The effort of calculating depreciation expense for a large collection of assets often can be reduced without sacrificing a material amount of accuracy by aggregating the assets and treating them as if they are a single asset. The group approach to aggregation is applied to collections of assets that share similar service lives and other attributes.
For example, machinery, furniture, or fleets of vehicles are often depreciated as groups. While each item is unlikely to have the same expected service life as every other, an item should not be included in the group if its life is materially different. This point is key to the group approach because it involves applying a single straight-line rate to the average total cost of the group for the period. Thus, the accountant need only make one calculation for the entire group instead of one for each individual member.
The approach produces results identical to those obtained from a more detailed calculation as long as the assets have identical lives and as long as the group remains intact. Some variation in service life can be tolerated as the understatements on some of the assets offset the overstatements on others in the year. The problem of partial years’ depreciation caused by the acquisition and retirement of assets is solved by using the average balance of the asset account. The average may be computed on an annual, quarterly, or monthly basis according to the rate of change the group experienced in the year.
Additions are recorded by debiting the group asset account for cost. Retirements are recorded under the assumption that the book value of the items exactly equals the salvage proceeds; therefore, a gain or loss will not be recognized on retirement. This practice will not produce material distortions if the unrecorded gains tend to counteract the losses. The journal entry to record retirement credits the group account for the item’s original cost, debits Cash for the proceeds and debits Accumulated Depreciation for the difference.
The following example presents the property records of the office equipment group for Sample Company. A real situation could include literally thousands of items.
The additions during 20×1 would be recorded as follows:
The retirements of 4001 and 4003 (that cost $1,260 and $762 and which were sold for $120 and $85) would be recorded as follows:
The annual depreciation expense would be computed by dividing the average group cost by the number of years in the typical life of the members:
This journal entry would be made:
The composite approach to aggregation works virtually the same as the group method except that the aggregated items are components of a physically unified operating asset, such as a building. Consequently, the individual members of the composite asset may have diverse expected lives. As a result of this condition, a composite system is more likely than a group system to produce an annual depreciation charge that varies materially from the amount that would be computed if each component were to be depreciated separately.
Because of this potential, composite systems generally are not encountered as frequently as group systems. For collections of relatively low-valued assets with short service lives, retirement and replacement systems are occasionally encountered in practice. Under both approaches, the aggregate asset account is debited at the time that the initial collection is acquired.
For retirement systems, the cost of subsequent acquisitions is debited to the asset account. When an item is retired, the asset account is credited for its cost, and Depreciation Expense is debited for the difference between cost and the proceeds. No other entries are made to Depreciation Expense, with the consequence that one or more periods can pass without any expense being recognized if no retirements occur. For example, this entry would record the acquisition of 1,000 hand calculators at $150 each:
When 100 new ones are acquired later at $120 each, this journal entry would be made:
When 100 old ones are retired, this entry would be made (if $100 cash was received):
The retirement system represents a FIFO flow of asset costs as depreciation expense. A replacement system, on the other hand, represents a LIFO flow. The initial acquisition entry is the same as shown above for the retirement method; however, the amount paid for the new (or replacement) assets is debited to Depreciation Expense instead of the asset account. When items are retired, the amount of the proceeds is credited to Depreciation Expense instead of the asset account. For the acquisition of the 100 new calculators, this entry would be made:
The retirement of the old ones would be recorded as:
The asset account balance thus remains the same throughout the life of the aggregated collection of assets.
Because their practices are likely to produce aggregate expense measurements that differ materially from individual calculations, retirement and replacement systems are acceptable only in situations where even a large distortion in the amount of depreciation expense will not have a material effect on reported income. They are occasionally encountered in regulated industries such as utilities and railroads, but only as exceptions to otherwise generally accepted accounting practice.