DEPRECIATION

DEPRECIATION

The systematic allocation of the depreciable amount of an asset over its useful life. The objective of depreciation is to have each period benefiting from the use of the asset bear an equitable share of the asset cost. Except for land, all property should be depreciated on a systematic basis over the useful life of the asset irrespective of the earnings of the enterprise.

Depreciation period

Depreciation of an asset begins when it is available for use, meaning, when the asset is in the location and condition necessary for it to be capable of operating in the manner intended be the management. Depreciation of an asset ceases when the asset is derecognized. Therefore, depreciation does not cease when the asset becomes idle or is retired from active use and held for disposal unless the asset if fully depreciated.

Kinds of Depreciation

Physical depreciationis related to the assets wear and tear and deterioration over a period. Caused by:
Wear

and tear Passage of time Action of elements (wind, sunshine, rain or dust) Accidents (fire, flood, earthquake and other natural disaster) Diseases (to animals and wooden buildings)

Kinds of Depreciation

Functional or economic depreciationarises from obsolescence or inadequacy of the asset to perform efficiently. May arise from:
When

the no future demand for the product which the depreciable asset produces. When the new depreciable asset becomes available and the new asset can perform the same function for substantially less cost. Inadequacy arises when the asset is no longer useful to the firm because of an increase in the volume of operation.

Factors of Depreciation

Depreciable amountis the cost of an asset or other amount substituted for cost, less residual value. Residual valueis the estimated amount that an entity would obtain from the disposal of the asset, after deducting the estimated cost of disposal, if the asset were already of the age and condition expected at the end of its useful life. Useful lifeis either the period over which the an asset is expected to be available for use by the entity or the number of production or similar units expected to be obtained from the asset by the entity. Expressed in: Time periods as in years Units of output or production Service hour or working hours

METHODS OF DEPRECIATION
1.)Equal or uniform charge methods 2.) Variable charge or use-factor methods 3.) Decreasing charge or accelerated or diminishing balance methods 4.) Other methods

Equal or uniform charge methods

Straight line Composite method Group method

Straight line method

the annual depreciation charge is calculated by allocating the amount to be depreciated equally over the number of years of estimated useful life.

Formula:
Annual Depreciation = Cost minus residual value Life in years

Problem 25-5
a.) Straight line Annual dep. = 635T- 35T/5 = 120T Depreciation expense = 120T per year from 2011 to 2015

Composite Method

assets that are dissimilar in nature or assets that have different physical characteristics and vary widely in useful life, are grouped and treated as a single unit.

Procedures: Depreciation is reported in single accumulated depreciation account. The composite rate is multiplied by the cost of the assets in the group to get the periodic depreciation. When an asset is retired, no gain or loss is recognized. The asset account is credited and accumulated depreciation account is debited for the cost minus salvage proceeds. When there is a replacement of similar asset, asset account is debited and cash or other appropriate amount is credited. The balance asset account is multiplied by the composite rate to get the periodic depreciation.

Problem 25-11
Cost Dep. Cost Annual Dep.
60T 10T 100T 100T 270T M 310T 300T OE 110T 100T B 1,600T 1,500T DE 430T 400T Total 2,450T 2,300T a.) rate = 270T/2,450T = 11.02% b.) life = 2,300T/270T = 8.52 years c.) Entry: Dep. 270T AD 270T

Group Method

assets that similar in nature and in estimated useful life grouped and treated as a single unit. The procedures are the same as the composite method.

Variable charge or use-factor methods

Working hours or service hours Output or production method

Working Hours or Service Hours

Depreciation rate per hour is computed by dividing depreciable amount by the estimated life in terms of service hours. The rate is then multiplied by the actual hours worked in one period to get the depreciation for that period.

Problem 25-5 # b service hours

Dep. Rate per hour = 600T/60T = P10 2011 = 10 x 14T = 140T 2012 = 10 x 13T = 130T 2013 = 10 x 10T = 100T 2014 = 10 x 11T = 110T 2015 = 10 x 12T = 120T

Output Method
Depreciation rate per hour is computed by dividing depreciable amount by the estimated life in terms of units of output. The rate is then multiplied by the yearly output to get the annual depreciation.

Problem 25-5 # c production

Dep. Rate per unit = 600T/150T = 4 per unit 2011 = 4 x 34T = 136T 2012 = 4 x 32T = 128T 2013 = 4 x 25T = 100T 2014 = 4 x 29T = 116T 2015 = 4 x 30T = 120T

DECREASING CHARGE or ACCELERATED METHODS

These provide higher depreciation in the earlier years and lower depreciation in the later years of the life of the asset. These methods result in a decreasing depreciation charge over the useful life. The cost of using an asset includes not only depreciation but also repairs on such assets. Such repair cost should be allocated over the life of the asset on a systematic and uniform basis.

Three Decreasing Charge Methods:

Sum of Years Digits (SYD) Declining Balance Method Double declining Balance Method

Sum of Years Digits (SYD)

This method provides for depreciation that is computed by multiplying the depreciable amount by a series of fractions whose numerator is the digit in the life of the asset and whose denominator is the sum of the digits in the life of the asset. The fractions are developed by getting the sum of the digits in the life of the assets.

Sum of Years Digits (SYD)

Formula SYD = Life [(Life + 1)/2]

Problem 25-5 # d
SYD = 5[ (5+1)/2] 2011 = 5/15 x 600T = 200T 2012 = 4/15 x 600T = 160T 2013 = 3/15 x 600T = 120T 2014 = 2/15 x 600T = 80T 2015 = 1/15 x 600T = 40T

Declining Balance Method

Under this method, a fixed or uniform rate is multiplied by the declining book value or undepreciated cost of the asset in order to arrive at the annual depreciation. Also known as fixed rate or percentage on book value method

Declining Balance Method

Refer to the textbook for the formula The value of the asset cannot be reduced to zero and the formula cannot be used unless there is a residual value. Thus, a residual value must always be assigned to the asset.

Problem 25-7
Fixed rate = 1-.5623 = .4377 2011 (500T x. 4377) 2012 (500T 218,850 x.4377) 2013 (500T 341,909 x .4377) 2014 (500T 411,105 50,000)
218,850 123,059 69,196 38,895

Double declining Balance Method

Just as the declining balance method, a fixed rate is multiplied by the declining book value of the asset to arrive at the annual depreciation. But under this method, the straight line rate is simply doubled to get the fixed rate. This this method is also known as 200% declining balance method.

Problem 25-5 # e
Double declining rate = 100%/5 x2 = 40% 2011 40% x 635T 254,000 2012 40% x 381,000 152,400 2012 40% x 228,600 91,440 2013 40% x 137,160 54,864 2014 82,296 -35,000 47,296

Problem 25-6

Inventory method
Depreciation for the year= the difference between the balance of the asset account and the value at the end of the year No accumulated depreciation account is maintained; credited directly to the asset account. Applied to small and relatively inexpensive assets

Problem 25-18 # 3

Retirement method
No depreciation is recorded until the asset is retired Depreciation = original cost-salvage proceeds

Problem 25-18 # 1

Replacement method
No depreciation is recorded until the asset is retired and replaced. Depreciation = replacement cost of the asset retired salvage proceeds If the asset retired is not replaced, the original cost of the asset retired but not replaced is charged off as depreciation.

Problem 25-18 # 2

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