assume the position. act 1100 introduction to accounting lecturer: troy j. wishart summer course
TRANSCRIPT
Assume the Position
ACT 1100
Introduction to Accounting
Lecturer: Troy J. Wishart
Summer Course
ACT 110Is EASY
POP!
Our Confession
And I am Going to get an “A”!
Depreciation
Lecture Notes 6
Depreciation
DefinitionDepreciation 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.
Depreciation
Definition• Depreciation 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]
Depreciation
Definition• Where natural resources, such as
timber, gravel, oil and coal, are involved, the term depletion is employed.
[Keiso & Weygandt 1990:543]
Depreciation
Definition• The expiration of intangible assets,
such as patents, or goodwill is called amortization
[Keiso & Weygandt 1990:543]
Depreciation
Depreciation in Accounting• Depreciation is defined as:
the accounting process of allocating the cost of tangible assets to expense
in a systematic and rational manner to those periods expected to
benefit from the use of the asset.
[Keiso & Weygandt 1990:543]
Depreciation
Depreciation in Accounting• To accountants, depreciation is not
a matter of valuation but a means of cost allocation.
•
[Keiso & Weygandt 1990:543]
Depreciation
Depreciation in Accounting• Assets 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]
Depreciation
Depreciation in the Financial Statements
• Unless 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]
Depreciation
Depreciation in the Financial Statements
• Assets 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]
Depreciation
Service Life – vs. – Physical Life• Basic difference
A piece of machinery may be physically capable of producing a given product for many years beyond its service life,
[Keiso & Weygandt 1990:544]
Depreciation
Service Life – vs. – Physical Life• But 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]
Depreciation
How does an Asset Depreciate?• Through wear and tear in use
as in the case of machinery, furniture and fittings, loose tools, motor vans and other vehicles.
[Favell 1977:104]
Depreciation
How 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]
Depreciation
How 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]
Depreciation
Depreciation Methods1. Activity Method • (units or use or production)
2. Straight Line Method • (Equal Instalment Method)
Depreciation
Depreciation Methods3. Decreasing Charge Methods –
a) Sum-of-the-years digitsb) Declining-Balance
method/Reducing Balance Method
Depreciation
Depreciation Methods3. Special Depreciation Methods –
a) Inventory Methodb) Retirement & Replacement
Methodsc) Group & Composite Methodsd) Compound Interest Methods
Depreciation
Activity Method
• This 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 Measure
Depreciation
Straight Line Method• Using this method it is assumed
that the net cost of the asset should be allocated equally over the useful life of the asset.
Depreciation
Straight Line Method
• To 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 Life
Depreciation
Straight 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,
Depreciation
Straight Line MethodAdvantages• Complies with the Income Tax Act
in the vast majority of the cases.
Depreciation
Straight 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.
Depreciation
Sum-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,
Depreciation
Sum-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.
Depreciation
Sum-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 Years
Depreciation
Reducing Balance Method• This 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.
Depreciation
Reducing 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.
Depreciation
Reducing Balance MethodFormula• Depreciation Charge =
Reduce Balance for the Year X Rate of Depreciation
Rate of Depreciation • ROD = (1 – {n √s/c}) x 100%– n = expected useful/service life in years– s = salvage/residual/scrap value– c = the acquisition cost
Depreciation
Reducing Balance MethodAdvantages• No recalculation is necessary
when additional assets are purchased. [Whitehead 1974:218]
Depreciation
Reducing Balance MethodAdvantages• It 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.
Depreciation
Reducing Balance MethodAdvantages
In the later years, when repairs are heavy, this is counterbalanced by the decreasing charge for depreciation.
Depreciation
Reducing Balance MethodDisadvantages• The percentage figure to be
calculated each year is difficult to calculate.
(Whitehead 1974:218).
Depreciation
Reducing Balance MethodDisadvantages• For assets with a very short life,
the percentage figure is so high that it becomes ridiculous.
(Whitehead 1974:218).
Depreciation
Depreciation and Disposal Policy• In addition to the basis or
method of depreciation, the Disposal Policy adopted by the organisation is important.
Depreciation
Depreciation and Disposal Policy• It determines how depreciation is
charged against profits for assets acquired and disposed of during an accounting period.
