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Financial Statements & Depreciation Lecture Notes 9

Depreciation Definition Depreciation is the measure of the: – wearing out, –consumption –or other reductions in the useful economic life of a fixed asset, whether arising from: –use, –passage of time or –obsolescence.

Depreciation Definition Depreciation is the term most often employed to indicate that tangible plant assets have declined in service potential. Depreciation in the Financial Statements Unless assets are depreciated their value may sometimes be overstated on the Balance Sheet. Assets must be depreciated so as to give a true and fair value of the assets in the Balance Sheet.

Depreciation Depreciation in Accounting Depreciation is defined as: –the accounting process of allocating the cost of tangible assets to expense –in a systematic and rational manner –to those periods expected to benefit from the use of the asset. To accountants, depreciation is not a matter of valuation but a means of cost allocation. Assets are not depreciated on the basis of a decline in their fair market value, but on the basis of systemic charges to expense. [Keiso & Weygandt 1990:543]

Depreciation Where to find it? Depreciation is found in: –Trial Balance – Accumulated Depreciation –Notes to the trial balance – Years Depreciation Charge Accumulated Depreciation Accumulated Depreciation – Total depreciation provided on asset from date of purchase to date on current balance sheet

Depreciation How to treat it? – Trial Balance Accumulated Depreciation in the trial balance is deducted from the Asset at cost in the Balance Sheet. NOTES to Trial Balance Calculate - Depreciation Charge should be calculated using the Method prescribed by notes. Record – Depreciation charge is recorded in the Profit and Loss A/c as an expense.

Depreciation NOTES to Trial Balance Add – Depreciation Charge is added to the accumulated Depreciation found in the Trial Balance before deducting it from Asset at cost in Balance Sheet. If there is no Accumulated Depreciation in the Trial Balance then the Depreciation Charge Calculated is the only thing deduction from the Asset in Balance sheet

Depreciation Example Trial Balance (Extract)DebitCredit Machinery50,000 Depreciation18,000 Notes Provide for depreciation on machinery which has a useful life of 5 years and will be worth $5,000 at the end of that time

Depreciation Example Calculation Straight Line Method = Cost – Scrap Value Useful Life = 50,000 – 5,000 5 = $9,000

Depreciation Example Profit and Loss (extract) Depreciation9,000 Balance Sheet (Extract)CostDep.NBV Machinery50,00027,00023,000

Depreciation Example – NO Accumulated Depreciation Trial Balance (Extract)DebitCredit Machinery50,000 Notes Provide for depreciation on machinery which has a useful life of 5 years and will be worth $5,000 at the end of that time

Depreciation Example Calculation Straight Line Method = Cost – Scrap Value Useful Life = 50,000 – 5,000 5 = $9,000

Depreciation Example Profit and Loss (extract) Depreciation9,000 Balance Sheet (Extract)CostDep.NBV Machinery50,0009,00041,000