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DEPRECIATION

The document discusses concepts and methods of depreciation. It defines depreciation and outlines physical and economic depreciation. It also describes factors of depreciation and various methods used including straight line, declining balance, and inventory methods.

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Kimberly Zafra
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26 views3 pages

DEPRECIATION

The document discusses concepts and methods of depreciation. It defines depreciation and outlines physical and economic depreciation. It also describes factors of depreciation and various methods used including straight line, declining balance, and inventory methods.

Uploaded by

Kimberly Zafra
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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DEPRECIATION

CONCEPT OF DEPRECIATION
Deprecation is defined as the systematic allocation of the depreciable amount of an asset over
its useful life. Depreciation is a matter of cost allocation in recognition of the exhaustion of the
useful life of an item of PPE. The objective of depreciation is to have each period benefiting
from the use of the asset bear an equitable share of the asset cost.
KINDS OF DEPRECIATION
1. Physical depreciation is related to the depreciable asset’s wear and tear and
deterioration over a period.

Physical depreciation may be caused by:


a. Wear and tear due to frequent use
b. Passage of time due to nonuse
c. Action of the elements such as wind, sunshine, rain or dust
d. Casualty or accident such as fire, flood, earthquake and other natural disaster
e. Disease or decay – This physical cause is applicable to animals and wooden
buildings

2. Functional or economic depreciation arises from inadequacy, suppression and


obsolescence.

FACTORS OF DEPRECIATION
a. Depreciable amount
b. Residual Value
c. Useful Life

METHODS OF DEPRECIATION
1. Equal or uniform charge methods
a. Straight line. This approach considers depreciation as function of time rather
than as function of usage. Under this method, the annual depreciation is
calculated by allocating the depreciable amount equally over the number of
years of estimated useful life.

Annual depreciation = Depreciable amount / Useful life

Depreciable amount = Cost – Residual value

b. Composite method. Assets that are dissimilar in nature or assets that have
different physical characteristics and vary widely in useful life, are grouped and
treated as a single unit.

c. Group method. All assets that are similar in nature and estimated useful life are
grouped and treated as essentially the same.
2. Variable charge or use-factor or activity methods
a. Working hours or service hours. A depreciation rate per hour is computed by
dividing the depreciable amount by the estimated useful life in terms of service
hours. The depreciation rate per hour is then multiplied by the actual hours
worked in one period to get the depreciation for that period.

b. Output or production method. Depreciation rate per unit is computed by dividing


the depreciable amount by the estimated useful life in terms of units of output.
The rate per unit is then multiplied by the yearly output to get the annual
depreciation.

3. Decreasing charge or accelerated or diminishing balance methods


a. Sum of year’s digit. Depreciation is computed by multiplying the depreciable
amount by a series of fractions whose numerator is the digit in the useful life of
the asset and whose denominator is the sum of the digits in the useful life of
the asset. The fractions are developed by getting the sum of the digits in the
useful life of the asset.

b. Declining balance method. A fixed or uniform rate is multiplied by the declining


carrying amount of the asset in order to arrive at an annual depreciation.

c. Double declining balance. The procedure for double declining balance method
is the same as the declining balance method in that a fixed rate is multiplied by
the declining carrying amount of the asset to arrive at the annual depreciation.
A straight-line rate is simply doubled to get the required fixed rate.

4. Other methods
a. Inventory or appraisal. The inventory method consists of merely estimating the
value of the asset at the end of the period. The difference between the balance
of the asset account and the value at the end of the year is then recognized as
depreciation for the year.

In recording depreciation, no accumulated depreciation is maintained. The


depreciation is credited directly to the asset account.

b. Retirement Method. No depreciation is recorded until the asset is retired. The


amount of depreciation is equal to the original cost of the asset retired minus
salvage value.

c. Replacement Method. No depreciation is recorded until the asset is retired and


replaced. The amount of depreciation is equal to the replacement cost of the
asset retired, minus salvage value. If the asset retired is not replaced, the
original cost of the asset retired but not replaced is recognized as depreciation.

CHANGE IN USEFUL LIFE


The useful life of an item of PPE shall be reviewed at least at each financial year-end and if
expectations are significantly different from previous estimate, the change shall be accounted
for as change in accounting estimate and shall be treated prospectively. Therefore, the
depreciation charge for the current and future periods shall be adjusted.

CHANGE IN DEPRECIATION METHOD


The depreciation method used shall be reviewed at least at each financial year-end and if
there has been a significant change in the expected pattern of economic benefits embodied
in the asset, the method shall be changed to reflect the new pattern. When such change in
depreciation method is necessary, the change shall be accounted for as a change in
accounting estimate and the depreciation charge for the current and future periods shall be
adjusted.

Source: Financial Accounting Vol.I, First Part, 2016 Edition Valix, Conrado T., Peralta, Jose
F. and Valix, Christian Aris M.

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