Businesses often acquire fixed assets at different points during the accounting period rather than at the beginning of the financial year. When this happens, depreciation must be adjusted to reflect the period of actual use. This article explores how to account for assets acquired during an accounting period, how to calculate partial-year depreciation, and its impact on financial statements.
1. Understanding Accounting for Assets Acquired During an Accounting Period
Definition
When an asset is acquired in the middle of an accounting period, businesses must calculate depreciation only for the months the asset was in use. This prevents overstating expenses and ensures accurate financial reporting.
Key Considerations:
- Depreciation is charged from the month the asset is put into use.
- The annual depreciation amount is prorated for the months of usage.
- Some businesses round to the nearest month for simplicity.
2. Formula for Partial-Year Depreciation
To adjust depreciation for assets acquired mid-year, businesses use the following formula:
Partial-Year Depreciation = (Annual Depreciation × Months in Use) ÷ 12
- Annual Depreciation: The amount if the asset were used for a full year.
- Months in Use: The number of months the asset has been in use.
3. Example of Depreciation for an Asset Acquired Mid-Year
Scenario:
A company purchases equipment for $20,000 on September 1st. The equipment has a useful life of 10 years and a residual value of $2,000. The straight-line depreciation method is used.
Step-by-Step Calculation:
Step 1: Calculate Full-Year Depreciation
Annual Depreciation = (Cost – Residual Value) ÷ Useful Life
= ($20,000 – $2,000) ÷ 10
= $18,000 ÷ 10 = $1,800 per year
Step 2: Adjust for Partial Year
The equipment was purchased on September 1st, meaning it will be in use for 4 months before the year ends.
Partial-Year Depreciation = ($1,800 × 4) ÷ 12
= $600
4. Journal Entry for Partial-Year Depreciation
At the end of the accounting year, the following journal entry is made:
Journal Entry:
Debit: Depreciation Expense $600
Credit: Accumulated Depreciation $600
5. Depreciation Schedule for an Asset Acquired Mid-Year
After the first year, full depreciation is charged annually until the last year, where adjustments are made if necessary.
| Year | Depreciation Expense ($) | Accumulated Depreciation ($) | Book Value ($) |
|---|---|---|---|
| Year 1 (4 months) | 600 | 600 | 19,400 |
| Year 2 | 1,800 | 2,400 | 17,600 |
| Year 3 | 1,800 | 4,200 | 15,800 |
| Year 4 | 1,800 | 6,000 | 14,000 |
| Year 10 (Final Year – 8 months) | 1,200 | 18,000 | 2,000 (Residual Value) |
6. Mid-Year Disposal of an Asset
Scenario:
A company purchases a vehicle on April 1st for $15,000 with a useful life of 5 years and no residual value. The company sells the vehicle after 2 years and 6 months.
Step 1: Calculate Full-Year Depreciation
Annual Depreciation = $15,000 ÷ 5 = $3,000
Step 2: Calculate Total Depreciation Until Disposal
Depreciation for 2 years = $3,000 × 2 = $6,000
Depreciation for 6 months = ($3,000 × 6) ÷ 12 = $1,500
Total Depreciation = $6,000 + $1,500 = $7,500
Step 3: Book Value at the Time of Disposal
Book Value = Cost – Accumulated Depreciation
= $15,000 – $7,500 = $7,500
Step 4: Journal Entry for Sale (Sold for $8,000)
Gain on Sale = Sale Price – Book Value = $8,000 – $7,500 = $500
Journal Entry:
Debit: Cash $8,000
Debit: Accumulated Depreciation $7,500
Credit: Vehicle $15,000
Credit: Gain on Sale of Asset $500
7. Advantages of Prorated Depreciation
- Ensures Fair Expense Allocation: Reflects actual asset usage.
- Improves Financial Accuracy: Prevents overstating expenses.
- Complies with Accounting Standards: Required for accurate reporting.
Properly Accounting for Assets Acquired During an Accounting Period
When businesses acquire assets at different times of the year, they must adjust depreciation accordingly. Using prorated depreciation ensures that financial statements reflect the true expense allocation, maintain compliance with accounting principles, and avoid misstating profits.