Revising Depreciation After an Upgrade at Calder Foods
Calder Foods bought a packaging line on 1 January 2021 for $120,000. It was depreciated straight-line over ten years with an estimated residual value of $12,000. On 1 January 2024 the company spent $15,000 on a new control module that extends the line's total useful life to eight years from acquisition and reduces the estimated residual to $6,000. The module has been capitalised. Three full years of depreciation have been recorded. The accountant has drafted 2024 depreciation as $10,800 - the same as prior years - on the grounds that "the method has not changed". She also proposes switching all machinery to reducing-balance depreciation this year to "make the numbers more conservative".
1. Compute the correct 2024 depreciation charge and show the working.
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Step 1 - carrying amount before the revision (1 January 2024).
- Depreciable base: $120,000 - $12,000 = $108,000
- Annual charge: $108,000 / 10 = $10,800
- Accumulated after 3 years: $32,400
- Carrying amount: $120,000 - $32,400 = $87,600
Step 2 - capitalise the upgrade. $87,600 + $15,000 = $102,600 (the module is properly capitalised: it extends life, so it enhances the asset rather than restoring it).
Step 3 - revised remaining life and residual. Total life is now 8 years, of which 3 are used, so 5 years remain. Residual is now $6,000.
Step 4 - new charge. ($102,600 - $6,000) / 5 = $19,320 per year for 2024-2028.
The $10,800 draft is wrong: it ignores both the capitalised cost and the revised estimates.
2. Explain the accounting treatment of the change (prospective or retrospective) and why the accountant's reasoning is mistaken.
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A change in estimated useful life or residual value is a change in accounting estimate, applied prospectively: the remaining carrying amount is spread over the remaining life from the date of change. No prior years are restated and no catch-up adjustment is made for the $10,800 charged in 2021-2023 - those charges were correct on the information then available.
There is no contradiction in saying "the method has not changed". The method (straight-line) is unchanged; the inputs to it are. The accountant has confused stability of method with stability of charge. Holding the charge constant would systematically overstate profit and the asset over the remaining life: the shortfall relative to $19,320 is $8,520 a year for five years, leaving $42,600 of depreciable amount unabsorbed.
Journal entry 2024: Dr Depreciation expense 19,320 / Cr Accumulated depreciation 19,320.
If the $15,000 had instead been routine maintenance that merely restored the line to its previous condition, it would be expensed, and the revised-life computation would run on the original $87,600 carrying amount.
3. Evaluate the proposal to switch all machinery to reducing-balance depreciation for 2024.
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This is a change in accounting policy, not an estimate, and the two must not be mixed in one memo just because they touch the same account.
Treatment. A change in depreciation method is normally applied retrospectively: restate prior periods and adjust opening retained earnings for the cumulative effect, and disclose the reason. It is not a free choice made annually.
Substance test. "More conservative" is not an acceptable justification on its own. A switch is only defensible if the new method better reflects the pattern in which the asset's future economic benefits are consumed - for example, if the machinery genuinely loses value faster in early years. A packaging line used evenly over its life is a poor candidate.
Practical consequences if it proceeds. The retrospective restatement will change prior-year profit and the comparatives, will affect any profit-linked bonus or covenant, and will need disclosure. Combined with the prospective revision above in the same year, readers will need the two effects clearly separated: one changes estimates, the other changes policy.
Recommendation. Keep straight-line for the machinery, apply the prospective revision for the packaging line, and defer any genuine method change to a year where the economics support it and the restatement can be properly prepared.