(Depreciation Computation—Addition, Change in Estimate) In 1990, Herman Moore Company completed the construction of a building at a cost of \(2,000,000 and first occupied it in January 1991. It was estimated that the building will have a useful life of 40 years and a salvage value of \)60,000 at the end of that time.

Early in 2001, an addition to the building was constructed at a cost of \(500,000. At that time, it was estimated that the remaining life of the building would be, as originally estimated, an additional 30 years and that the addition would have a life of 30 years and a salvage value of \)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.

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.

Computation of annual depreciation charged from 1991 through 2000

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

Computation of annual depreciation charged from 2001 through 2018

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

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.

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

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