Introduction to Accounting Lecturer Troy J Wishart Summer Course ACT 110 Is EASY POP Our Confession And I am Going to get an A Depreciation Lecture Notes 6 ID: 684782
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Slide1
Assume the PositionSlide2
ACT 1100Introduction to Accounting
Lecturer: Troy J.
Wishart
Summer CourseSlide3
ACT 110Is EASY POP!
Our Confession
And
I am Going to get an “A”!Slide4
Depreciation
Lecture Notes 6Slide5
DepreciationDefinitionDepreciation is the measure of the: wearing out,
consumption
or
other reductions in the useful economic life of a fixed asset, whether arising from:use,
passage
of time or
obsolescence.Slide6
DepreciationDefinitionDepreciation is the term most often employed to indicate that tangible plant assets have declined in service potential
.
The term
tangible refers to physical assets within the business.
[
Keiso
& Weygandt 1990:543] Slide7
DepreciationDefinitionWhere natural resources, such as timber, gravel, oil and coal, are involved,
the term depletion is employed
.
[Keiso & Weygandt 1990:543] Slide8
DepreciationDefinitionThe expiration of intangible assets, such as patents, or goodwill is
called amortization
[
Keiso & Weygandt 1990:543] Slide9
DepreciationDepreciation in AccountingDepreciation is defined as:the accounting process of
allocating the cost
of tangible assets to
expensein a
systematic and rational
manner
to those periods expected to benefit from the use of the asset. [Keiso & Weygandt 1990:543] Slide10
DepreciationDepreciation in AccountingTo accountants, depreciation is not a matter of valuation but a means of cost allocation.
[Keiso
&
Weygandt
1990:543] Slide11
DepreciationDepreciation in AccountingAssets are
not depreciated
on the basis of a
decline in their fair market value, but on the basis of
systemic charges to expense
.
[Keiso & Weygandt 1990:543] Slide12
DepreciationDepreciation in the Financial StatementsUnless assets are depreciated their value may sometimes be overstated on the Balance Sheet
.
Assets must be depreciated so as to
give a true and fair value of the assets in the Balance Sheet.
[Whitehead 1974:215]Slide13
DepreciationDepreciation in the Financial StatementsAssets such as plant and machinery are held for the purpose of earning
income.
The
loss arising on those assets through wear and tear is undoubtedly an
expense against such income
.
[Garbutt 1976:0602]Slide14
DepreciationService Life – vs. – Physical LifeBasic differenceA piece of machinery may be physically capable of producing
a given product
for many years beyond its service life,
[Keiso & Weygandt 1990:544]Slide15
DepreciationService Life – vs. – Physical LifeBut the equipment is not used for all of those years because the cost of producing the product in later years may be too high. [
Keiso
&
Weygandt 1990:544]Slide16
DepreciationHow does an Asset Depreciate?Through wear and tear in useas in the case of machinery, furniture and fittings, loose tools, motor vans and other vehicles.
[
Favell
1977:104]Slide17
DepreciationHow does an Asset Depreciate?Through effluxion or passage of time
as
in the case of leases of factories and other buildings and of patent rights.
[Favell 1977:104]Slide18
DepreciationHow does an Asset Depreciate?Through obsolescence where,
for
example, a machine is rendered out of date through the invention of a more efficient machine.
[Favell 1977:104]Slide19
DepreciationDepreciation MethodsActivity Method
(
units or use or production)
Straight Line Method
(
Equal Instalment Method
)Slide20
DepreciationDepreciation MethodsDecreasing
Charge Methods
–
Sum-of-the-years digits
Declining-Balance method/Reducing Balance
MethodSlide21
DepreciationDepreciation MethodsSpecial
Depreciation Methods
–
Inventory Method
Retirement & Replacement Methods
Group & Composite Methods
Compound Interest MethodsSlide22
DepreciationActivity MethodThis method assumes that the asset has a useful life in terms of production hours.Formula
(
Cost Less Salvage) x
Production Measure this year Total Production MeasureSlide23
DepreciationStraight Line MethodUsing this method it is assumed that the net cost of the asset should be allocated equally over the useful life of the asset. Slide24
DepreciationStraight Line MethodTo determine depreciation for a period, the cost of the asset or value of the asset, its useful life and the estimated scrap value is required
.
