1 depreciation. 2 concept and definition of depreciation causes of depreciation

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DEPRECIATION

2

DEPRECIATION

• CONCEPT AND DEFINITION OF DEPRECIATION

• CAUSES OF DEPRECIATION

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LEARNING OUTCOMES:

• understand the concept and definition of depreciation.

• relate depreciation to National Education.

• understand and explain the causes of depreciation.

At the end of the lesson, students should be able to:

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FIXED ASSETS

• Assets acquired not for resale.

Examples :

- A printing machine in a printing company.

- A van in a courier service company.

• Help to earn revenue for more than 1 financial year.

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• The portion of the cost allocated to a particular accounting period is charged as an expense against revenue (Matching principle).

DEFINITION OF DEPRECIATION

• Applies only to fixed assets.

• The whole cost of the fixed assets must be spread over its useful life.

• This portion of the cost is called Depreciation.

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CAUSES OF DEPRECIATION

Physical Deterioration

Obsolescence

Depletion of an asset

Passage of Time

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• Caused by physical wear and tear - rust, erosion, rot and decay

Examples - office furniture

- printing machines

PHYSICAL DETERIORATION

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• Fixed assets become out-of-date

- when new model or more efficient tool come into existence.

Examples - cars

- computers

OBSOLESCENCE

Pentium I

Pentium IV

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Examples - Gold mines

- Quarries - Little Guilin is a depleted granite quarry now turned into a beautiful lake.

DEPLETION OF FIXED ASSETS

• An asset that depletes over time as resources are extracted from it. Little Guilin

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• Some assets confer upon their holders the exclusive rights to enjoy certain privileges for a fixed period of time.

PASSAGE OF TIME

Examples - copyrights

- patent rights

- leases on land

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NATIONAL EDUCATION

• 10-year depreciation policy on all vehicles including buses in Singapore.

Very high depreciation.

• Buses are in good condition and comfortable.

• Majority of people move around by bus.

• Few breakdowns, less traffic jam and air pollution.

An excellent public transport.

• No one owes us a living

We must appreciate it and work hard for the nation.

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HOMEWORK

• GCE ‘O’ Level Principles of Accounts Nov 2000 Q2(b).

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STRAIGHT LINE

METHOD OF

DEPRECIATION

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LEARNING OUTCOMES:

• record depreciation in the books using the Provision for Depreciation method.

• calculate depreciation using Straight Line method.

• understand the advantages and disadvantages of Straight Line Depreciation method.

• understand the features of Straight Line Depreciation method.

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• Revaluation

METHODS OF DEPRECIATION

• Straight-Line

• Reducing Balance

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• A fixed asset is depreciated by an equal amount per year.

STRAIGHT LINE METHOD

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 secondyear; $1,000 in the third year and this continues annuallyuntil it is fully depreciated.

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• Advantages


•Disadvantage

- Easy to understand.

- Easy to calculate.

- Assumes fixed asset gives same amount of service annually throughout its useful life.

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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.

Original cost - Residual value Expected useful life

Depreciation per year =

= $4,500

STRAIGHT LINE METHOD (I)

= 20,000 - 2000

4

( Scrap value is the same as residual value.)

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A printing machine costs $17,000 is expected to last 5 years.At the end of the 5th year, it can be sold for $2,000 as scrap.

Original cost - Residual value Expected useful life

STRAIGHT LINE METHOD (I)


= $3,000

= 17,000 - 2,000

5

20

An office equipment costs $5,000 is expected to depreciate by20% per annum.

= 20 100

= $1,000.

STRAIGHT LINE METHOD (II)

X 5,000

Rate of depreciation x Original costDepreciation per year =

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An office equipment costs $25,000 is expected to depreciate by10% per annum.

.

= $2,500

STRAIGHT LINE METHOD (II)


= 10 100

Rate of depreciation x original cost

X 25,000

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CALCULATION OF RATE OF DEPRECIATION:

Rate of depreciation =

= 500

= 10%

Depreciation of machine X = $500.Original cost of machine X = $5,000.

X 1005,000

Depreciation x 100%Original cost

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Mach. Cost Scrap value Useful life Annual dep. Rate of dep.

