DEPRECIATION

DEPRECIATION CONCEPT AND DEFINITION OF DEPRECIATION CAUSES OF DEPRECIATION

LEARNING OUTCOMES: At the end of the lesson, students should be able to: understand the concept and definition of depreciation. understand and explain the causes of depreciation. relate depreciation to National Education.

FIXED ASSETS Assets acquired not for resale. Help to earn revenue for more than 1 financial year. Examples : - A printing machine in a printing company. - A van in a courier service company.

DEFINITION OF DEPRECIATION Applies only to fixed assets. The whole cost of the fixed assets must be spread over its useful life. The portion of the cost allocated to a particular accounting period is charged as an expense against revenue (Matching principle). This portion of the cost is called Depreciation.

CAUSES OF DEPRECIATION Physical Deterioration Obsolescence Depletion of an asset Passage of Time

PHYSICAL DETERIORATION Caused by physical wear and tear - rust, erosion, rot and decay Examples - office furniture - printing machines

Fixed assets become out-of-date OBSOLESCENCE Fixed assets become out-of-date - when new model or more efficient tool come into existence. Pentium I Pentium IV Examples - cars - computers

DEPLETION OF FIXED ASSETS An asset that depletes over time as resources are extracted from it. Little Guilin Examples - Gold mines - Quarries - Little Guilin is a depleted granite quarry now turned into a beautiful lake.

PASSAGE OF TIME Some assets confer upon their holders the exclusive rights to enjoy certain privileges for a fixed period of time. Examples - copyrights - patent rights - leases on land

NATIONAL EDUCATION 10-year depreciation policy on all vehicles including buses in Singapore. Very high depreciation. Majority of people move around by bus. Buses are in good condition and comfortable. Few breakdowns, less traffic jam and air pollution. An excellent public transport. No one owes us a living We must appreciate it and work hard for the nation.

HOMEWORK GCE ‘O’ Level Principles of Accounts Nov 2000 Q2(b).

STRAIGHT LINE METHOD OF DEPRECIATION

LEARNING OUTCOMES: At the end of the lesson, students should be able to: understand the features of Straight Line Depreciation method. understand the advantages and disadvantages of Straight Line Depreciation method. calculate depreciation using Straight Line method. record depreciation in the books using the Provision for Depreciation method.

METHODS OF DEPRECIATION Straight-Line Reducing Balance Revaluation

STRAIGHT LINE METHOD A fixed asset is depreciated by an equal amount per year. Example: If an asset is depreciated by $1,000 in the first full year of usage, it will also be depreciated by $1,000 in the second year; $1,000 in the third year and this continues annually until it is fully depreciated.

STRAIGHT LINE METHOD Advantages Disadvantage - Easy to calculate. - Easy to understand. Disadvantage - Assumes fixed asset gives same amount of service annually throughout its useful life.

STRAIGHT LINE METHOD (I) A machine X costs $20,000 is expected to last 4 years. At the end of the 4th year, it can be sold for $2,000 as scrap. ( Scrap value is the same as residual value.) Original cost - Residual value Expected useful life Depreciation per year = 20,000 - 2000 = 4 = $4,500

STRAIGHT LINE METHOD (I) A printing machine costs $17,000 is expected to last 5 years. At the end of the 5th year, it can be sold for $2,000 as scrap. Original cost - Residual value Expected useful life Depreciation per year = = 17,000 - 2,000 5 = $3,000

STRAIGHT LINE METHOD (II) An office equipment costs $5,000 is expected to depreciate by 20% per annum. Depreciation per year = Rate of depreciation x Original cost = 20 100 X 5,000 = $1,000.

STRAIGHT LINE METHOD (II) An office equipment costs $25,000 is expected to depreciate by 10% per annum. Depreciation per year = Rate of depreciation x original cost = 10 100 X 25,000 . = $2,500

CALCULATION OF RATE OF DEPRECIATION: Depreciation of machine X = $500. Original cost of machine X = $5,000. Rate of depreciation = Depreciation x 100% Original cost = 500 X 100 5,000 = 10%

STRAIGHT LINE METHOD Mach. Cost Scrap value Useful life Annual dep. Rate of dep. X $5,000 Nil 10 years Y $10,000 $1,000 5 years Z $8,000 Nil 5 years $500 10% $1,800 18% $1,600 20%

