DEPRECIATION
-It is that part of the original cost of a non current asset that is consumed during
its period of use by the business.
-It is the loss in monetary value ( fall in value) of an asset due to use.
-It is based on accrual and consistency accounting concepts.
CAUSES OF DEPRECIATION:
1)PHYSICAL FACTORS.
This includes:
a)Wear and tear- non current assets wear out in the process of use.
b)Erosion, rust , rot and decay – Land may be eroded or wasted away by the
action of elements of nature and a lack of proper attention.
Metal in motor vehicles and machinery rust away. Wood will rot
eventually.
2.ECONOMIC FACTORS.
-These reasons cause a non current asset to be put out of use even though
it is in good physical condition. They are:
i)Obsolescence
-Happens when a non current asset becomes out of date due to advanced
technology or change in processes.
ii)Inadequacy
-this arises when a non current asset is no longer used because of the growth and
change in the size of the business.
3)TIME FACTOR
Refers to the assets which have a legal life fixed in terms of years e.g a lease. The
lease life is depreciated (amortized) each year until the lease expires and the
value is nil.
4)DEPLETION
-Means the wasting away of an asset as it is used.
- This applies to assets of a ‘wasting nature’ such as extraction of raw materials
from mines and quarries, or oil from oil wells. To provide for the consumption of
an asset of a wasting character is called provision for depletion.
METHODS OF CALCULATING DEPRECIATION
-A business has to calculate depreciation at the end of each financial
year and charge as an expense in the statement of profit and loss.
Methods of calculating:
(i) Straight Line Method(SLM)
(ii) Reducing Balance Method(RBM)
STRAIGHT LINE METHOD
It is also known as depreciation on cost or equal instalment method.
In SLM depreciation is calculated on the cost of the asset each year and
therefore the amount of depreciation is constant each year.
There are three options for calculating depreciation depending on the
information available. These are:
Option 1
Depreciation = Cost/estimated useful life of an asset
This method is used when the scrap/residual value of the assets is zero.
Example: A machine was acquired for $80, 000. Its estimated useful life
is 5 years.
Depreciation = $80,000/5
= $16,000 per year
Option 2
Depreciation = (Cost – scrap value)/estimated useful life of an asset
This method is used when the scrap/residual value of the assets is
greater than zero.
Example:A computer was acquired for $50, 000 on 1/1/2012. Its value
estimated to be $20,000 after 6 years.
Depreciation = ($50,000 - $20,000)/6
= $5,000 per year
Option 3 : Depreciation is calculated as a percentage of cost.
Depreciation = x%/100 X cost of the asset
Example: A van was bought by cheque $250, 000 on 1/1/2015. Depreciation
is provided at 10% per annum(p.a).
Calculate the annual depreciation for 2015, 2016 and 2017.
Depreciation = 10 X250,000
100
= $ 25,000 per year
2015 = $25,000
2016 =$25,000
2017 = $25,000
REDUCING BALANCE METHOD (RBM)
It is also known as diminishing balance method or written down value
method.
In RBM depreciation is calculated on the carrying value/net book value
of non- current assets each year and therefore the amount of
depreciation is reducing in value each year.
Carrying Value = Original cost of asset – accumulated depreciation
Procedure of calculating depreciation:
1. First year: Depreciation is calculated on the original cost of the
asset.
depreciation = x% X cost
100
2. Subsequent years: Depreciation is calculated on the carrying value/
net book value of the asset
depreciation = x% X carrying value
100
Example: A van was bought by cheque on 1/1/2015 for $ 100,000.
Depreciation is provided at 10% per annum using reducing
balance method.
Calculate depreciation for the following financial years ending 31st
December 2015,2016 and 2017.
2015: depreciation = 10/100 x 100,000
= 10,000
2016; depreciation= 10/100 * carrying value
= 10/100 x (100,000 – 10,000)
= 9,000
2017: depreciation = 10/100 * carrying value
10/100 x (100,000-19,000)
= 8,100
Accounting Entries for Depreciation
1.Double Entry
Debit : income statement
Credit: provision for depreciation
Date details $ date details $
31/12/17 Balance c/d X 31/12/17 Income statement x
x X
1/1/18 Balance b/d x
2.Recording in statement of profit and loss
-Annual depreciation is an expense
Expenses: $ $
Depreciation: motor vehicle x
equipment x
• Recording in statement of financial position.
The total depreciation/ accumulated depreciation at the end of each
year is deducted from the cost of the non current asset in the
statement of financial position.
Non current Assets $ $
Motor vehicle (xx-x) x
Equipment (xx-x) x
