Reducing balance method for depreciation

Tell me the story!A forklift purchase for a warehouse!

At time of purchase …..5 years later

Is there an impact on the Financial Statements?

Profit and LossStatement Balance Sheet

If so how, which, what, where, why?

Cash Flow Statement

• A non-current asset undergoes wear and tear, so that its expected selling price declines over time.

• Depreciation is the allocation of the cost of a non current asset over its effective working life

• The difference between a non-current asset’s original purchase price and its final selling price is allocated as an expense each year called depreciation

Depreciation

Cost of non-current asset

• The original cost (historical cost)

• Any other costs required to get the asset into a condition to be able to earn revenue

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Farmer Fred!

Fred owns a sheep and cattle farm. A variety of machinery helps him to successfully run this farm.

Purchase of a Tractor

• Farmer Fred wants to add a front end loader to his new tractor purchase on 1 July 2012.

Cost $70000

$10000 for the front end loader

Historical cost = $70000+$10000+$1000=$81000

Cost of installation $1000

The value of the tractor

Purchase Price = $81000

Estimated scrap value = $21000

Fred expects to keep it for 5 years (Useful Life)

Calculating Depreciation

Two methods studied

Straight LineUnit 3

Diminishing BalanceUnit 4

Same amount expensed each

reporting period

Amount of depreciation reduces each

reporting period

How do you know which depreciation method to choose?

Reducing Balance Method

• Reducing balance method is used when….a non-current asset is more efficient in its earlier years of its life. The asset does not breakdown as much, and repairs are kept to a minimum. As it gets older it is likely to be out of operation for periods of time while it is being repaired. Income needs to be matched with expenses over that time.

Straight Line Depreciation

The formula:-

Cost – ScrapUseful Life

Including costs incurred to get non current asset ready

to earn revenue

Reducing Balance Depreciation

Calculating the amount of depreciation

Cost – ScrapUseful Life

Including costs incurred to get non current asset ready

to earn revenue

X 1.5

Tractor

$81000 - $21000 (scrap value)5 (years)

=$12000 depreciation x 1.5= 22% per annum

Where does depreciation appear?General journal

The General Ledger

Depreciation Tractor (expense)

Accumulated Depreciation Tractor

Profit and LossBalance Sheet

Non current AssetsTractorLess accumulated depreciation

How does it look?

Tell me the story of what you can see in the figures above?

• Where will each of the above calculations appear in the financial statements? Why do they appear there?• How would it be different if straight

line depreciation was used?

Which depreciation method would you use for each of the following?

1. Draw up a table with 3 columns/9rows2. List the non-current asset 3. Choose the method4. Explain and justify your choice

Tool Chest

1. Woolshed and 2. The sheepyards

Furniture and Fittings

Shop shelving

• Goto http://www.wordle.net and create your own word cloud – “reducing balance depreciation in a wordle”

Reducing Balance Depreciation in a

Word Cloud

or…

Find all the term(s) in the above word cloud and explain their relevance to depreciation.

• Reflections• What did you find easy?• What did you find most challenging?• What do you need to do?

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