STRAIGHT LINE METHOD Mach. Cost Scrap value Useful life Annual dep. Rate of dep. X $1,500 Nil 5 years Y $5,000 $500 10 years Z $10,000 $1,000 18 years $300 20% $450 9% $500 5%

STRAIGHT LINE METHOD Mach. Cost Scrap value Useful life Annual dep. Rate of dep. X $10,000 $1,000 10 years $900 9% Y $1,600 Nil $400 25% 4 years Z $1,000 Nil 5 years $200 20% Next table y z

MACHINE Y Original cost = $1,600 Scrap value = nil Depreciation = $400 Depreciation = Original cost - scrap value Useful life 400 = 1,600 - 0 Useful life Useful life = 1,600 400 = 4 years

MACHINE Z Original cost = $1,000 Useful life = 5 years Depreciation = $200 Depreciation = Original cost - scrap value Useful life 200 = 1,000 - scrap value 5 1,000 = 1,000 - scrap value Scrap value = 0

STRAIGHT LINE METHOD Mach. Cost Scrap value Useful life Annual dep. Rate of dep. A $2,000 Nil $250 8 years 12.5% B $5,000 $500 10% 9 years $500 C Nil 5 years $800 $4,000 20% Record depreciation A B C

MACHINE A Original cost = $2,000 Scrap value = nil Depreciation = $250 Depreciation = Original cost - scrap value Useful life 250 = 2,000 - 0 Useful life Useful life = 2,000 250 = 8 years

MACHINE B Original cost = $5,000 Scrap value = $500 Rate of Depreciation = 10% Depreciation = Rate of depreciation x Original cost = 10 x 5,000 100 = $500 Depreciation = Original cost - scrap value Useful life 500 = 5,000 - 500 Useful life Useful life = 4,500 500 = 9 years

MACHINE C Useful life = 5 years Scrap value = nil Depreciation = $800 Depreciation = Original cost - scrap value Useful life 800 = Original cost - 0 5 Original cost = 800 x 5 = $4,000

DEPRECIATION IN THE BOOKS RECORDING DEPRECIATION IN THE BOOKS - Provision for depreciation method Example: An office equipment was bought for $16,000 on 1 Jan 1999. It is expected to have a useful life of 8 years with zero residual value. Using straight line depreciation method, show the records on your books for 2 years.

Office equipment 1999 Jan 1 Bank $16,000 1999 Dec 31 Bal. c/d $16,000 2000 Jan 1 Bal. b/d $16,000 2000 Dec 31 Bal.c/d $16,000 2001 Jan 1 Bal. b/d $16,000 B/S

Provision for depreciation - office equipment 1999 Dec 31 Prov. for dep. $2,000 1999 Dec 31 P&L a/c $2,000 2000 Dec 31 P&L a/c $2,000 2000 Dec 31 Prov.for dep. $2,000 Provision for depreciation - office equipment P&L 1999 Dec 31 Bal. c/d $2,000 1999 Dec 31 Depreciation $2,000 2000 Jan 1 Bal. b/d $2,000 2000 Dec 31 Bal. c/d $4,000 Dec31 Depreciation 2,000 $4,000 $4,000 2001 Jan 1 Bal. b/d $4,000 B/S

P & L a/c for year ended 31 Dec 2000 1999 Dec 31 Depreciation $2,000 P & L a/c for year ended 31 Dec 2000 2000 Dec 31 Depreciation $2,000 Dep

Fixed asset Office equipment $16,000 Less Prov. for dep. 2,000 $14,000 Balance Sheet as at 31 Dec 1999 Fixed asset Office equipment $16,000 Less Prov. for dep. 2,000 $14,000 Balance Sheet as at 31 Dec 2000 Fixed asset Office equipment $16,000 Less Prov. For dep. 4,000 $12,000 Dep O/E

IMPORTANT FEATURES: Fixed asset account shows original cost of asset. Provision for Depreciation account shows accumulated depreciation of fixed asset. Net book value of fixed asset (in Balance Sheet) is original cost less Provision for Depreciation.

HOMEWORK Textbook Betsy Li p319 Q7. GCE ‘O’ Level Principles of Accounts November 1998 Section B Q7.

REDUCING (OR DIMINISHING) BALANCE METHOD OF DEPRECIATION

LEARNING OUTCOMES: At the end of the lesson, students should be able to: understand the features of Reducing Balance Depreciation method. understand the advantages and disadvantages of Reducing Balance Depreciation method. calculate depreciation using Reducing Balance method. record depreciation in the books using the Provision for Depreciation method.

