Dr. Mohamed A. Hamada Lecturer of Accounting Information Systems 1-1 Chapter 6 Depreciation
Definition Depreciation is the ‘ allocation of the depreciable amount of an asset over its estimated life ’.
The Objective of Depreciation According to the matching concept, revenues should be matched with expenses in order to determine the accounting profit. The cost of the asset purchased should be spread over the periods in which the asset will benefit a company.
Depreciation Methods (A) Straight Line Method (B) Reducing Balance Method/Diminishing Balance Method (C) Revaluation Method (D) Sum of Digits Method/Sum of The Years ’ Digits Method (E) Production Output Method/Units of Production Method
(A) Straight Line Method Depreciation is computed by dividing the depreciable amount of the asset by the expected number of accounting periods of its useful life. Depreciation = Cost of Asset – Estimated Residual Value Estimated Useful Economic Life
Useful Economic Life Useful economic life is not equal to physical life It is the period over which the present owner intends to use the asset
Residual Value It is the amount received after disposal of the asset Cost of asset - Residual value = Total amount to be depreciated
Example Cost of asset $1200 Residual/scrap/salvage value $200 Estimated useful life4 years Annual charge for depreciation = $1200-$200 4 = $1000 4 =$250
Accounting for Depreciation Fixed assets other than land lose their ability over time to provide services Costs of equipment, buildings, and land improvements should be transferred to expense accounts in a systematic manner during their expected useful lives. DEPRECIATION Adjusting entry to record depreciation is usually made at the end of each month or at the end of the year Fixed assets other than land lose their ability over time to provide services
Depreciation Accumulated depreciation Shows the amount that the asset has lost in value since its purchase Depreciation expense Shows the amount that the asset has lost in value this period.
Factors in Computing Depreciation Expense The fixed asset’s initial cost Its expected useful life Its estimated value at the end of its useful life.
Depreciation Methods Straight line Declining balance Units of production
Straight line Method Provides for the same amount of depreciation expense for each year of the asset’s useful life Annual depreciation expense = Cost – Salvage value Life
Example 1 A machine had a cost of $24,000, salvage value of $2,000 and useful life of 5 years Annual depreciation expense = Cost – Salvage value Life = $24,000 - $2,000 5 years = $4,400 annual depreciation