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Notes on depreciation

This document explains the concept of depreciation for non-current assets, including its causes, methods of calculation, and the accounting principles involved. It outlines various depreciation methods such as Straight Line, Reducing Balance, and Revaluation, along with examples of how to calculate annual depreciation charges. Additionally, it distinguishes between capital and revenue expenditure and emphasizes the importance of selecting the appropriate method for different types of assets.

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2 views

Notes on depreciation

This document explains the concept of depreciation for non-current assets, including its causes, methods of calculation, and the accounting principles involved. It outlines various depreciation methods such as Straight Line, Reducing Balance, and Revaluation, along with examples of how to calculate annual depreciation charges. Additionally, it distinguishes between capital and revenue expenditure and emphasizes the importance of selecting the appropriate method for different types of assets.

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Sam
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Depreciation of Non-Current Assets At the end of this chapter, you will be able to: © Understand the causes of depreciation. Calculate the annual depreciation charge using the straight lin revaluation methods. Evaluate the most appropriate method of calculating depreciation. fe, reducing balance ang current assets, Prepare ledger accounts and journal entries for the disposal of non: {including part exchange). Calculate the profit or loss on disposal of a non-current asset. Identify the accounting concepts which apply to depreciation: Non-Current Assets are purchased by a business in order to generate profits and are used for more than one financial year. Examples of non-current assets are premises, delivery van, machinery computers and buildings. A non-current asset (except land) has a limited useful life and hence should be depreciated. All assets that have finite useful lives should be depreciated. Depreciation should, therefore, be provided on all assets except freehold land which does not have a finite useful life. ‘The following costs can be included as part of the cost of a non-current asset when it is purchased, (a) ‘The initial purchase price (e) Installation and assembly costs (b) Any import duties (8 Cost of testing the asset (c) Cost of site preparation (g) Professional fees or legal fees (d) Initial delivery and handling costs (h) Sign writing on a vehicle 5.1 Capital and Revenue Expenditure ssets oF at Capital Expenditure is expenditure which results in the acquisitions of non-current a ; the improvement in their earning capacity. Capital expenditure is not charged as an expense income statement. Revenue expenditure, however, is charged to the Income Statement. Revenve expenditu is expenditure incurred in running a business on a day-to-day basis. It is als expendi iture incurred to maintain the earning capacity of non-current assets. Examples of revente expenditure are administration costs, repairs and electricity. 5.2 Depreciation One way of defining depreciation is to describe it as a means of spreading the cost of a non- Current asset over its useful life. In other words, depreciation is that part of the original cost of a non-culrrent asset that is consumed during its period of use by the business. In simple terms, depreciation js the loss in value of a non-current asset and is charged to the income statement. Depreciation is a non-cash expense IAS 16 views depreciation as a process of allocation and not valuation because in the statement of financial position non-current assets are shown at net book values (carrying values) and not at current market values. The cash payment of a non-current asset is made when the asset is purchased and the annual depreciation is that cost being spread over the lifetime of the asset. ‘The annual depreciation of the asset in subsequent years is a non-cash expense because it allocates costs to later years for a cash payment that has occurred previously. Hence, the annual depreciation, being a non-cash item, does not provide fund for the replacement of an asset when itis no longer in use. Assets may depreciate for a number of reasons: causes of depreciation ‘Wear and tear: Non-current assets inevitably decline with use. Obsolescence: An asset becomes out of date either through technological advances or a change in tastes and fashion Passage of time : Passage of time also reduces the value of an asset even if it is not used. Depletion: Depletion is used for wasting assets (mines). A wasting asset has a limited life. Usage : ‘This method apportions the cost of a non-current asset in relation to output and usage. 5.3 Methods of Depreciation ‘The three main methods of calculating depreciation are Straight Line Method , Reducing Balance Method and Revaluation Method. Straight Line Method This is the most commonly used method. A fixed amount is charged per annum to the Income Statement over the life of the asset. Depreciation under straight line is calculated as a fixed percentage on cost. Depreciation charge is the same each year and therefore assumes that the benefit is consumed evenly. Straight line method is useful for assets which provide equal benefit each year, suich as, machinery and fixtures and fittings. cost - residual value depreciation charge =» —COStTesidual value _ Annual depreciation charge = — ed useful life (years) BDL wie Reducing balance method ‘The reducing balance method of depreciation calculates the annual depreciation charge asa fixed percentage of the carrying value (net book value) of the asset, as at the end of the previous accounting period. The annual charge for depreciation is higher in the earlier yeats of the assets life and lower in the later years. In other words, a decreasing amount of depreciation is charged each year (o the income statement and so assumes that more benefit is consumed in earlier yea's Reducing balance method is useful for assets which provide more benefit in earlier years, fo example : computers and cars. A formula is required to calculate the rate of depreciation when the rate is not given. ns rate = (i -Vt ) 100 n= number of years Ss = scrap value c = cost 54 . £5) CamScanner Revaluation Method ‘The revaluation method is used when a non-current asset consists of many items each of small value making it impractical to calculate a depreciation charge on each item. The most common example of assets being depreciated using the revaluation method are loose tools in a large auto repair garage or in a construction works, Loose tools is the term used to describe small items of non-current assets which may individually be of limited value but taken together their value may become significant, Calculation of depreciation: $ Opening valuation ~ (Value ofthe items atthe start ofthe yeat) ‘Add any purchases during the year x xx Less closing valuation {Value of the items at the end of the year) (xx) Depreciation for the year xx Example 4 many small loose tools that are added to ot replaced regularly. At the company valued these loose tools at $3 800. During the yeat, dof the financial year, the estimated value ‘An engineering company uses the start of the financial year, new loose tools were purchased for $2 400. At the en was $4 100. Required Calculate the depreciation for the year of loose tools. | Answer s ning valuation 3.800 Piha 2400 | 6 200 | Closing valuation 4.100 | Depreciation charge forthe year _2 100 56 Selecting the Right Depreciation Method Providing for depreciation is an application of the matching

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