Furniture And Library Equipment
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Depreciation of Inventory

Definition

  • Expensing of a capital asset (equipment, furniture, building) at periodic intervals over its useful life.
  • Key elements
    • Original cost
    • Estimated salvage value
    • Useful life

Several approaches

  1. straight line depreciation – equal amounts each period are subtracted from the depreciation base cost (original cost less estimated salvage value)
  2. Double declining Balance method – twice the straight line each year, but ignore salvage value
  3. Activity method – based on activity of asset (miles driven, for example)
  4. Units of production – calculate a per unit produced depreciation charge
  5. Composite depreciation method – used with assets that are related (computer equipment) but not similar (printers and computers). Usually uses straight line method.

Straight Line example

  • Asset purchased for $10,000
  • Salvage value $200
  • Estimated life 5 years
  • Annual depreciation is purchase price minus salvage value divided by 5
  • (10,000-200)/5 = $1,960 per year depreciation
  • Depreciation a function of time, not usage

Double Declining Balance

  • Depreciation rate is a multiple (here 2) of the straight line method.
  • Declining balance rate remains constant and is applied to the reducing book value each year.
  • Salvage value not included in depreciation base.
  • Process continues until book value reduced to its salvage value, at which time is discontinued
  • Example
    • Same data as before
    • Depreciation rate is now 40%, but based on cost alone
  • Obviously goes beyond estimated useful life.
  • Often switch to straight line or other as it nears end of useful life
  • Depreciation costs lower as asset ages to compensate for high maintenance and repair costs

Sum of the years’ digits method

  • Depreciation charge based on decreasing fraction of depreciable cost.
  • Uses salvage value
  • For five year asset, sum of years as a denominator and number of years of estimated life remaining as of the beginning of the year as a numerator.
  • Here denominator is 5+4+3+2+1 =15
  • Example Sum of years’ digits
    • Choice of method
    • Depends on how one allocates the cost of using the asset to specific accounting periods.
    • If used constantly and equally each period, then straight line would be appropriate.
    • If a new asset is used up early in its life, then some kind of accelerated depreciation would be applicable.
    • In for profit businesses, tax considerations also play a role.

Inventory Management

  • Two meanings:
  1. recording of tangible assets for internal control, maintenance, and depreciation
  2. valuing the cost of saleable goods or parts used in manufacturing in the period in which they are used.

Recording of Tangible Assets

  • When capitalized assets are purchased, their existence is recorded by management in an inventory control system (often a spreadsheet of some kind)
  • Elements recorded include the description of the asset (including model numbers, serial numbers), the initial cost, the location where it is being used, an internally assigned inventory number, and other information.
  • Each of the assets recorded is usually tagged with a sticker and a unique inventory number, which is also recorded in the inventory management system.
  • When an item is sold, it is removed from the active inventory list.
  • Periodic checks of these items are made to insure that any items not sold are still available for use.
  • This system is also often used to record depreciation of the item.

Valuing inventory used in production of goods or services

  • The second meaning of inventory control deals with assigning costs of manufacturing goods or services provided to the period in which they are produced and sold.
  • A car dealer purchases parts for repairing vehicles. The parts are held in inventory until they are needed for a repair. When a part is retrieved from inventory to make the repair, the cost of that part is assigned to the period when the transaction takes place.
  • Up until that time inventory is an asset. When it is purchased it is not expensed.
  • The expense is charged when it is used or “consumed.”
  • Often items that are used regularly may not be treated as an asset when purchased, but immediately expensed, such as office supplies.
  • Boxes of security strips as an example
    • You are engaged in a multi-year project to security strip your collection of 1,000,000 physical volumes.
    • In the first year you estimate you will use 20 boxes of strips. Cost per box is $100. These are recorded as an asset (inventory).
    • Halfway through the year, after having used about 9 boxes, your security strip vendor offers a sale of security strips for $90 per box.
  • Knowing that you will definitely need these strips in the second and subsequent years, you buy 25 boxes at $90. These are recorded as an asset (inventory).
  • The boxes are identical and stored in the library basement.
  • In the first year, when you record the expense for the grant, which price do you use for the security strips you have used?

Methods of Valuing Inventory Used

  • There are several methods:
    • LIFO (Last in First Out) – assumes that the last box of security strips purchased is the first one used
    • FIFO (First in First Out) – assumes that the first box of security strips purchased is the first one used
    • These affect net income in for profit companies.
  • Example
    • We used 9 boxes valued at $100 per box.
    • In the second part of the year we used 12 more boxes. What was the total cost of items used?
    • FIFO – for 21 boxes we used
      • (20 x $100) + (1 x $90) = $2,090
    • LIFO – for 21 boxes we used
      • (9 x $100) + (12 x $90) = $1980
  • Example 2
    • The example for LIFO could be different if we had already expensed the first 9 boxes.

Conclusion

  • In some contexts with library financial management, it is instructive to know how the use of inventory is valued because this will affect the Statement of Activities and by extension, budget preparation in subsequent periods.
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