Depreciation
Depreciation and Disposal PolicySome of the policies that be adopted are:-
1. Full depreciation in the year of acquisition and none in the year of disposal.
2. Full depreciation in the year of disposal and none in the year of acquisition.
Depreciation
Depreciation and Disposal PolicySome of the policies that be adopted are:-
3. Half depreciation in the year of acquisition and half in the year of disposal
4. Prorated depreciation.
Depreciation
Double Entry For Depreciation• The double entry for depreciation:
Credit the Accumulated Depreciation Account and
Debit the Profit and Loss Account • With the Depreciation Charged
for the period
DepreciationComparison of Methods
Lecture Notes 6
Depreciation
Comparison of Straight Line to Reducing Balance Method• Exercise – 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.
Depreciation
Comparison of Straight Line to Reducing Balance Method
Straight Line Method Reducing Balance MethodCost Price 8,000
Depreciation Y1 1,875Net Book Value 6,125Depreciation Y2 1,875Net Book Value 4,250Depreciation Y3 1,875Net Book Value 2,375Depreciation Y4 1,875
500
Cost Price 8,000Dep. Y1 – 50% 4,000Net Book Value 4,000Dep. Y2 – 50% 2,000Net Book Value 2,000Dep. Y3 – 50% 1,000Net Book Value 1,000Dep. Y4 – 50% 500Net Book Value 500
Depreciation Double Entry and Posting
Lecture Notes 6
Depreciation
Double Entry For Depreciation• The 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 sheet
Depreciation
Double Entry For Depreciation• Accumulated Depreciation – Total
depreciation provided on asset from date of purchase to date on current balance sheet
Depreciation
Posting 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 DepreciationCost Price 20,000Dep. Y1 – 20% 4,000Net Book Value 16,000Dep. Y2 – 20% 3,200Net Book Value 12,800Dep. Y3 – 20% 2,560Net Book Value 10,240
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 4,000Jan 1Dec 31 Profit and Loss A/c 3,200Dec 31 Balance c/d
7,2007,2007,200
Balance b/d 7,200Jan 1Dec 31 Profit and Loss A/c 2,560Dec 31 Balance c/d
9,7609,7609,760
Balance b/d 9,760Jan 1
DepreciationPosting DepreciationStep 2 – Post to Profit and Loss Account Extract
L HartProfit and Loss Account Extract
2011
2012
Depreciation 4,000
Depreciation 3,200
2013 Depreciation 2,560
DepreciationPosting DepreciationStep 3 – Charge Accumulated Depreciation against Assets in Balance Sheet
L Hart Balance Sheet (Extracts)
. As at December 31, 2011
Machinery at Cost 20,000Less Depreciation to date 4,000Net Book Value 16,000
As at December 31, 2012
Machinery at Cost 20,000Less Depreciation to date 7,200Net Book Value 12,800
As at December 31, 2013
Machinery at Cost 20,000Less Depreciation to date 9,760Net Book Value 10,240
Depreciation & DisposalsLecture Notes 6
Depreciation
Disposal of an Asset• When 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.
Depreciation
Disposal of an Asset• As such it will be sold at its fair
market value• The sale or disposal may result in a:
Gain on Sale – Sale Price > Net Book Value
Loss on Sale – Sale Price < Net Book Value
Depreciation
Disposal of an Asset• The gain or loss should be
accounted for along with the removal of the assets and depreciation from the books of accounts.
Depreciation
Disposal of an Asset – Accounting Entries
1. Transfer the cost of the Asset sold to Disposal Account
Debit Assets Disposal AccountCredit Asset Account
Depreciation
Disposal of an Asset – Accounting Entries
2. Transfer total depreciation of asset to Disposal A/cDebit Accumulated Depreciation
AccountCredit Assets Disposal Account
Depreciation
Disposal of an Asset – Accounting Entries
3. Record Receipt of money for asset sold
Debit Cash AccountCredit Assets Disposal Account
Depreciation
Disposal of an Asset – Accounting Entries
4. Determine if there is a gain or loss on Sale of Asset (Difference or balance on Disposal Account)
Depreciation
Disposal of an Asset – Accounting Entries
• If the account shows a credit balance, it is a gain on sale:Debit Assets Disposal AccountCredit Profit and Loss Account
Depreciation
Disposal of an Asset – Accounting Entries
• If the account shows a debit balance, it is a Loss on sale:Debit Profit and Loss AccountCredit Assets Disposal Account