Topic 9 Accounting for Depreciation
In this topic we will learn about:
what is depreciation;
why is it needed;
methods of calculating depreciation and;
the accounting entries.
How to account for the sales of a non-current asset.
Revaluation of non-current assets.
Non-current assets
A non- current asset is an asset intended for use on a continuing basis in the business.
A tangible non- current asset is one that can be touched and refers to such items as plant, buildings and
motor vehicles.
A non-tangible non-current asset is one that cannot be touched and refers to such items as goodwill and
patents.
Depreciation
Depreciation is the charging of a non-current asset over its useful life.
Factors affecting the useful life of an asset are:
Physical- due to wear and tear and exposure to the weather condition
Technology- the technology advancement makes the asset obsolete( out of date)
Economy- the usage of the asset is no longer cost effective
Legislation
The purchase of a car for Rs100, 000 is an expense of running the business just as electricity is an
expense. However, if the car is expected to last 5 years, it would be misleading to have one expense in
the income statement of Rs100, 000 every 5 years and nothing in the other years. It would be more
sensible to reflect the fact that the car is being used in the business over 5 years by charging an expense
each year of (say) Rs20, 000.
The charge in the Income statement each year is known as depreciation. At the same time, the
Statement of Financial Position value of the car will be reduced by Rs20, 000 each year to reflect the fact
that it is being used up.
Methods of calculating depreciation
There are several methods of calculating depreciation. The methods that you are expected to be aware
of are the following:
straight line method
reducing balance method
These are the most common methods in practice.
, Straight line method
Under this approach we charge an equal amount of depreciation each year.
The depreciation charge each year is calculated as:
Original cost – residual value
Estimated useful life
Example 1
ABC has a year end of 30 June each year.
On 01st October 2009 it purchases a car for Rs120, 000. The car is expected to last for 5 years and to
have a scrap value at the end of 5 years of Rs20, 000.
Your are required to calculate the depreciation charge for each of the first three accounting periods,
and to show extracts from the Statement of Financial Position and Income statement of each of the
three accounting periods.
Answer to Example 1
Depreciation =120,000-20,000 =20,000 pa
5
Rs
Year end 30.06.2010 9/12 x20,000 15,000
Year end 30.06.2011 20,000
Year end 30.06.2012 20,000
Extracts of Income statement 30.06.2010 30.06.2011 30.06.2012
Rs Rs Rs
Depreciation 15,000 20,000 20,000
Extracts of SFP
Cost 120,000 120,000 120,000
Less: Accumulated Depreciation (15,000) (35,000) (55,000)
105,000 85,000 65,000
Note in the first accounting period we have charged a fraction of the annual depreciation because the
asset was purchased during the year. A very common alternative in practice is to charge a full year in the
year of purchase, regardless of when in the year it was actually purchased. In the examination, read the
question carefully. If you are told to charge a full year in the year of purchase then do so. If you are not
told, then charge a fraction (or time- apportion) as above.
Reducing balance method
In this topic we will learn about:
what is depreciation;
why is it needed;
methods of calculating depreciation and;
the accounting entries.
How to account for the sales of a non-current asset.
Revaluation of non-current assets.
Non-current assets
A non- current asset is an asset intended for use on a continuing basis in the business.
A tangible non- current asset is one that can be touched and refers to such items as plant, buildings and
motor vehicles.
A non-tangible non-current asset is one that cannot be touched and refers to such items as goodwill and
patents.
Depreciation
Depreciation is the charging of a non-current asset over its useful life.
Factors affecting the useful life of an asset are:
Physical- due to wear and tear and exposure to the weather condition
Technology- the technology advancement makes the asset obsolete( out of date)
Economy- the usage of the asset is no longer cost effective
Legislation
The purchase of a car for Rs100, 000 is an expense of running the business just as electricity is an
expense. However, if the car is expected to last 5 years, it would be misleading to have one expense in
the income statement of Rs100, 000 every 5 years and nothing in the other years. It would be more
sensible to reflect the fact that the car is being used in the business over 5 years by charging an expense
each year of (say) Rs20, 000.
The charge in the Income statement each year is known as depreciation. At the same time, the
Statement of Financial Position value of the car will be reduced by Rs20, 000 each year to reflect the fact
that it is being used up.
Methods of calculating depreciation
There are several methods of calculating depreciation. The methods that you are expected to be aware
of are the following:
straight line method
reducing balance method
These are the most common methods in practice.
, Straight line method
Under this approach we charge an equal amount of depreciation each year.
The depreciation charge each year is calculated as:
Original cost – residual value
Estimated useful life
Example 1
ABC has a year end of 30 June each year.
On 01st October 2009 it purchases a car for Rs120, 000. The car is expected to last for 5 years and to
have a scrap value at the end of 5 years of Rs20, 000.
Your are required to calculate the depreciation charge for each of the first three accounting periods,
and to show extracts from the Statement of Financial Position and Income statement of each of the
three accounting periods.
Answer to Example 1
Depreciation =120,000-20,000 =20,000 pa
5
Rs
Year end 30.06.2010 9/12 x20,000 15,000
Year end 30.06.2011 20,000
Year end 30.06.2012 20,000
Extracts of Income statement 30.06.2010 30.06.2011 30.06.2012
Rs Rs Rs
Depreciation 15,000 20,000 20,000
Extracts of SFP
Cost 120,000 120,000 120,000
Less: Accumulated Depreciation (15,000) (35,000) (55,000)
105,000 85,000 65,000
Note in the first accounting period we have charged a fraction of the annual depreciation because the
asset was purchased during the year. A very common alternative in practice is to charge a full year in the
year of purchase, regardless of when in the year it was actually purchased. In the examination, read the
question carefully. If you are told to charge a full year in the year of purchase then do so. If you are not
told, then charge a fraction (or time- apportion) as above.
Reducing balance method