Formula
Depreciation Charge = Cost – Scrap Value Useful LifeSlide25
DepreciationStraight Line MethodAdvantages
It is
easy to understand
and the calculations are simple.The valuation of the asset appearing on the balance sheet each year is reasonably fair
, Slide26
DepreciationStraight Line MethodAdvantages
Complies
with the Income Tax Act
in the vast majority of the cases.Slide27
DepreciationStraight Line MethodDisadvantage
The
charge to the Profit and Loss account increases over the years;
for in the first year or two repairs will be uncommon, but as the machine gets older it will require more frequent attention.Slide28
DepreciationSum-of –the year’s Digits Method This method also assumes that more of the net cost should be allocated in the earlier years
.
Using this method, we must first
find the sum of the total years, Slide29
DepreciationSum-of –the year’s Digits Method For Example - If the useful life is 5 years then the sum would be 5+4+3+2+1 = 15. If the life is
3 years
it would be 3+2+1 = 6.
The depreciation for year would be a fraction of the net cost.Slide30
DepreciationSum-of –the year’s Digits Method The remaining years as the numerator and total as the denominator.Formula
Depreciation Charge =
Remaining Years
x COST Sum of the YearsSlide31
DepreciationReducing Balance MethodThis method assumes that more of the cost of the asset should be allocated to the earlier years.Why?Maintenance would be low in earlier years and less in its later years when maintenance is higher.
How to Calculate Depreciation Charge
Using the reducing balance method multiply the rate by the balance at the beginning of the period and not the cost of the asset.Slide32
DepreciationReducing Balance MethodHow
to Calculate Depreciation Charge
Using the reducing balance method multiply the rate by the balance at the beginning of the period and not the cost of the asset.Slide33
DepreciationReducing Balance MethodFormula
Depreciation Charge =
Reduce Balance for the Year X Rate of DepreciationRate of Depreciation ROD = (1 – {n √s/c}) x 100%
n = expected useful/service life in years
s = salvage/residual/scrap value
c = the acquisition costSlide34
DepreciationReducing Balance MethodAdvantages
No recalculation is necessary
when additional assets are purchased.
[Whitehead 1974:218]Slide35
DepreciationReducing Balance MethodAdvantagesIt tends to give a fairly even charge against revenue each year.
For while depreciation is heavy during the first few years, this counterbalanced by the repairs being light.
In the later years, when repairs are heavy, this is counterbalanced by the decreasing charge for depreciation.Slide36
DepreciationReducing Balance MethodAdvantagesIn the later years, when repairs are heavy, this is counterbalanced by the decreasing charge for depreciation.Slide37
DepreciationReducing Balance MethodDisadvantagesThe percentage figure
to be calculated each year
is difficult to calculate.
(
Whitehead 1974:218).Slide38
DepreciationReducing Balance MethodDisadvantagesFor assets with a very short life, the
percentage figure is so high
that it becomes ridiculous.
(Whitehead 1974:218).Slide39
DepreciationDepreciation and Disposal PolicyIn addition to the basis or method of depreciation, the Disposal Policy adopted by the organisation is important.Slide40
DepreciationDepreciation and Disposal PolicyIt determines how depreciation is charged against profits for assets acquired and disposed
of during an accounting period.Slide41
DepreciationDepreciation and Disposal PolicySome of the policies that be adopted are:-
Full depreciation
in the year of
acquisition and none in the year of disposal.
Full depreciation
in the year of
disposal and none in the year of acquisition.Slide42
DepreciationDepreciation and Disposal PolicySome of the policies that be adopted are:-
Half
depreciation
in the year of acquisition and half in the year of disposal
Prorated depreciation
.Slide43
DepreciationDouble Entry For DepreciationThe double entry for depreciation:Credit the Accumulated Depreciation Account and
Debit
the
Profit and Loss Account With the Depreciation Charged for the period Slide44
DepreciationComparison of MethodsLecture Notes 6Slide45
DepreciationComparison of Straight Line to Reducing Balance MethodExercise – A firm has just bought a Machine for $8,000. It will be kept in use for four years and then it will be disposed of for an estimated amount of $500. The firm asks for a comparison of the amounts charged as depreciation using both methods.For the straight line method, a figure of ($8,000 - $500) ÷ 4 = $1,875 per annum is to be used.
