So remember that the useful life of an asset and the residual value of an asset are both estimates. Well, sometimes we get better information and we want to update those estimates. What do we do? Let's check it out. The useful life of an asset, as we said, is an estimate at the time that we purchased the asset. But at a later date, we may reevaluate that with new data. So when we change the useful life or the residual value of an asset, this is regarded as a change in accounting estimate, okay? There are different changes that we can make. A change in accounting estimate is a type of change that makes us make our changes going forward, okay? So we're going to change our calculations going forward into the future, all right? Remember, we're dealing with estimates here. Back when we made depreciation expense in prior years, we were using the old estimates; well, that was the best information we had and it wasn't technically wrong. We were doing our best, right? So we don't need to make any retroactive changes. We don't need to go to last year and change the depreciation expense from last year and update our financial statements. No. We're going to leave those as is and then we're going to use our new estimates to change our calculations going forward, okay? So when we deal with these changes in the estimated useful life, we're generally going to just deal with straight line depreciation in this class because it's a little more complicated when we have other methods. So they usually just stick to straight line depreciation to make sure that you understand the idea. All right?
So how are we going to do this? Well, we're going to have to use the remaining depreciable value of the asset, and we're going to recalculate depreciation expense. So what's going to happen is we're going to have been doing some depreciation based on our original estimates, and then there's going to come a day that we're going to change our estimates. On that day, we have to reevaluate our depreciation expense per year, right? Because we're going to be doing this in the straight line method. So we're going to figure out how much remaining depreciable value we have and then we're going to adjust our depreciation expense for the remaining life. So, again, like I said, this is a change in estimate and another estimate is the salvage value. So if we're going to reevaluate our salvage value, we would just change that in our calculation as well and then update our depreciation expense based on the new data, okay?
So how do we calculate this remaining depreciable value? Well, the remaining depreciable value, it's going to be similar to the net book value, except we also consider the salvage value. So we've got our initial cost, what we paid for it, minus the accumulated depreciation. Right? And that's what we are used to. Right? So initial cost minus accumulated depreciation, that's our net book value, and then we're going to take out the remaining salvage value as well for the amount that we're going to depreciate, right? Because we don't want to depreciate the salvage value; that's what we want to have left at the end. So to find out how much depreciable value we have, it's the initial cost minus accumulated depreciation, the depreciation we took in prior years with our old estimate, minus the salvage value. Cool. Let's see this all in an example here. On January 1st year 1, ABC Company purchased a machine for $65,000. So January 1st year 1, they purchased it for 65,000 and they made some estimates on that day. They estimated a 5-year useful life and $5,000 salvage value. Now on July 1st year 2, so July 1st year 2, notice they were already depreciating it for a while, for all of year 1 and some of year 2, they were depreciating it on those old estimates. So on July 1st year 2, the company reevaluated its estimated life for the machine to 6 years from that date, okay? So it's not 6 total years from when they bought it; it's 6 additional years from that date on July 1st year 2. The company uses the straight line method for depreciation. Calculate depreciation expense for year 2 with the net book value of the machine on December 31st year 2. Okay. So let's go through the steps of how we're going to do this. The first thing we need to do is calculate all the accumulated depreciation we've taken up to this point, right? Because we had some depreciation in year 1 and some depreciation during year 2 as well. So what we're trying to get to is this remaining depreciable value, okay? So let's start here with the accumulated depreciation, and that's going to be, let's look at year 1's depreciation expense. Well, what we're going to need to do is our straight line formula, right? Depreciation expense per year, and I'm gonna put old on this because this is the old estimates when we did this. Okay? So let's see what that is. Depreciation expense per year, well, we bought it for 65,000, and we had a $5,000 salvage value, and how long was the useful life? 5 years. So 65,000 minus 5,000, and we're going to divide that by 5; that's 12,000 per year in depreciation from the original estimates, right? So during year 1, well, we would have taken 12,000 in depreciation, right? A full year's depreciation. What about in year 2 using the old estimates all the way up to July 1st? So this is year 2 and I'm gonna put up to July 1st, up to July 1st, right? And that's when we changed our estimates. Well, it would have been 12,000 for the whole year, right? 