(Depreciation—Replacement, Change in Estimate) Greg Maddox Company constructed a building at a cost of \(2,200,000 and occupied it beginning in January 1998. It was estimated at that time that its life would be 40 years, with no salvage value.

In January 2018, a new roof was installed at a cost of \)300,000, and it was estimated then that the building would have a useful life of 25 years from that date. The cost of the old roof was $160,000.

Instructions

1. What amount of depreciation should have been charged annually from the years 1998 to 2017? (Assume straight-line depreciation.)
2. What entry should be made in 2018 to record the replacement of the roof?
3. Prepare the entry in January 2018 to record the revision in the estimated life of the building if necessary.
4. What amount of depreciation should be charged for the year 2018?

Depreciation is a branch of accounting that deals with systematically spreading or dividing the cost or other principal value of a fixed assetover its expected useful life by charging regular expenses or revenues.

Determining the depreciation

$\begin{array}{rcl}\text{Depreciation}& =& \frac{\text{Cost}\text{of}\text{asset}-\text{Residual}\text{value}}{\text{Useful} \text{life}}\\ & =& \frac{\$2,200,000}{40}\\ & =& \$55,000\end{array}$

Working note:

Calculation of accumulated depreciation-Building

$\begin{array}{rcl}\text{Depreciation}& =& \text{Cost}\text{of}\text{roof}\times \frac{\text{Useful}\text{life}}{\text{Estimated}\text{life}}\\ & =& \$160,000\times \frac{20}{40}\\ & =& \$80,000\end{array}$

Note: Since the cost of the previous roof is known, the most suitable entry would be to remove it and record a loss on disposal. Another option is to deduct Accumulated Depreciation— Buildings on the basis that the replacement will extend the building's useful life. In this scenario, the entry would be as follows:

In January 2018, while recording the revision in the estimated life of the building, it was found that no entry is required to be passed in the books of accounts.

Working Notes:

Calculation of Depreciation for 2018

$\begin{array}{rcl}\text{Depreciation}& =& \frac{\text{Building}\text{amount}\text{after}\text{adjustment}}{\text{Useful} \text{life}}\\ & =& \frac{\$1,320,000}{25}\\ & =& \$52,800\end{array}$

There is another option for determining depreciation

Working notes:

Calculation of Depreciation for 2018

$\begin{array}{rcl}\text{Depreciation}& =& \frac{\text{Cost}\text{of}\text{building}\text{after}\text{adjustment}}{\text{Useful}\text{life}}\\ & =& \frac{\$1,400,000}{25}\\ & =& \$56,000\end{array}$