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    © All Rights Reserved
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    5 views18 pages

    Depreciation Year 11

    Uploaded by

    Dominic Otieno

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
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    of 18
    Accounting for depreciation and disposal Omi cae Learning objectives In this chapter you will learn to: Ce cen ur ean Derg ‘You earned about the yearend adjustments for accruals and prepayments in Chapter 1.and wil lear about other year- lend acjustments in Chapter 13, ‘You learned about capital expenditurein Chapter 19, aaa ‘You learned about the accounting arinciples of matching, ovudence and historic cost in Chapter 10, uP Depreciation is anon- monetary expense as ‘doesnot involve an outiow of money, nor doesitprovide cash fund to use forthe replacement of anen- current asset, 12.1 Introduction As explained in Chapter 11, itis often necessary to include year-end adjustments in a set of financial statements. This ensures that the accounts provide a more accurate view of the arafit or loss of the business and the financial position of the business. This chapter focuses (on the year-end adjustments made far depreciation of non-current assets, Depreciation is an estimate of the loss in value of a non-current asset over its expected working life, Most ofthe non-curtent assets oa business lose value over a period of time that they are used by the business. the accounting records continue to show these assets attheir cost prices then the eccounts wil provide misleading information, iis, therefore, necessary to record an estimate ofthe loss in value. {he recards can only show an estimate ofthe loss in value ofa non-current asset because of depreciation. The exact amount will only be known when the assetis disposed of or sold. Bulldings depreciate overtime but and does not usualy ose value (unlessitis something like awell or mine when value is removed from the land). The purchase of a non-current asset is capital expenditure. The cost of a no rent asset is not charged as an expense in the year of purchase asit benefits the business for several years, Matching the capital expenditure against the sales it »as helped the business to earn is done by an annwal charge for depreciation, This means that the cost of the non-current asset is spread over the years which benefit from the use of that asset. The depreciation for the year is included in the expenses in the income statement, so the profit for the year is nat overstated, This is an application of the principle of prudence. Ifthe profits overstated, the awner of a business may be tempted to withdras nore cash than the business can actually afora. The principle of prudence is also applied in the statement of financial position as the non- current assets are recorcled at a figure less than the cost price (this s known as the net book value or the written down value). This overrides the historic cost principle as it ensures that the non-current assets are shown at more realistic values, 12.2 Causes of depreciation The four main causes of depr cof time and depletion. ation are physical deterioration, economic reasons, passage Physical deterioration ‘Thisis the result of wear and tea’ due to the normal usage ofthe non-current asset. can also be because the asset fall into a poor physical state due torus, rot, decay and so on, Economic reasons The non-current asset mey become inadequate as it can no longer meet the needs of the Dusiness, can also be because the nan-current asset has become obsolete as newer and more efficient assets are now available Passage of time This arises where a non-current asset, for example a lease, has a fixed life ofa set number of years rere Ce ee ee UU eer eae Depletion This arises in connection with non-current assets such as wells and mines. The worth of the assel reduces as values taken from the asset. 1 Explain the meaning of depreciation, 2. Explain how depreciationis an application ofthe matching principle. 3 List four causes of depreciation of non-current assets, 12.3 Methods of calculating depreciation There are several methods used to calculate the estimated loss in value af anon-current asset Different types of non-current assets are often depreciated using diferent methods. ‘lu earned about the The method selected should be the one which spreads the cost of the asset as fairly as Reese possible over the periods which benefit ram its use. Once a method has been selected for inchaprer to, particule non-curtent asset, it should be applied each year. This is an application of the principle of consistency bn practice, many factors re consicered before a depreciation method isslected. These ae + Howlongisthe asset expect to last? + How muchwillthe asset be sold for hen it's putoutof use? © How can the benefits from the use of the asset be measured? a ‘There are three rain methods of depreciation + Straightline method + Reducing balance method + Revaluation method These are explained below. There are several other methods, but they are outside the scope of the syllabus. Straight line method of depreciation This is also known as the fixed instalment method. The formule used for calculating the annual depreciation using this method is: Costof asset Number of expected years of use This expresses the annual depreciation as an amount of money. The ansiver to this formula is expressed as 3 percentage of the total cost. This method applies the same amount of depreciation (or the same percentage rate of tthe cost price) each year, The value of the asset can fall to nil if there is no residual value (see below). This method is used where each year is expected to benefit equally from the use of the asset. Ce cen ur ean Derg Walkthrough 12.1 Kavita’ nancial year ends on 20 June (On 1 July 20-3 she purchased fitures costing $25 000 and paid by cheque. She estimated that she would be able louse the fixtures for four years. Calculate the annual depreciation charge a asanemount of money bas apercentage, $25000 Fas 86250 $6250 25% $2500 Where’ is estimated that the asset will have some value at the end of its working life, this jual value. the formula ‘must be included in the calculation. Such 2 value is known as a es then becomes: Costof asset Residual value Number of expected years of use Walkthrough 12.2 16 Aavit’s financial year ends on 30 June (07 1 uly 20-3 she purchased fixtures costing $25000 and paid by cheque. She estimated that she would be able to use the fixtures forfour years and then be able to sel them for $3000, Calculate the annual depreciation charge a asanamountof money basa percentage (based on the origina cost $25000- $3000 2 = $5500 $5500, 100 325000 “T 2% Advantages ofthe straight line method of deprecation. 1 Itisrelatively easyte calculate 2 Itisuseful when arnan-current asset provides equal benefit foreach year fits useul fe. Disadvantages ofthe straight ine method of depreciation. 21 Itisnecessary to estimate the useful life andthe residual value of the non-current asset, 2 Itignores the actual rate at which the non-current asset wil lose value rece Ce Ge oe ee uur eer Co nea Reducing balance method of depreciation Pom ‘As the name implies, the amount of depreciation reduces each year. The same percentage rate is applied, but itis calculated on a different value each year. Al the end of the frst ‘year the depreciation for that year is calculated on the cost of the assat. Ihe depreciation for the following yearis calculated {using the same percentage] on the cost ofthe asst ess the epreciation previousiy written off,The figure of cost less deprecation is known as the net book value (or written down value) of the asset. The value ofthe asset can never fall to nil asthe depreciation is always calculated as a percentage of the net book value. ‘This method is used where the greater benefits from the use of the set will be gained in the carly years ofits life, Assets depreciated by this method often have lower maintenance costs in tne carly years This method is often usec for those assets which quicdly become out of data because of advancing tecinological progress. Any residual value is taken into consideration when the percentage rates selected Walkthrough 12.3 Kavita’ financial year ends on 30 June. (On 1 July 20-3 she purchased fixtures costing $25000 and paid by cheque. She estimated that she would be able to use the fixtures for four years and then be able to sell them for $3000, Calculate the depreciation for each ofthe four years ofthe fitures' working life using the reducing balance method at the rate of 40% per annurn, s Cost 25000 Depreciation for year ended 30 June 20-4 at 4056 10000 Book value at July 20-4 15000 Depreciation for year ended 20 June 20-5 at 40% “6000 2 analy Book value at 1 July 20-5 3000 sree etinaieat Depreciation for year ended 30 June 20-6 at A0%6 3600 whole eoirs so emsy Bookvalue at July 20-6 400 Deoxys aut Deprecation for year ended 30 June 20-7 at 40% 2160 any cents Book value at 1 July 20-7 “3240 1 Advantages ofthe reducing balance methed af deprecation. 1 Itmatches costs with revenue. 2 Itisusetl for those non-

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