12,000 would have been the whole year, but we have to do our partial year depreciation because we didn't get a whole year's worth before we changed our estimate. How much of the year had passed? Well, it was January, February, March, April, May, June. We're talking about half the year, right? 6 out of the 12 months. So this would have been 6,000 in depreciation that we took in year 2 up to July 1st using the old estimates. Alright, so what was our accumulated depreciation? Well, that was the 12,000 plus the 6,000. We're talking about 18,000 in accumulated depreciation up to July 1st year 2. Alright? So now we're ready to say, well how much is left to depreciate at this point? So now we're on July 1st, and we're changing our estimates, right? So how much is left to depreciate at this point? Well, the remaining depreciable value, so I'm just going to put remaining here. The remaining depreciable value, well that's going to be what we paid for it, the 65,000 minus the accumulated depreciation we took so far of 18,000 minus the 5,000 of salvage value, right? We didn't change our estimate for salvage value, so that's going to stay the same. So let's see how much remaining we have, 65 minus 18 minus 5. Well, we've got 42,000 left in remaining depreciable value, so that's the amount that we want to depreciate over the rest of the life, okay? So how much is the rest of the life? Well, we're ready to, we want to calculate the rest of the depreciation for year 2, right? So let's leave that on the screen up there, actually, so you see the question. So notice, we had 42,000 left to depreciate before we get to our $5,000 salvage value at this point. And now it told us that there's going to be 6, 6 years from this date. So from July 1st till the asset is fully depreciated, we think it has 6 more years of useful life. So what we want to do is take that remaining depreciable value and divide it by the 6 years that we still have going forward, right? So it's not 6 years from when we bought it, it's 6 years from this date, July 1st year 2. So we're gonna depreciate it for the next 6 years. So we'll have $7,000 per year in depreciation going forward. Notice our original estimate was $12,000 per year. We did that for a year and a half, and then we said actually it's going to last us a lot longer than we had first expected, so that's why this depreciation is going down, and there's also less depreciable value, so we're going to take less per year. Cool? So let's keep going forward here, let's calculate the entire depreciation or let's calculate, sorry, the depreciation expense for the second half of the year, and then we'll be able to calculate the full year's depreciation. We already took, remember from the first half of year 2, we already took some depreciation. Now, we're going to look for the other half of year 2. How much depreciation we take? Well, that's that $42,000 divided by the 6 years, right? That would be $7,000 per year. But this isn't a full year we're talking about in year 2, right? We're talking about just the second half of the year from July through December 31st. So $7,000 per year times those 6 months, right? July, August, September, October, November, December. Those 6 months, well, we need to depreciate it for that half of the year, and that's going to be $3,500 in depreciation, right? Half of a full year's depreciation using our new estimates. Alright? So now we've got our value for the second half of the year. We took $6,000 with the old estimates from the first half of the year, and now with our new estimates, the second half of the year is going to use this $3,500 in depreciation. So it's going to equal the $6,000 that we took in the first half of the year. So I'll say January through June, and then we took $3,500 for July through December, right? So our total depreciation in year 2 is going to be $9,500 in total depreciation. Okay? So the last thing is to calculate the net book value at the end of year 2. Well, our net book value, remember that's just our cost minus accumulated depreciation. Our cost, we bought it for $65,000, that never changed. We paid $65,000 for it. And then our accumulated depreciation, right? How much depreciation have we taken? Let me get out of the way, and I'm going to do a little T-account behind me here. So accumulated depreciation in year 1, so in year 1, we took $12,000 of depreciation in year 1 with our old estimates, right? So that would go into our accumulated depreciation account, and then in year 2, we took the $6,000 plus the $3,500, we took this $9,500 for the whole year of year 2, and that's the addition of those two calculations, the $6,000 plus the $3,500. Cool. So this is our total accumulated $21,500. So if we take out our accumulated depreciation, this will get us to our net book value. $65,000 minus $21,500, and it gets us to $43,500. All right? So our net book value is $43,500 after those 2 years. So notice when we change the estimate, we only change our calculations going forward. Everything that we did in the past, well, it stays as such. All right? Why don't we try some practice problems with these changes in estimate?
