going to talk about a subject company, Legacy Clothing. And then we're going to talk about depreciation and how that relates to our company, why our company uses it and needs depreciation. And then we're going to do a case study of performing a depreciation calculation using a couple different methods for our subject company.

But let's learn a little bit about this company, Legacy Clothing. What type of company is it? It's a sole proprietorship, meaning it's a type of company that is owned by a single individual and where the individual and the business are legally treated as the same. What's the business purpose of the company? Well, they own and operate their own clothing and merchandise store, so they sell men's, women's, children's clothing and other related items.

The business has locations in Washington, DC, and they have a staff of 50 people. So now our subject company and depreciation. Does our company need to calculate depreciation? Of course they do. Well, why do they need to calculate depreciation? So, our company has assets. They have long-term assets, whether it's building equipment, et cetera. And those assets are used over multiple periods, so those assets provide benefits to multiple periods.

So we need to allocate the cost of that asset or assets over those multiple usage periods. And what this is doing, it allows us to achieve matching. So we're matching cost and benefits. We're matching the cost of the asset through depreciation expense, and the benefit is being received through revenue. So we're matching expense with revenue. So that's why we need depreciation.

Now let's look at performing some depreciation calculations for our subject company, Legacy Clothing. OK, so the first calculation that we're going to perform is straight line depreciation. And we're going to start with the asset buildings. So the information we need to know in order to perform straight line depreciation, we need to know our total cost, residual value, as well as the useful life.

And you'll see here the formula for straight line depreciation is cost minus residual value divided by the number of years of the useful life. So let's go ahead and put the information in for our subject company. So we have buildings with a cost of $500,000, and we assume there is no residual value for those buildings. And we're going to say those buildings have a useful life of 30 years.

So if we plug in this information-- cost minus residual value, number of years of useful life-- we'll get our straight line depreciation. So that's going to be our depreciation expense every year under straight line depreciation. And now we can break that out into monthly depreciation, so then if we wanted to know the total accumulated depreciation in any point throughout this asset's life, we can look at the number of months.

So if we look in this case after 60 months, so after five years, our total accumulated depreciation is going to be $83,333, which is our monthly depreciation multiplied by 60. Now we're going to perform the same straight line calculation, but for in this case it's going to be our equipment, so another fixed asset that we need to depreciate. Again, we need total cost, residual value, and we need to know the useful life.

So for our equipment, we have $200,000 worth of equipment and a residual value of $10,000 for that equipment. And that equipment has a useful life of 10 years. So if we look at our straight line depreciation formula, cost minus residual value divided by the number of years of useful life, we can plug in that information. So it's $190,000 divided by 10. That means that our straight line depreciation every year is going to be $19,000.

And again, we can break that into monthly depreciation by dividing the straight line number by 12. And then we can figure out the total accumulated depreciation at any point in time by plugging in the number of months that we're looking for. So after 48 months, if we take our monthly depreciation and multiply that by 48, we would get $76,000.

Now let's turn our attention to another method of depreciation, double declining balance. So we're going to be calculating double declining balance depreciation. We're going to start with our buildings, and so we need the same information that we needed before. We need to know the total cost, residual value, as well as the useful life.

So if we use the same information, our buildings that cost $500,000 with a useful life of 30 years, so the straight line depreciation percentage is 3.3%. So every year 3.3% of that asset would be depreciated. Now the double declining balance, we take that and multiply it by 2. So you multiply your straight line depreciation rate by 2 to get your double declining balance rate.

So now we need to prepare our depreciation table, starting with the year. So if we look at in year one, beginning book value is 500,000. We have a depreciation rate of 6.7%, so our depreciation expense is this $33,333. So then the book value at the end of the year would be this value here, $466,667. And now that value, that ending book value of year one, then becomes our beginning book value in year two, and we go through that same process of multiplying it by the depreciation rate to get to the depreciation expense.

We add the current year's depreciation expense from the prior year to get the accumulated depreciation. Now we can also see that in year 30, because this asset has a 30 year useful life and no residual value, we would record $67,614 of depreciation expense in this case in order to bring the book value at the end of 30 years to zero.

Now we're going to do that same calculation, but we're going to do it for our equipment. So just like we saw earlier, we need the total cost, residual value, and useful life. So we're going to use that same information as before, total cost of $200,000, residual value of $10,000, and a useful life of 10 years. So our straight line depreciation percentage is 10%. So 10% of this equipment is being depreciated every year under the straight line method.

So for double declining balance, we would double that. So it should be 20%. So if we come down here, our double declining balance depreciation table, we can start to populate this information. So you'll see here, again we go through this same process. In year one, we have a beginning book value, which is the equipment's cost. And under double declining balance, we have a depreciation rate of 20%.

We multiply the book value by that depreciation rate to get to a depreciation expense of $40,000/ so the book value at the end of year one is $160,000. and that becomes our beginning book value at the beginning of year two. And then we go through that same process. But now when we get down to year 10, because this asset has a useful life of 10 years, we see that we would not record 20% depreciation.

We would record whatever depreciation gets us to $10,000 residual value. OK, so because we're in the last year of the asset's useful life, we don't depreciate it to zero. We can only depreciate it to the residual value. We cannot depreciate beyond that point.

Great, so now that we've seen those depreciation calculations, let's summarize what we talked about today. In a nutshell, we discussed our case study company, Legacy Clothing. We looked at an example of calculating depreciation, both straight line depreciation and double declining balance. I hope everybody enjoyed this video, and I hope to see you next time.