I am having some trouble understanding the calculation provided in the CFA book on how to calculate the cash received from the sale of equipment.
Page 288 of FRA;
When you have determined the historical cost of the equipment , you then need to subtract accumulated depreciation to end up at the Book Value of equipment sold… this is where I am confused.
Historical cost of equipment sold is equal to $1,057.
Beginning accumulated depreciation: $2,891
Ending accumulated depreciation: $3,443
(Assume that accumulated depreciation is related to equipment)
Depreciation expense (Income Statement) = $1,052
Calculation: 2,891 + 1,052 - 3,443 = $500 (accumulated depreciation on equipment sold)
I understand that we are trying to find the depreciation accumulated over the years relating to the $1,057 worth of equipment sold. Thus, we cannot use the change in accumulated depreciation ($552) - as you wouldn’t know how much of that would relate to the equipment you just sold?
However, I don’t understand why we add the depreciation expense of $1,052 to the beginning balance of the accumulated depreciation and then subtract the ending balance?
Any help appreciated greatly
From what I have understood, the opening balance of the accumulated depreciation represents the amount of depreciation that has been charged over the years but has not been deducted from the historical cost of the asset. Now when you sell an asset, its accumulated depreciation is a part of the accumulated depreciation already appearing in the books and as you have already said that we dont know the amount to be related to the asset you have sold, you know the basic idea. But when it comes to the point that why do we add the depreciation expense to the opening balance, think it this way. The accumulated depreciation has a credit balance, now when you sell an asset, you are basically charging the depreciation on the asset being sold, thereby reducing the balance of the accumulated depreciation and hence it should be deducted from the opening balance. But since you havent sold whole of the assets on your books, you need to charge depreciation on the remaining assets. Now when you charge depreciation it means that you are increasing the accumulated depreciation and hence it is added. To make it more clear, try to make a ledger account of the accumulated depreciation. It will make it more clear. Hope it hepled.
If we start with the beginning accumulated depreciation (on everything we owned at the beginning of the year) and add this year’s depreciation expense (on everything we owned at the beginning of the year), we have the total accumulated depreciation for everything we owned _at the beginning of the year _. Call this amount A.
The ending accumulated depreciation is the total accumulated depreciation for everything we owned _ at the end of the year _. Call this amount B. The difference between these amounts (A – B) is the total depreciation for everything we did own at the beginning but didn’t own at the end; i.e., it’s the total depreciation for everything we sold during the year.
Ahh makes perfect sense now!
thank you guys!