8 Depreciation

1. DEPRECIATION

2. FIXED ASSETS • Assets acquired not for resale. • Help to earn revenue for more than 1 financial year. • Examples : • - A printing machine in a printing company. • - A van in a courier service company.

3. DEFINITION OF DEPRECIATION • Applies only to fixed assets. • The whole cost of the fixed assets must be spread over • its useful life. • The portion of the cost allocated to a particular accounting • period is charged as an expense against revenue • (Matching principle). • This portion of the cost is called Depreciation.

4. CAUSES OF DEPRECIATION • Physical Deterioration • Obsolescence • Depletion of an asset • Passage of Time

5. PHYSICAL DETERIORATION • Caused by physical wear and tear • - rust, erosion, rot and decay Examples - office furniture - printing machines

6. Pentium I Pentium IV OBSOLESCENCE • Fixed assets become out-of-date - when new model or more efficient tool come into existence. Examples - cars - computers

7. DEPLETION OF FIXED ASSETS • An asset that depletes over time as resources • are extracted from it. Little Guilin Examples - Gold mines - Quarries - Little Guilin is a depleted granite quarry now turned into a beautiful lake.

8. PASSAGE OF TIME • Some assets confer upon their holders the • exclusive rights to enjoy certain privileges • for a fixed period of time. Examples - copyrights - patent rights - leases on land

9. METHODS OF DEPRECIATION • Straight-Line Units-of-output • Reducing Balance Double-declining-balance • Revaluation Sum-of-the-years'-digits

10. STRAIGHT LINE METHOD • A fixed asset is depreciated by an equal amount per year. Example: If an asset is depreciated by $1,000 in the first full year of usage, it will also be depreciated by $1,000 in the second year; $1,000 in the third year and this continues annually until it is fully depreciated.

11. STRAIGHT LINE METHOD • Advantages - Easy to calculate. - Easy to understand. • Disadvantage - Assumes fixed asset gives same amount of service annually throughout its useful life.

12. = STRAIGHT LINE METHOD (I) A machine X costs $20,000 is expected to last 4 years. At the end of the 4th year, it can be sold for $2,000 as scrap. ( Scrap value is the same as residual value.) Original cost - Residual value Expected useful life Depreciation per year = 20,000 - 2000 4 = $4,500

13. Balance Sheet as at 31 Dec 1999 Fixed asset Office equipment $16,000 Less Prov. for dep. 2,000 $14,000 Balance Sheet as at 31 Dec 2000 Fixed asset Office equipment $16,000 Less Prov. For dep. 4,000 $12,000 Dep O/E

14. IMPORTANT FEATURES: • Fixed asset account shows original cost of asset. • Provision for Depreciation account shows • accumulated depreciation of fixed asset. • Net book value of fixed asset (in Balance Sheet) • is original cost less Provision for Depreciation.

15. REDUCING BALANCE METHOD OF DEPRECIATION

16. REDUCING BALANCE METHOD • The amount of depreciation per year diminishes with • every successive year. Example: - If an asset is depreciated by $2,000 in the first full year of usage, it will be depreciated by less than $2,000 (eg $1,600) in the second year; and even less (eg $1,300) in the third year. This continues until it is fully depreciated.

17. REDUCING BALANCE METHOD • Advantage - Overall expenses ( including repairs and maintenance) charged for the use of a fixed asset would be fairly constant. • Disadvantages - Difficult to calculate. - Assets are always left with a small value at the end of useful life.

18. REDUCING BALANCE METHOD Depreciation per year = Rate of depreciation X Net book value at beginning of accounting period Net book value = Original cost - Accumulated depreciation Accumulated depreciation is the sum of the yearly depreciation.

19. REDUCING BALANCE METHOD A machine Y costs $10,000 is depreciated at 20% per annum on the reducing balance method. Show depreciation for the first 3 years. Net Book Value Depreciation 20 100 Year 1 Year 2 Year 3 X 10,000 = $2,000 $10,000-2,000=$8,000 20 100 X 8,000 = $1,600 $10,000-3,600= $6,400 20 100 $10,000-4,880=$5,120 X 6,400 = $1,280

20. REVALUATION METHOD OF DEPRECIATION

21. Depreciation is the difference between the value of the fixed asset at the beginning and end of the accounting period. REVALUATION METHOD • The fixed asset is revalued at the end of every accounting • period. • The amount of depreciation varies every year.

22. REVALUATION METHOD Example: - An asset can be depreciated by $1,000 in the first full year of usage, it can be depreciated by a different amount in the second year (eg $500 ); and a different amount in the third year (eg $1,200 ) depending on the valuation at the end of the accounting period and the cost or valuation at the beginning of the accounting period.

23. REVALUATION METHOD • Advantage - Fixed asset is shown at current or realisable value. • Disadvantage - Time consuming and costly to value the fixed asset.

24. REVALUATION METHOD (I) Cost of printing machine on 1 Jan 2000 = $15,000. Market value on 31 Dec 2000 = $13,000. Depreciation of printing machine for FY2000 = cost on 1 Jan 2000 – market value on 31 Dec 2000 = 15,000 – 13,000 = $2,000

25. REVALUATION METHOD (II) This method is normally used for loose tools where it is difficult to estimate the rate of depreciation. The value of the asset may be inflated by new purchases and this has to be taken into account when calculating depreciation. Depreciation expense = Value of asset at the beginning - Value of asset at the end + Any new purchases

26. REVALUATION METHOD (II) On 1 Jan 2000 loose tools in the workshop were valued at $2,000. During the year, tools worth $1,000 were bought. On 31 Dec 2000, the estimated market value of the tools was $2,600. Depreciation expense = Value of tools on 1 Jan 2000 - Value of tools on 31 Dec 2000 + New purchases - 2,600 + 1,000 = 2,000 = $400

27. THE UNITS-OF-OUTPUT METHOD

28. THE DOUBLE-DECLINING BALANCE METHOD

29. THE SUM-OF-THE-YEARS'-DIGITS METHOD