REDUCING BALANCE METHOD The amount of depreciation per year diminishes with every successive year. Example: - If an asset is depreciated by $2,000 in the first full year of usage, it will be depreciated by less than $2,000 (eg $1,600) in the second year; and even less (eg $1,300) in the third year. This continues until it is fully depreciated.

REDUCING BALANCE METHOD Advantage - Overall expenses ( including repairs and maintenance) charged for the use of a fixed asset would be fairly constant. Disadvantages - Difficult to calculate. - Assets are always left with a small value at the end of useful life.

REDUCING BALANCE METHOD Depreciation per year = Rate of depreciation X Net book value at beginning of accounting period Net book value = Original cost - Accumulated depreciation Accumulated depreciation is the sum of the yearly depreciation.

REDUCING BALANCE METHOD A machine Y costs $10,000 is depreciated at 20% per annum on the reducing balance method. Show depreciation for the first 3 years. Net Book Value Depreciation 20 100 Year 1 Year 2 Year 3 X 10,000 = $2,000 $10,000-2,000=$8,000 20 100 X 8,000 = $1,600 $10,000-3,600= $6,400 20 100 X 6,400 $10,000-4,880=$5,120 = $1,280

REDUCING BALANCE METHOD An office equipment costs $15,000 is depreciated at 10% per annum on the reducing balance method. Show depreciation for the first 3 years. Depreciation Net Book Value 10 100 X 15,000 = $1,500 $13,500 Year 1 Year 2 Year 3 10 100 $12,150 = $1,350 X 13,500 10 100 $10,935 = $1,215 X 12,150

REDUCING BALANCE METHOD Complete the missing items in the table: Annual depreciation for the year ended 31 Dec 2000 Date of purchase Rate of depreciation Mach Cost $5,000 1.1.2000 10% $500 X Y $10,000 1.1.1999 15% $1,275 $12,000 1.1.1998 10% $972 Z NEXT TABLE z y

REDUCING BALANCE METHOD Machine Y Cost = $10,000 Date of purchase = 1.1.1999 Rate of depreciation = 15% Depreciation Net Book Value Yr ended 15 100 31.12.1999 X 10,000 = $1,500 $10,000-1,500=$8,500 15 100 X 8,500 = $ 1,275 $10,000-2,775= $7,225 31.12.2000

REDUCING BALANCE METHOD Machine Z Cost = $12,000 Date of purchase = 1.1.1998 Rate of depreciation = 10% Depreciation Net Book Value Yr ended 10 100 31.12.1998 X 12,000 = $1,200 $12,000-1,200=$10,800 10 100 X 10,800 = $ 1,080 $12,000-2,280=$9,720 31.12.1999 10 100 X 9,720 $12,000-3,252=$8,748 = $972 31.12.2000

REDUCING BALANCE METHOD Complete the missing items in the table: Annual depreciation for the year ended 31 Dec 2000 Date of purchase Rate of depreciation Mach Cost $6,000 1.1.1999 15% X $765 Y $8,000 1.1.1998 20% $1,024 $15,000 1.1.1997 10% $1093.50 Z Y X Z Recording depreciation

REDUCING BALANCE METHOD Machine X Cost = $6,000 Date of purchase = 1.1.1999 Rate of depreciation = 15% Depreciation Net Book Value Yr ended 15 100 31.12.1999 X 6,000 = $900 $6,000-900=$5,100 15 100 X 5,100 = $765 $6,000-1,665= $4,335 31.12.2000

REDUCING BALANCE METHOD Machine Y Cost = $8,000 Date of purchase = 1.1.1998 Rate of depreciation = 20% Depreciation Net Book Value Yr ended 20 100 31.12.1998 X 8,000 = $1,600 $8,000-1,600=$6,400 20 100 X 6,400 = $ 1,280 $8,000-2,880=$5,120 31.12.1999 20 100 X 5,120 $8,000-3,904=$4,096 = $1,024 31.12.2000

REDUCING BALANCE METHOD Machine Z Cost = $15,000 Date of purchase = 1.1.1997 Rate of depreciation = 10% Yr ended Depreciation Net Book Value 10 100 X 15,000 = $1,500 $15,000 - 1,500 = $13,500 31.12.1997 10 100 31.12.1998 X 13,500 = $1,350 $15,000 - 2,850 = $12,150 10 100 31.12.1999 X 12,150 = $ 1,215 $15,000 - 4,065 = $10,935 10 100 X 10,935 = $1,093.50 $15,000 -5,158.50=$9,841.50 31.12.2000

DEPRECIATION IN THE BOOKS RECORDING DEPRECIATION IN THE BOOKS - Provision for depreciation method Example: An office equipment was bought for $10,000 on 1 Jan 1999. It is depreciated at 10% per annum on the reducing balance method. Show the records on your books for 2 years.

