The purpose of depreciation is to allocate the cost of an asset as a deduction from
profit over the useful life of the asset.
In calculating, depreciation managers and accountants need to make the following
judgements: i estimate useful life of the asset ii estimate ‘salvage value’ iii economic use pattern of the asset over its life
The following methods of depreciation are available:
i. straight-line ii. reducing balance iii. units-of-production. With the straight-line method, depreciation expense is the same each year of the asset’s useful life, so profit is reduced by the same amount each year. With the reducing balance method, expense is larger in the earlier years than in the later years, so profit is reduced by larger amounts in the early years of the asset’s life. With the units-of-production method, the expense depends on each year’s volume of production, so the reduction in profit varies according to the amount of production achieved.
The objective is to represent the pattern of use of the asset:
a. even consumption pattern (a warehouse truck) b. reducing balance – decreasing benefits (e.g. an airplane or computer, which is used more in the early years) c. units of production – uneven consumption (e.g. a paving machine is used seasonally and more in some years than others). This is often used by mining companies where mines are closed down for periods when production is uneconomical (e.g. a gold mine). Problem PROBLEM 10.7 Depreciation calculations and selection of method An item of equipment was purchased on 1 July 2015 at a cost of $625 000. It was estimated to have a useful life of four years and a salvage value at the end of that period of $25 000. 1. Calculate the depreciation expense that would be charged with respect to this equipment in each of the years ending 30 June 2016, 2017, 2018 and 2019 using: a. the straight-line method b. the reducing balance method (use 40 per cent rate). 2. Outline the main factors to be considered in selecting an appropriate depreciation method. PROBLEM 10.8 Depreciation calculations, entries, effects and choice At the beginning of 2015, SD Corporation acquired machinery that cost $100 000 and had an anticipated useful life of 10 years. SD Corporation depreciated this machinery for 2015 and 2016, using the straight-line method. During 2017, it decided to change to the reducing balance method of depreciation. 1. Prepare the journal entry to record depreciation expense for 2016, using the straight- line method. 2. Prepare the journal entry to record depreciation expense for 2016 using the reducing balance method, at a rate of 20 per cent. 3. Show the effects of changing from the straight-line method to the 20 per cent reducing balance method on: a. the net profit before tax for 2017 b. the total assets for 2017. 4. In what circumstances is the use of reducing balance depreciation more appropriate than using the straight-line method? Chapter 11 Liabilities Problem PROBLEM 11.20 GST reporting ABC Ltd undertakes consulting services for sustainability issues. The company is registered for GST and accounts for GST on a cash basis. During June 2019 ABC Ltd recorded these transactions: 10 June Received $6000 + GST for consulting on energy usage 18 June Received $3850 (including GST) for consulting on workplace injury reduction 22 June Purchased computer equipment for use in the ABC business. The cost of equipment was $2000 + GST. How much GST is payable by ABC for the month of June? PROBLEM 11.21 GST reporting Tony Cheng recently opened a restaurant in Hobart serving Asian Creole food, as well as exporting its own brand of spice mixture. The business is registered for GST, and accounts for GST on an accrual basis using a monthly tax period. Summarised below are the events that need to be considered in preparing the Business Activity Statement for June 2019: 1. On 2 June, a grinding machine was acquired for $1100 (including GST). It is estimated that 85 per cent of the grinder ’ s usage will be for the restaurant business and the rest to make spice mixture for export. 2. Fresh food was purchased for $65 000 (GST free). 3. Invoices for other purchases totalled $9900. At the end of the month, inventory to the value of $230 was still in store and Cheng still owed $2475. 4. Cash sales in the restaurant were $264 000, including GST. 5. Credit sales of spice mixture totalled $13 500, of which only $12 000 was collected during the month. 6. The restaurant owner estimates that 5 per cent of all acquisitions are for private use. 2 Determine the following items for Tony Cheng’s Business Activity Statement for the month of June: