DEPRECIATION

Classification of expenditure Capital expenditure Revenue expenditure

Method of depreciation Straight-line method

Reducing balance method

Capital expenditure
Capital expenditure is incurred when a business spends money

either to 1. Buy fixed asset, or 2. Add to the value of an existing fixed asset.
1. 2. 3. 4. 5.

Included in such amounts should be spending on: Acquiring fixed assets Bringing them into the business Legal costs of buying buildings Carriage inwards on machinery bought Any other cost needed to get a fixed asset ready for use
Journal Entry: DR Fixed Asset CR Cash/Bank

Capital expenditure cont

In calculating the cost of fixed asset, the capital

expenditure must be taken into consideration. Eg: Purchase price of the fixed asset +) Transportation cast to get the fixed asset to the purchasers premises +) Insurance on the purchased of fixed asset +) Taxes on the purchase of the fixed asset +) Installation cost Total cost of the fixed asset

Revenue expenditure
Expenditure which is not spent on increasing the

value of fixed assets, but on running the business on a day-to-day basis, is known as revenue expenditure. Example:

Motor vehicle repair, maintainance, petrol,

Journal Entry:

DR Expenses CR Cash/Bank

Exercise
Expenditure
1. Buying van 2. Petrol costs for van 3. Repairs to van 4. Putting extra headlights on van 5. Buying machinery 6. Electricity costs of using machinery 7. Spent RM1,500 on machinery: RM1000 was for an item (improvement) added to machine; and RM500 was for repairs 8. Painting outside of new building 9. One year later- repainting outside of building above

Type of expenditure
Capital Revenue Revenue Capital Capital Revenue

ANSWER

Capital : RM1000 Revenue: RM500 Capital Revenue

What is Depreciation?????

Definition:
Depreciation is that part of the original cost of fixed asset that is consumed during its period of use by the business. The annual charge (allocation) to profit & loss for depreciation is based upon an estimate of how much overall economic usefulness of a fixed asset has been used up in that accounting period. It is an expense for services consumed in the same way as expenses are incurred for items such as wages, rent or electricity. Because it is charged as an expense to the profit and loss account, depreciation reduces net profit.

The kind of asset which depreciate

Depreciable assets:

Long term tangible assets which the economic benefits of which will expire over their useful life
Non-depreciable assets:

Investment property such as freehold land and money invested in the bank (investment @ fixed deposit) since their values tended to rise instead of fall, therefore it is inappropriate to charge depreciation.

Causes of depreciation
Wear & Tear: the physical used up of fixed asset which may take the form of corrosions, rot, rust and decay.
Inadequacy or superfluity: superfluous or inadequate because either the size of the firm changes or the scale of operation changes, requiring a different fixed asset to be used. Effluxion of time: passage of time which makes the fixed asset less valuable.

Obsolescence: out of date or become obsolete because of new technology advances, therefore it became less efficient.

Physical factors: the rise of floods, dampness, excessive heat or excessive cold may make a fixed assets lose its value.

Journal Entry: DR Depreciation a/c xx CR Provision For Depreciation a/c (Accumulated depreciation a/c)

xx

The depreciation expenses is not credited directly to the fixed asset account but to an account called the provision for depreciation account which represent the amounts of depreciation charged for the fixed asset from the time its was purchased to the current date Depreciation account Maintain one account for all fixed asset on each accounting period Provision for depreciation account Maintain one account for each types of fixed assets through all their useful life

It was charged to the Profit loss account Shown in the balance sheet as a contra to fixed asset in arising the net book value of the assets

Straight-line method
Definition: the method which allocate the same

depreciation amount for each year Basis of calculation: 1. Percentage : % of depreciation x cost of fixed asset 2. Formula :

Cost Salvage Value Estimated Useful Life

(salvage value & economic useful life is a matter of estimation only)

EXAMPLE 1
Maju Berhad owned two motor vehicles. The information on

the assets for the year ended 31st March 2006 are as follows: DAX 2882 was purchased on 21st May 2003 for RM31,200 DBN 1234 was purchased on 20th April 2005 for RM29600.

Depreciation is charged at 20% per annum on cost (yearly basis). You are required to prepare the following accounts for the year ended 31st March 2006. a) Motor vehicles account b) Depreciation account c) Accumulated depreciation account

Solution
Step 1: Identify the current accounting period of the

company 1st April 2005 ----- 31st March 2006 Step 2: Identify the method of depreciation Straight line method by percentage Step 3: Identify the usage year of every asset (not including the current year)
DAX 2882 :21st May 2003 - 31st March 2006 = 2 years DBN 1234 : 20th April 2005 - 31st March 2006 = 0 year

Solution: Alternative for step 4

Step 4: Calculate the current year depreciation

and the accumulated depreciation DAX 2882 Year 1: 2004: RM31,200 x 20% = RM 6,240 Year 2: 2005 : RM31,200 x 20% = RM 6,240 Accumulated depreciation : RM 12,480 Current year: 2006: RM31,200 x 20% = RM 6,240 Depreciation = RM 6,240

Bal b/d Accumulated depreciation a/c

DR Depreciation a/c 6,240 CR Accumulated Depreciation a/c 6,240

Assets Cost (B.S)

Less: ACC DEP Acc dep. Previous year (Bal b/d for PFD) Depreciation this year (P&L) ACC DEP (Bal c/d PFD) (B.S) Net book value (B.S)

DAX 2882 RM31,200

DBN 1234 Total RM29,600 RM60,800

Year 1: RM6,240 Year 2: RM6,240 RM 6,240

RM12,480

RM 5,920

RM 12,160

(RM 18,720) (RM 5,920) (RM24,640)

RM12,480

RM23,680

RM36,160

Solution
Step 5:

Open the motor vehicles account, depreciation account and Acc.dep. of motor vehicles account.
Motor vehicles a/c 1st April 2005 Bal b/d 31,200 20th April 2005 EON Motor 29,600 31st March 2006 Bal c/d 60,800

Solution
Step 5:

Open the motor vehicles account, depreciation account and Acc.dep. of motor vehicles account.
Depreciation of Motor Vehicles a/c 31st March 2006 Acc. depreciation 12,160 31st March 2006 P & L a/c 12,160

Solution
Step 5:

Open the motor vehicles account, depreciation account and Acc.dep. of motor vehicles account.
Accumulated depreciation of Motor Vehicles a/c 1st April 2005 Bal b/d 12,480 31st March 2006 Depreciation 12,160 31st March 2006 Bal c/d 24,640

Reducing balance method

Definition: A method of depreciation which allocate a

greater amount in the earlier year and smaller amount in the later year. Depreciation is calculated based on Net Book Value (Cost Acc.Dep) Basis of calculation: year of purchased: Cost x % year 2 : (Cost Acc. Depreciation ) x % Year 3 : (Cost Acc. Depreciation ) x % Year 4 : (Cost Acc. Depreciation ) x %

* The calculation above continue until the end of the noncurrent asset useful life

EXAMPLE 2
Donno Berhad owned two office equipment. The information on the

assets for the year ended 30th June 2007 are as follows:

Computer was purchased on 21st May 2003 for RM5,400 Photostat machine was purchased on 20th April 2005 for RM6,600. Depreciation is charged at 20% per annum on net book value (yearly basis).

You are required to prepare the following accounts for the year ended 30th June 2007. a) Office Equipment account b) Depreciation account c) Accumulated depreciation account

Solution
Step 1: Identify the current accounting period of the

company 1st July 2006 ----- 30th June 2007 Step 2: Identify the method of depreciation Reducing balance method Step 3: Identify the usage year of every asset (not including the current year)
Computer :21st May 2003 30th June 2007 = 4 years Photostat machine : 20th April 2005 - 31st June 2007 = 2 year

Solution
Step 4: Calculate the current year depreciation and the

accumulated depreciation
Computer :

Year of purchased (30th June 2003): 5,400 x 20% = 1,080 Year 2 (30th June 2004) : (5,400 1,080 ) x 20% = 864 Year 3 (30th June 2005) : (5,400 1,944 ) x 20 % = 691 Year 4 ( 30th June 2006) : (5,400 2,635 ) x 20 % = 553 ACCUMULATED DEPRECIATION 3,188 Current year depreciation ( 30th June 2007) : (5,400 3,188) x 20 % = 442

Solution
Step 4: Calculate the current year depreciation and the

accumulated depreciation
Photostat machine :
Year of purchased (30th June 2005): 6,600 x 20% = 1,320 Year 2 (30th June 2006) : (6,600 1,320 ) x 20% = 1,056 ACCUMULATED DEPRECIATION 2,376 Current year depreciation ( 30th June 2007) : (6,600 2,376) x 20 % =

845

Solution
Step 5:

Open the office equipment account, depreciation account and Acc.dep. of office equipment account.
Office Equipment a/c 12,000 30th June 2007 Bal c/d 12,000

1st July 2006

Bal b/d

Solution
Step 5:

Open the office equipment account, depreciation account and Acc.dep. of office equipment account.
Depreciation of Office Equipment a/c 30th June 2006 Acc. depreciation 1,287 30th June 2007 P & L a/c 1,287

Solution
Step 5:

Open the office equipment account, depreciation account and Acc.dep. of office equipment account.
Accumulated depreciation of Office Equipment a/c 1st April 2005 Bal b/d 5,564 31st March 2006 Depreciation 1,287 31st March 2006 Bal c/d 6,851

Presentation in the Profit and Loss account

Company names Trading, profit and loss account for the year ended 31st December 20XX (EXTRACT)
Expenses: Depreciation expenses

(xx)

Presentation in the Balance Sheet

Company Name Balance Sheet as at 31st December 20XX (EXTRACT) Fixed Asset Building Machinery Motor Vehicles Total Fixed Asset Cost xxx xxx xxx Acc.Dep (xx) (xx) (xx) NBV xxx xxx xxx xxxx

Requirement
Prepare the extract trading, profit and loss account of Maju Berhad for the year ended 31st March 2006 and of Donno Berhad for the year ended 30th June 2007 2. Prepare the extract Balance Sheet of Maju Berhad as at 31st March 2006 and of Donno Berhad as at 30th June 2007
1.

SOlution
Maju Berhad Trading, profit and loss account for the year ended 31st March 2006 (EXTRACT) Expenses: Depreciation expenses (12,160)

Donno Berhad Trading, profit and loss account for the year ended 30th June 2007 (EXTRACT)
Expenses: Depreciation expenses (1,287)

Solution
Maju Berhad Balance Sheet as at 31st March 2006 (EXTRACT) Fixed Asset Motor Vehicles Total Fixed Asset Cost 60,800 Acc.Dep NBV (24,640) 36,160 36,160

Donno Berhad Balance Sheet as at 30th June 2007 (EXTRACT) Fixed Asset Office Equipment Total Fixed Asset Cost 12,000 Acc.Dep (6,851) NBV 5,149 5,149