REDUCING BALANCE METHOD A machine costs $10,000 is depreciated at 10% per annum on the reducing balance method. Depreciation (10%) Net Book Value 10 x 10,000 = $1,000 100 $10,000 -1,000=$9,000 31.12.1999 10 x 9,000 = $900 100 $10,000 -1,900 = $8,100 31.12.2000

Office equipment 1999 Jan 1 Bank $10,000 1999 Dec 31 Bal. c/d $10,000 2000 Jan 1 Bal. b/d $10,000 2000 Dec 31 Bal.c/d $10,000 2001 Jan 1 Bal. b/d $10,000 B/S

Provision for depreciation - office equipment 1999 Dec 31 Prov. for dep. $1,000 1999 Dec 31 P&L a/c $1,000 2000 Dec 31 Prov.for dep. $900 2000 Dec 31 P&L a/c $900 Provision for depreciation - office equipment P&L 1999 Dec 31 Bal. c/d $1,000 1999 Dec 31 Depreciation $1,000 2000 Jan 1 Bal. b/d $1,000 2000 Dec 31 Bal. c/d $1,900 Dec31 Depreciation 900 $1,900 $1,900 2001 Jan 1 Bal. b/d $1,900 B/S

P & L a/c for year ended 31 Dec 2000 1999 Dec 31 Depreciation $1,000 P & L a/c for year ended 31 Dec 2000 2000 Dec 31 Depreciation $900 Dep

Fixed asset Office equipment $10,000 Less Prov. for dep. 1,000 $9,000 Balance Sheet as at 31 Dec 1999 Fixed asset Office equipment $10,000 Less Prov. for dep. 1,000 $9,000 Balance Sheet as at 31 Dec 2000 Fixed asset Office equipment $10,000 Less Prov. For dep. 1,900 $8,100 Dep O/E

IMPORTANT FEATURES: Fixed asset account shows original cost of asset. Provision for Depreciation account shows accumulated depreciation of fixed asset. Book value of fixed asset (in Balance Sheet) is original cost less Provision for Depreciation.

HOMEWORK Textbook Betsy Li - p318 Q4 - p320 Q9

REVALUATION METHOD OF DEPRECIATION

LEARNING OUTCOMES: At the end of the lesson, students should be able to: understand the features of Revaluation method of Depreciation. understand the advantages and disadvantages of Revaluation method of Depreciation. calculate depreciation using Revaluation method. record depreciation in the books using the Provision for Depreciation method.

REVALUATION METHOD The fixed asset is revalued at the end of every accounting period. Depreciation is the difference between the value of the fixed asset at the beginning and end of the accounting period. The amount of depreciation varies every year.

REVALUATION METHOD Example: - An asset can be depreciated by $1,000 in the first full year of usage, it can be depreciated by a different amount in the second year (eg $500 ); and a different amount in the third year (eg $1,200 ) depending on the valuation at the end of the accounting period and the cost or valuation at the beginning of the accounting period.

REVALUATION METHOD Advantage Disadvantage - Fixed asset is shown at current or realisable value. Disadvantage - Time consuming and costly to value the fixed asset.

REVALUATION METHOD (I) Cost of printing machine on 1 Jan 2000 = $15,000. Market value on 31 Dec 2000 = $13,000. Depreciation of printing machine for FY2000 = cost on 1 Jan 2000 – market value on 31 Dec 2000 = 15,000 – 13,000 = $2,000

REVALUATION METHOD (I) Market value of printing machine on 1 Jan 2000 = $22,000. Market value on 31 Dec 2000 = $19,000. Depreciation of printing machine for FY2000 = Market value on 1 Jan 2000 – Market value on 31 Dec 2000 = 22,000 – 19,000 = $3,000

