After depreciation has been calculated for the current period, how is this allocation of the asset’s cost to expense recorded within the company’s accounting system? Answer: An adjusting entry is prepared at the end of each period to move the assigned cost from the asset account on the balance sheet to expense on the income statement. To reiterate, the building account is not directly reduced. A separate negative or contra account (accumulated depreciation) is created to reflect the total amount of the cost that has been expensed to date. Thus, the asset’s present book value as well as its original historical cost are both still in evidence. The entries to record the cost of acquiring this building and the annual depreciation expense over the fiveyear life are as follows. The straight-line method is used here to determine the individual allocations to expense. Now that students should be familiar with using debits and credits for recording, the number in parenthesis is included (where relevant to the discussion) to indicate the total account balanceafter the entry is posted. As indicated in an earlier chapter, revenues, expenses, and dividends are closed out each year. Thus, the depreciation expense reported on each income statement measures only the expense assigned to that period.
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Property and equipment are occasionally sold before the end of their estimated lives. A company’s operational needs might change or officials could want the benefit of a newer or more efficient model. What accounting is necessary in the event that a piece of property or equipment is sold prior to the conclusion of its useful life?In the above example, assume that after the adjusting entry for depreciation is made on December 31, Year Two, the building is sold for $290,000 cash. How is that transaction recorded? Answer: Accounting for the disposal of property and equipment is relatively straightforward. First, to establish account balances that are appropriate at the date of sale, depreciation is recorded for the period of use during the current year. In this way, the expense is matched with any revenues earned in the current period. Second, the amount received from the sale is recorded while the book value of the asset (both its cost and accumulated depreciation) is removed. If the owner receives less for the asset than this book value, a loss is recognized for the difference, which decreases reported net income. If more is received than book value, the excess is recorded as a gain so that net income increases.
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