X $5,000 Nil 10 years

Y $10,000 $1,000 5 years

Z $8,000 Nil 5 years

$500

$1,800

$1,600

10%

18%

20%

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X $1,500 Nil 5 years

Y $5,000 $500 10 years

Z $10,000 $1,000 18 years

$300 20%

$450 9%

$500 5%

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X $10,000 $1,000 10 years

$400

5 years $200

$900 9%

4 years 25%

Nil 20%

Y $1,600 Nil

Z $1,000

y zNext table

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MACHINE Y

Depreciation = Original cost - scrap value Useful life 400 = 1,600 - 0

Useful life

Useful life = 1,600 400

= 4 years

Original cost = $1,600Scrap value = nilDepreciation = $400

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MACHINE Z

Depreciation = Original cost - scrap value Useful life

200 = 1,000 - scrap value 5

1,000 = 1,000 - scrap value

Scrap value = 0

Original cost = $1,000Useful life = 5 yearsDepreciation = $200

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A $2,000 Nil $250

9 years

20%

B $5,000 $500 10% C Nil 5 years $800

A B

8 years 12.5%

$500

$4,000

CRecord depreciation

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MACHINE A

Depreciation = Original cost - scrap value Useful life 250 = 2,000 - 0

Useful life

Useful life = 2,000 250

= 8 years

Original cost = $2,000Scrap value = nilDepreciation = $250

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MACHINE B

Depreciation = Rate of depreciation x Original cost

500 = 5,000 - 500 Useful life Useful life = 4,500

500

= 9 years

Original cost = $5,000Scrap value = $500Rate of Depreciation = 10%

= 10 x 5,000 100

= $500


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MACHINE C


800 = Original cost - 0 5

Original cost = 800 x 5

= $4,000

Useful life = 5 yearsScrap value = nilDepreciation = $800

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Example:

An office equipment was bought for $16,000 on 1 Jan 1999.It is expected to have a useful life of 8 years with zero residualvalue. Using straight line depreciation method, show the records on your books for 2 years.

RECORDINGDEPRECIATION IN THE BOOKS- Provision for depreciation method

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Office equipment

1999 Jan 1 Bank $16,000

1999Dec 31 Bal. c/d $16,000

2000Jan 1 Bal. b/d $16,000

2000Dec 31 Bal.c/d $16,000

2001Jan 1 Bal. b/d $16,000

B/S

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Depreciation - office equipment

1999 Dec 31 Prov. for dep. $2,000

Provision for depreciation - office equipment

1999 Dec 31 Bal. c/d $2,000

1999Dec 31 P&L a/c $2,000

1999Dec 31 Depreciation $2,000

2000Dec 31 Prov.for dep. $2,000

2000Dec 31 P&L a/c $2,000

2000Jan 1 Bal. b/d $2,000

2000Dec 31 Bal. c/d $4,000

2001Jan 1 Bal. b/d $4,000

Dec31 Depreciation 2,000

B/S

P&L

$4,000 $4,000

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P & L a/c for year ended 31 Dec 1999




Dep

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Balance Sheet as at 31 Dec 1999

Fixed assetOffice equipment $16,000


Fixed assetOffice equipment $16,000 Less Prov. for dep. 2,000 $14,000

Less Prov. For dep. 4,000 $12,000

DepO/E

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• Provision for Depreciation account shows accumulated depreciation of fixed asset.

IMPORTANT FEATURES:

• Fixed asset account shows original cost of asset.

• Net book value of fixed asset (in Balance Sheet) is original cost less Provision for Depreciation.

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HOMEWORK

• Textbook Betsy Li p319 Q7.

• GCE ‘O’ Level Principles of Accounts November 1998 Section B Q7.

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REDUCING

(OR DIMINISHING)

BALANCE METHOD OF

DEPRECIATION

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LEARNING OUTCOMES:


• calculate depreciation using Reducing Balance method.

• understand the advantages and disadvantages of Reducing Balance Depreciation method.

• understand the features of Reducing Balance Depreciation method.

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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.

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•Advantage


•Disadvantages

- Overall expenses ( including repairs and maintenance) charged for the use of a fixed asset would be fairly constant.

- Assets are always left with a small value at the end of useful life.

- Difficult to calculate.

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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.

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A machine Y costs $10,000 is depreciated at 20% per annumon the reducing balance method. Show depreciation for the first 3 years.

Net Book Value Depreciation

Year 1

Year 2

Year 3

20 100

X 10,000

20 100

X 8,000

20 100

X 6,400

= $2,000 $10,000-2,000=$8,000

= $1,600 $10,000-3,600= $6,400

= $1,280 $10,000-4,880=$5,120


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An office equipment costs $15,000 is depreciated at 10% per annum on the reducing balance method. Show depreciation for the first 3 years.

