Depreciation

Kawish Hussain Naqvi 1

Depreciationby Kawish Hussain

Accounting


1. It is a method of calculating the cost of a tangible asset over its useful life.

2. It is a decrease in an asset’s value caused by unfavourable market conditions.

what is depreciation?


Depreciation is a non cash expense which means there is no cash outflow from a business.

Depreciation is charged in the “Profit and Loss account”, so depreciation will reduce the net profit to a more realistic figure. This is an application of prudence concept.

depreciation contd.......


1. Straight line method

2. Reducing balance method

methods of calculating depreciation:


This may also be called the fixed instalment method, under this system the same percentage rate is used each year and the amount of the depreciation charged is the same each year.

The formula for calculating the straight line method of depreciation is

(cost of asset – scrap value) / number of expected years of use

straight line method of depreciation


Solution: 20,000 – 2,000 = 18,000/6 = 3,000 p.a Now this amount of depreciation will remain constant for 6 yrs of assets life. cost of fixed asset – accumulated depreciation 1st year = machine 20,000 less dep 3,000 Book value = 17,000 2nd year = machine 20,000 less accumulated dep 6,000 14,000 3rd year = machine 20,000 less accumulated dep 9,000 11,000

Henry brought a machine for $20,000 and the scrap value for it was $2,000, the life of the machine was assumed 6 years


This may also be called the diminishing balance method.

Under this method the same percentage is used each year but, because it is calculated on different value each year, the amount of depreciation will reduce each year.

RBM is used for assets which in the early years have lower maintenance costs but give greater benefits than in later years

reducing balance method of depreciation


1st year = $2,000 x 16/100 = $320 p.a 2nd year = $2,000 – 320= 1,680 x 16/100 = $269 p.a 3rd year = 1,680 – 269 = 1411 x 16/100 = $266

p.a

Calculated the book value by using RBM

Halley brought a microwave for $2,000 and decided to charge depreciation by using RBM at the rate of 16% p.a. She calculated the amount of depreciation along with the book value for 3 yrs.

Cost of asset

depreciation

Book value

1st year

$2,000 320 $1,680

2nd year

$2,000 589 $1,411

3rd year

$2,000 855 $1,145


physical deterioration: when a fixed asset falls in a physical bad condition.

economic reasons: when the asset is out-dated, and is no longer able to meet the needs of the business.

passage of time: this arises when a fixed asset has a fixed life of certain number of years e.g. a lease.

depletion: this occurs in assets such as wells or mines when the worth of the asset falls over a period of time as value is removed from the asset.

The main causes of depreciation are:

Documents

Depreciation