REVALUATION METHOD (I) Complete the missing items: Mach Cost or value Market value Depreciation on 1.1.2000 on 31.12.2000 for FY2000 X Y Z $6,000 $4,800 $1,200 $3,200 $2,500 $700 $5,600 $4,000 $1,600

REVALUATION METHOD (I) Complete the missing items: Mach Cost or value Market value Depreciation on 1.1.2000 on 31.12.2000 for FY2000 X Y Z $9,000 $6,200 $2,800 $6,300 $4,500 $1,800 $7,500 $5,500 $2,000

REVALUATION METHOD (II) This method is normally used for loose tools where it is difficult to estimate the rate of depreciation. The value of the asset may be inflated by new purchases and this has to be taken into account when calculating depreciation. Depreciation expense = Value of asset at the beginning - Value of asset at the end + Any new purchases

REVALUATION METHOD (II) On 1 Jan 2000 loose tools in the workshop were valued at $2,000. During the year, tools worth $1,000 were bought. On 31 Dec 2000, the estimated market value of the tools was $2,600. Depreciation expense = Value of tools on 1 Jan 2000 - Value of tools on 31 Dec 2000 + New purchases = 2,000 - 2,600 + 1,000 = $400

REVALUATION METHOD (II) On 1 Jan 2000 loose tools in the workshop were valued at $3,500. During the year, tools worth $1,500 were bought. On 31 Dec 2000, the estimated market value of the tools was $3,000. Depreciation expense = Value of tools on 1 Jan 2000 - Value of tools on 31 Dec 2000 + New purchases = 3,500 - 3,000 + 1,500 = $2,000

DEPRECIATION IN THE BOOKS RECORDING DEPRECIATION IN THE BOOKS - Provision for depreciation method Example: An office equipment was bought for $8,000 on 1 Jan 1999. It is depreciated on the revaluation method. The market values of the office equipment are shown below. Show the records on your books for 2 years. Market value as at 31.12.1999 $6,800 Market value as at 31.12.2000 $5,800

REVALUATION METHOD Yr 1 Depreciation = cost on 1.1.1999 - Market value on 31.12.1999 = $8,000 - $6,800 = $1,200 Yr 2 Depreciation = Market value on 1.1.2000 - Market value on 31.12.2000 = $6,800 - $5,800 = $1,000

Office equipment 1999 Jan 1 Bank $8,000 1999 Dec 31 Bal. c/d $8,000 2000 Jan 1 Bal. b/d $8,000 2000 Dec 31 Bal.c/d $8,000 2001 Jan 1 Bal. b/d $8,000 B/S

Provision for depreciation - office equipment 1999 Dec 31 Prov. for dep. $1,200 1999 Dec 31 P&L a/c $1,200 2000 Dec 31 Prov.for dep. $1,000 2000 Dec 31 P&L a/c $1,000 Provision for depreciation - office equipment P&L 1999 Dec 31 Bal. c/d $1,200 1999 Dec 31 Depreciation $1,200 2000 Dec 31 Bal. c/d $2,200 2000 Jan 1 Bal. b/d $1,200 Dec31 Depreciation 1,000 $2,200 $2,200 2001 Jan 1 Bal. b/d $2,200 B/S

P & L a/c for year ended 31 Dec 2000 1999 Dec 31 Depreciation $1,200 P & L a/c for year ended 31 Dec 2000 2000 Dec 31 Depreciation $1,000 Dep

Fixed asset Office equipment $8,000 Less Prov. for dep. 1,200 $6,800 Balance Sheet as at 31 Dec 1999 Fixed asset Office equipment $8,000 Less Prov. for dep. 1,200 $6,800 Balance Sheet as at 31 Dec 2000 Fixed asset Office equipment $8,000 Less Prov. For dep. 2,200 $5,800 Dep O/E

IMPORTANT FEATURES: Fixed asset account shows original cost of asset. Provision for Depreciation account shows accumulated depreciation of fixed asset. Book value of fixed asset (in Balance Sheet) is original cost less Provision for Depreciation.

COMPARE THE 3 METHODS OF DEPRECIATION Depreciation amount per successive year Depreciation mtds Constant Decrease Increase Straight Line Reducing Balance Revaluation * X X X X X *Depreciation can either be constant, decrease or increase with every successive year depending on the valuation of the fixed asset at the end of the accounting period.

HOMEWORK Textbook Betsy Li p318 Q6. GCE ‘O’ Level Principles of Accounts June 1997 Q3(b) & (c).

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