DepreciationNet BookValue

Year 1

Year 2

Year 3

10 100

X 15,000 = $1,500 $13,500

10100

X 13,500 = $1,350 $12,150

10 100

X 12,150 = $1,215 $10,935

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REDUCING BALANCE METHODComplete the missing items in the table:

Mach CostDate ofpurchase

Annual depreciation for the year ended31 Dec 2000

Rate of depreciation

X $5,000 1.1.2000 10%

Y $10,000 1.1.1999 15%

Z $12,000 1.1.1998 10%

$500

$1,275

$972

yzNEXT TABLE

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Machine YCost = $10,000Date of purchase = 1.1.1999Rate of depreciation = 15%

Depreciation Net Book ValueYr ended

31.12.1999 15100 X 10,000 $10,000-1,500=$8,500

31.12.2000 15100

X 8,500 $10,000-2,775= $7,225

= $1,500

= $ 1,275

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Machine ZCost = $12,000Date of purchase = 1.1.1998Rate of depreciation = 10%


31.12.1998 10100

X 12,000 $12,000-1,200=$10,800

31.12.1999 10100

X 10,800 $12,000-2,280=$9,720

31.12.2000 10100

X 9,720 $12,000-3,252=$8,748

= $1,200

= $ 1,080

= $972

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Complete the missing items in the table:

Mach CostDate ofpurchase

Annual depreciation for the year ended31 Dec 2000

Rate of depreciation

X $6,000 1.1.1999 15%

Y $8,000 1.1.1998 20%

Z $15,000 1.1.1997 10%

$765

$1,024

$1093.50

Recording depreciationX

YZ

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Machine XCost = $6,000Date of purchase = 1.1.1999Rate of depreciation = 15%


31.12.1999 15100 X 6,000 $6,000-900=$5,100

31.12.2000 15100

X 5,100 $6,000-1,665= $4,335

= $900

= $765

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Machine YCost = $8,000Date of purchase = 1.1.1998Rate of depreciation = 20%


31.12.1998 20100

X 8,000 $8,000-1,600=$6,400

31.12.1999 20100

X 6,400 $8,000-2,880=$5,120

31.12.2000 20100

X 5,120 $8,000-3,904=$4,096

= $1,600

= $ 1,280

= $1,024

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REDUCING BALANCE METHODMachine ZCost = $15,000Date of purchase = 1.1.1997Rate of depreciation = 10%

Yr ended Depreciation Net Book Value

31.12.1998 10100 X 13,500 $15,000 - 2,850 = $12,150

31.12.1999 10100 X 12,150 $15,000 - 4,065 = $10,935

31.12.2000 10100

X 10,935 $15,000 -5,158.50=$9,841.50

= $1,350

= $ 1,215

= $1,093.50

31.12.1997 10 100

X 15,000 = $1,500 $15,000 - 1,500 = $13,500

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Example:

An office equipment was bought for $10,000 on 1 Jan 1999.It is depreciated at 10% per annum on the reducing balancemethod. Show the records on your books for 2 years.

RECORDING DEPRECIATION IN THE BOOKS - Provision for depreciation method

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Depreciation (10%) Net Book Value

31.12.1999

31.12.2000

A machine costs $10,000 is depreciated at 10% per annumon the reducing balance method.

10 x 10,000 = $1,000 100

10 x 9,000 = $900 100

$10,000 -1,000=$9,000

$10,000 -1,900 = $8,100

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Office equipment

1999 Jan 1 Bank $10,000

1999Dec 31 Bal. c/d $10,000

2000Jan 1 Bal. b/d $10,000

2000Dec 31 Bal.c/d $10,000

2001Jan 1 Bal. b/d $10,000

B/S

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1999 Dec 31 Prov. for dep. $1,000


1999 Dec 31 Bal. c/d $1,000

1999Dec 31 P&L a/c $1,000


2000Dec 31 Prov.for dep. $900

2000Dec 31 P&L a/c $900

2000Jan 1 Bal. b/d $1,000

2000Dec 31 Bal. c/d $1,900

2001Jan 1 Bal. b/d $1,900

Dec31 Depreciation 900

B/S

P&L

$1,900 $1,900

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2000Dec 31 Depreciation $900

Dep

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DepO/E

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IMPORTANT FEATURES:


• Book value of fixed asset (in Balance Sheet) is original cost less Provision for Depreciation.

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HOMEWORK

• Textbook Betsy Li - p318 Q4 - p320 Q9

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REVALUATION

METHOD OF

DEPRECIATION

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LEARNING OUTCOMES:


• calculate depreciation using Revaluation method.

