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    Depreciation

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    Depreciation

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    Depreciation

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    of 24

    FINANCIAL STATEMENT - ADJUSTMENTS

    1- Depreciation and Provision for Depreciation.


    What Is Depreciation In accounting concepts?

    Depreciation can be defined as a fall in the value of assets such as


    vehicles and machines.
    The important fact about depreciation to note here is that it is an
    allocation, rather than valuation, process that dictates the cost of an asset
    over its useful life.
    Useful life typically refers to the estimated productive life of an asset.
    What Causes Depreciation?
    1) Wear And Tear Due To Use Or Passage Of Time
    As suggested by its heading, wear and tear come with 2 different aspects. The former refers to

    the gradual diminishing value of an asset as a result of its use in business operations to

    generate revenue.

    The latter refers to the physical deterioration of an asset as a result of exposure to natural

    elements such as the weather, wind, and rain. For example, a sofa in an office requires

    replacement such as excessive scratches and dirt.


    2) Obsolescence

    This is also a factor that results in the depreciation of non-current assets. It implies that

    an existing asset is becoming outdated due to the availability of a newer/better type of

    asset. This may arise from factors such as technological changes, improvement in

    production methods, change in market demand for the product or service output of the

    asset and legal reasons.


    3) Depletion

    The value of the non-current asset may decrease in value when the benefits of the

    non-current asset are consumed (used up) by the business. It usually applied to natural

    resources type of non-current assets.


    4) Legal Rights

    An asset may involve usage rights in which can only be used until a specific point in

    time. The owner will be required to give up ownership once its usage rights expire. The

    depreciation of such assets has to be done over time and not simply be written off

    upon expiration. Such assets may include patent rights or computer software.
    How Is Depreciation Calculated?

    For the purpose of the current POA syllabus, we will cover the 2 most common
    depreciation calculation methods.

    These are the Straight-line Depreciation and Reducing Balance depreciation


    methods.

    1) Straight-Line Depreciation Method

    The straight-line depreciation method has an assumption that an asset depreciates at a constant rate
    over its useful life. This method spreads the cost of the non-current assets/ fixed assets evenly over
    its useful life.

    Straight-line Depreciation Method is ideal for assets requiring negligible maintenance expenses and
    are not prone to technological obsolescence.
    1. The straight-line depreciation method is calculated using the following formula:

    Depreciation charge per year=

    Cost - Disposal Value/ Residual Value / Salvage value/Scrap Value

    Use for life of the asset

    Or = (Original Cost – Scrap Value) x Depreciation Rate (%)

    Cost = The original cost of the asset

    Disposal/Residual/Salvage/ Scrap Value = the worth of the asset when it is no longer useful.

    Use for life of an asset = the number of years it is likely to remain in service.

    Depreciation rate = the percent at which depreciation is charged.


    What are the advantages of using the Straight-line Depreciation Method?

    ● Easiest and the most straightforward method of depreciating an asset

    ● Does not require complex calculations, lesser margin of error

    ● The book value of an asset can be reduced to zero (if no scrap value)

    ● Since the asset is uniformly depreciated, it does not cause the variation in the

    Profit or loss due to depreciation expense while other depreciation methods

    can have an impact on income statement variations.


    ● Difficult to estimate the useful life of an asset
    ● Not justifiable because depreciation amount of an asset remains the same
    every year.
    2) Reducing Balance Depreciation Method

    Reducing-Balance depreciation method, also known as the Diminishing-Balance


    method, refers to a constant rate of depreciation being applied to an asset’s book value
    each year, resulting in a faster rate of depreciation. There are then higher depreciation
    values in the early years of the life of an asset.

    Reducing-Balance Depreciation Method will be useful for assets that


    require more repairs and maintenance expenses as time passes.

    This method is also appropriate for assets that are prone to technological
    obsolescence because it results in higher depreciation during the initial years
    of an asset’s life.
    2) The reducing balance depreciation method is calculated using the
    following formula:

    Yearly Depreciation = Net Book Value x Rate of Depreciation


    (%)
    What are the advantages of using the Reducing-Balance
    Depreciation Method?

    ● Good method to record depreciation of assets that rapidly lose their value or

    become obsolete (e.g. a computer), hence, depicting fair market value on the

    balance sheet.

    ● Net income is reduced because of higher depreciation in the initial years. This

    leads to tax benefits due to lower tax outflows.


    ● Lower net income in the initial years of an asset as a result of the initial
    high rate of depreciation
    ● Not an ideal method for assets with a lower rate of depreciation such as
    office equipment
    ReFERENCE TO TEXTBOOK
    Chapter 25. Page 228 - 233
    How is Provision for depreciation treated under the two
    methods mentioned?
    Straight line method-

    Cost x depreciation rate = depreciation expense.

    Reducing balance method-

    (Cost - Provision/ accumulation for depreciation on asset )


    x depreciation rate =

    depreciation expense .
    How is depreciation treated in the financial statements ?
    ➢ Income statement for the year ended 31 December 2019

    Less: Expenses $

    Depreciation xxx

    ➢ Statement of financial position as at 31 December 2019

    Cost Total N.B.V

    Dep’n

    Motor Van XXX (xxx) XXX


    Recording Depreciation using Journal Entries
    1. The motor van was purchased and paid for by cheque.
    Dr. Motor van a/c
    Cr. Bank a/c
    2. To record depreciation and its provision.
    Dr. Profit and Loss with the depreciation on M.V. for
    that year.
    Cr. Provision/Accum for depreciation on M.V for that
    year.
    ➔ Depreciation is an expense in the income statement.
    ➔ Provision or Accumulated depreciation is used in the
    balance sheet.
    The disposal or sale of an asset
    Upon the sale (disposal ) of an asset we will remove it from our accounts as
    follows

    1)Transfer the cost price of the fixed asset (Non-Current Asset) to an asset disposal a/c.
    E.g.
    DrofMotor
    Motor van
    van disposals a/c

    Cr Motor van Asset a/c

    2)Transfer the depreciation already charged to the asset disposal a/c

    Dr provision for depreciation of the motor van a/c

    Cr Motor van disposals a/c


    3) Record The Sales Proceeds (Sales Price) of Non- current asset ( Motor van )

    Dr Cash at Bank / Cash in Hand / Other Receivable a/c

    Cr Motor van disposals a/c


    4) Record the Profit or Loss obtained due to the sale of the Non- current asset ( Motor van )
    disposal A/c to balance off the Motor van disposal a/c .

    (Loss on Sale of the asset (Motor Van))

    Dr Profit and Loss a/c

    Cr Motor van disposal a/c

    (Profit on Sale of the asset (Motor Van))

    Dr Motor Van disposal a/c

    Cr Profit and Loss a/c


    ReFERENCE TO TEXTBOOK
    Chapter 26 pages 235 t.o 240

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