For the reducing balance method
, a percentage figure of 50% will be used.Slide46
DepreciationComparison of Straight Line to Reducing Balance MethodStraight Line Method Reducing Balance Method
Cost Price 8,000
Depreciation Y1
1,875
Net Book Value 6,125
Depreciation Y2
1,875Net Book Value 4,250Depreciation Y3 1,875Net Book Value 2,375Depreciation Y4 1,875 500Cost Price 8,000Dep. Y1 – 50% 4,000Net Book Value 4,000Dep. Y2 – 50% 2,000Net Book Value 2,000
Dep. Y3 – 50%
1,000
Net Book Value 1,000
Dep. Y4 – 50%
500
Net Book Value
500Slide47
Depreciation Double Entry and Posting
Lecture Notes 6Slide48
DepreciationDouble Entry For DepreciationThe double entry for depreciation:Credit the Accumulated Depreciation Account and Debit
the
Profit and Loss
Account With the Depreciation Charged for the period
Accumulated Depreciation
–
Total depreciation provided on asset from date of purchase to date on current balance sheetSlide49
DepreciationDouble Entry For DepreciationAccumulated Depreciation
–
Total depreciation
provided on asset from date of purchase to date on current balance sheetSlide50
DepreciationPosting DepreciationExercise – In a business belonging to L Heywood with the financial years ending December 31 a machine is bought for $20,000 on January 1, 2011. It is to be depreciated at the rate of 20% using the Reducing balance method.Step 1 – Calculate Depreciation
Cost Price 20,000
Dep. Y1 – 20%
4,000Net Book Value 16,000Dep. Y2 – 20%
3,200
Net Book Value 12,800
Dep. Y3 – 20% 2,560Net Book Value 10,240Slide51
DepreciationPosting DepreciationStep 2 – Post Accumulated Depreciation Account
2011
2012
2013
2014
2011
2012
2013
2014
Accumulated Depreciation Account
Dec 31
Balance c/d
4,000
Dec 31
Profit and Loss A/c
4,000
Balance b/d
4,000
Jan 1
Dec 31
Profit and Loss A/c
3,200
Dec 31
Balance c/d
7,200
7,200
7,200
Balance b/d
7,200
Jan 1
Dec 31
Profit and Loss A/c
2,560
Dec 31
Balance c/d
9,760
9,760
9,760
Balance b/d
9,760
Jan 1Slide52
DepreciationPosting DepreciationStep 2 – Post to Profit and Loss Account Extract
L Hart
Profit and Loss Account Extract
2011
2012
Depreciation
4,000
Depreciation
3,200
2013
Depreciation
2,560Slide53
DepreciationPosting DepreciationStep 3 – Charge Accumulated Depreciation against Assets in Balance SheetL Hart Balance Sheet (Extracts) .
As at December 31, 2011
Machinery at Cost 20,000
Less Depreciation to date 4,000Net Book Value 16,000
As at December 31, 2012
Machinery at Cost 20,000
Less Depreciation to date 7,200Net Book Value 12,800As at December 31, 2013Machinery at Cost 20,000Less Depreciation to date 9,760Net Book Value 10,240Slide54
Depreciation & DisposalsLecture Notes 6Slide55
DepreciationDisposal of an AssetWhen an asset has reached the end of its useful life the company will
either dispose of the asset or donate it
.
The asset may have
reached the end of its useful life
but
may still have service life.Slide56
DepreciationDisposal of an AssetAs such it will be sold at its fair market valueThe sale or disposal may result in a:
Gain on Sale
– Sale Price > Net Book Value
Loss on Sale
– Sale Price < Net Book ValueSlide57
DepreciationDisposal of an AssetThe gain or loss should be accounted for along with the removal of the assets and depreciation from the books of accounts.Slide58
DepreciationDisposal of an Asset – Accounting EntriesTransfer the cost of the Asset sold to Disposal Account
Debit
Assets Disposal Account
Credit
Asset
AccountSlide59
DepreciationDisposal of an Asset – Accounting EntriesTransfer total depreciation of asset to Disposal A/c
Debit
Accumulated Depreciation Account
Credit
Assets Disposal
AccountSlide60
DepreciationDisposal of an Asset – Accounting EntriesRecord Receipt of money for asset sold
Debit
Cash Account
Credit Assets Disposal AccountSlide61
DepreciationDisposal of an Asset – Accounting EntriesDetermine if there is a gain or loss on Sale of Asset (Difference or balance on Disposal Account)Slide62
DepreciationDisposal of an Asset – Accounting EntriesIf the account shows a credit balance, it is a
gain
on sale:
Debit Assets Disposal Account
Credit
Profit and Loss AccountSlide63
DepreciationDisposal of an Asset – Accounting EntriesIf the account shows a debit balance, it is a
Loss
on sale:
Debit Profit and Loss Account
Credit
Assets Disposal Account