• understand the advantages and disadvantages of Revaluation method of Depreciation.

• understand the features of Revaluation method of Depreciation.

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• The fixed asset is revalued at the end of every accounting period.

REVALUATION METHOD

• The amount of depreciation varies every year.

• Depreciation is the difference between the value of the fixedasset at the beginning and end of the accounting period.

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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.

REVALUATION METHOD

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•Advantage

REVALUATION METHOD

•Disadvantage

- Fixed asset is shown at current or realisable value.

- Time consuming and costly to value the fixed asset.

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Cost of printing machine on 1 Jan 2000 = $15,000.Market value on 31 Dec 2000 = $13,000.

REVALUATION METHOD (I)

Depreciation of printing machine for FY2000

= cost on 1 Jan 2000

= 15,000 – 13,000

= $2,000

– market value on 31 Dec 2000

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Market value of printing machine on 1 Jan 2000 = $22,000.Market value on 31 Dec 2000 = $19,000.


Depreciation of printing machine for FY2000

= Market value on 1 Jan 2000

= 22,000 – 19,000

= $3,000

– Market value on 31 Dec 2000

68


Complete the missing items:

Mach Cost or value Market value Depreciation on 1.1.2000 on 31.12.2000 for FY2000

X

Y

Z

$6,000 $4,800

$3,200 $2,500

$5,600 $4,000

$1,200

$700

$1,600

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Complete the missing items:

Mach Cost or value Market value Depreciation on 1.1.2000 on 31.12.2000 for FY2000

X

Y

Z

$9,000 $6,200

$6,300 $4,500

$7,500 $5,500

$2,800

$1,800

$2,000

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REVALUATION METHOD (II)

Depreciation expense

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 purchasesand this has to be taken into account when calculating depreciation.

= Value of asset at the beginning

- Value of asset at the end

+ Any new purchases

71

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.



= Value of tools on 1 Jan 2000

= 2,000

= $400

- Value of tools on 31 Dec 2000

+ New purchases

- 2,600 + 1,000

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On 1 Jan 2000 loose tools in the workshop were valued at $3,500. During the year, tools worth $1,500 were bought.On 31 Dec 2000, the estimated market value of the tools was$3,000.



= Value of tools on 1 Jan 2000

= 3,500

= $2,000

- Value of tools on 31 Dec 2000

+ New purchases

- 3,000 + 1,500

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RECORDINGDEPRECIATION IN THE BOOKS- Provision for depreciation method

Example:

An office equipment was bought for $8,000 on 1 Jan 1999.It is depreciated on the revaluation method. The marketvalues of the office equipment are shown below.Show the records on your books for 2 years.

Market value as at 31.12.1999 $6,800Market value as at 31.12.2000 $5,800

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REVALUATION METHOD

Yr 1

Depreciation = cost on 1.1.1999 - Market value on 31.12.1999

= $8,000 - $6,800 = $1,200

Yr 2

Depreciation = Market value on 1.1.2000 - Market value on 31.12.2000

= $6,800 - $5,800 = $1,000

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Office equipment

1999 Jan 1 Bank $8,000

1999Dec 31 Bal. c/d $8,000

2000Jan 1 Bal. b/d $8,000

2000Dec 31 Bal.c/d $8,000

2001Jan 1 Bal. b/d $8,000

B/S

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1999 Dec 31 Prov. for dep. $1,200


1999 Dec 31 Bal. c/d $1,200

1999Dec 31 P&L a/c $1,200


2000Dec 31 Prov.for dep. $1,000

2000Dec 31 P&L a/c $1,000

2000Jan 1 Bal. b/d $1,200

2000Dec 31 Bal. c/d $2,200

2001Jan 1 Bal. b/d $2,200

Dec31 Depreciation 1,000

B/S

P&L

$2,200 $2,200

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Dep

78






DepO/E

79


IMPORTANT FEATURES:


• Book value of fixed asset (in Balance Sheet) is original cost less Provision for Depreciation.

80

COMPARE THE 3 METHODS OF DEPRECIATION

Depreciation amount per successive year

Depreciation mtds Constant Decrease Increase

Straight Line

Reducing Balance Revaluation *

X

X

X X X

*Depreciation can either be constant, decrease or increase with everysuccessive year depending on the valuation of the fixed asset at theend of the accounting period.

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HOMEWORK

• Textbook Betsy Li p318 Q6.

• GCE ‘O’ Level Principles of Accounts June 1997 Q3(b) & (c).

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THE END

1 depreciation. 2 concept and definition of depreciation causes of depreciation

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