Hello! For a few days I can’t solve the problem that looks easy-peasy. I will be grateful for help on this one. Problem: which items will be increased by depreciation entry, when a company has recorded X$ of depreciation on manufacturing equipment used to produce goods: - accumulated depreciation - work in process inventory - current assets - cost of goods sold - pp&e I have marked work in process inventory and accumulated depreciation first; that was wrong; after pondering for a while I have added cogs, but that’s also wrong. Please, take a look at my reasoning. The journal entry is: Dr Work in process inventory (+A) X Cr. Accumulated Depreciation (+XA) X 1) accumulated depreciation: yes, this account is increased when we record depreciation on manufacturing equipment, as well as a depreciation expense on pp&e; so my answer solid yes here; 2) work in process inventory: solid yes, as the I show in the journal entry; this is the equipment used to produce goods, so it is part of the cost; 3) current assets: no, because although we increase assets by debiting work in process, we immediately increase counter asset account, i.e. accumulated depreciation; so current assets do not increase; 4) cost of goods sold: well, I have not marked this one initially, because nothing’s said about selling the goods; the company has merely recorded depreciation; but later I thought that maybe the problem implies that whenever the company plans to sell these goods, their cost will be higher, and marked cogs as yes. 5) pp&e: no, this account can’t increase. Please, help me to understand my mistake. Thank you very much!
Do you have the answer ? For me only accumulated depreciation increase
And I think your journal entry is wrong, you don’t accumulate depreciation be decreasing inventory neither cogs
No, I don’t have the answer yet. But I am sure that my journal entry is correct: whenever a company is recording a depreciation on manufacturing equipment used to build a product, the depreciation increases work in process inventory and increases accumulated depreciation account.
I solved it. This depreciation recording will increase, as I have showed previously, Work in Process inventory and Accumulated Depreciation, but also Current assets; I have finally understood this. When a company has purchased an equipment, it went into PP&E account, so its cost is recorded in that account. Once we depreciate the production equipment used to produce goods, we increase the cost of those goods, hence increase work in process account and accumulated depreciation; but the original cost is still in the PP&E account, thus by increasing work in process we also increase current assets (sort of doubling the cost of the equipment) until we put that cost into COGS. Such a relief )
Ufff where did you found that ?
Last semester I taught a course in managerial (i.e., cost) accounting. I, for one, have never seen depreciation added to WIP inventory; it’s always been expensed. That’s sort of the point: you’re already incorporating a method (depreciation) to comply with the matching principle (i.e., spread the cost out over the life of the machine); I cannot see a need to use a two-step process to adjust that spreading-out.
Where’d you see that journal entry?
The reasoning behind adding the depreciation on manufacturing equipment (manufacturing equipment is the critical notion here; not land, building, or other similar assets) into WIP inventory is that this is a product cost; hence when you sell your products, this cost goes into cogs and thus being expensed. If you google depreciation on manufacturing equipment, you will find numerous sources that use this type of approach; that’s what I did when trying to find the explanation of what I am doing wrong.
Aslo I guess this type of entry is required by GAAP (have not yet checked that), and also vary depending on the way the company computes its product cots.
Hum I’m not If i understood correctly, aren’t you confusing depreciation and amortization
I understand the reasoning; I’ve simply never seen it in practice.
Frankly, I wouldn’t expect to see a significant difference in depreciation using this approach than using units-of-activity depreciation; that’s why I question its necessity. It complicates matters, and doesn’t really add much explanatory value.
Amortization is only for intangible assets, you amortize intangibles, but depreciate PP&E ) So, amortization is not applicable here.
Interesting that you haven’t seen this in practice. I have to dig deeper into this topic now because I am confused.
Aslo, this approach, to my point, creates some difficulties when it comes to analyzing financial statements because, usually, to get a rough idea on how much a company invests in new PP&E, which might indicate a growth stage, you would compare CAPEX with depreciation expense; and, if part of the depreciation on equipment is hidden in COGS, then it creates additional difficulties, more computation and requires much more information, which might not be available in reports.
As an aside, I have never worked in manufacturing but I would think that the Depreciation JE would be:
Dr Depreciation Expense
CR Accumulated Depreciation
And then you would separately move some portion of Depreciation expense into a pool that gets capitalized into inventory. And use a separate GL account (a contra depreciation account). it would be much cleaner this way.
Nor CFA stuff, but practical accounting stuff.