Week 7 Lecture 6 Depreciation

These flashcards cover essential concepts related to depreciation in financial accounting.

Depreciation

An accounting method that allocates the cost of a tangible asset over its useful life.

Non-current assets

Assets that are not intended for resale and are expected to be used in business operations for several years.

Matching concept

The principle that income earned during a period must be matched with the expenses incurred to generate that income.

Accruals basis

An accounting method where income and expenses are recorded when they are earned or incurred, not when cash is exchanged.

Going concern assumption

An assumption that a business will continue to operate for the foreseeable future.

Prudence concept

The principle that caution should be exercised when preparing financial statements to avoid overstating profits.

Straight-line method

A depreciation method that allocates an equal amount of depreciation expense each year over the useful life of the asset.

Reducing-balance method

A depreciation method that applies a fixed percentage rate of depreciation to the carrying amount of the asset each year.

Useful life

The estimated period during which an asset is expected to be used in business operations.

Residual value

The estimated amount that an asset can be sold for at the end of its useful life.

Carrying amount

The value at which an asset is recognized on the balance sheet, calculated as cost minus accumulated depreciation.

Amortisation

The process of gradually writing off the initial costs of an intangible asset over its useful life.

Tangible non-current assets

Physical assets that can be touched, such as machinery and buildings.

Intangible non-current assets

Non-physical assets that represent a legal right or advantage, such as patents and copyrights.

Depreciable amount

The amount of an asset's cost that can be depreciated, calculated as cost minus residual value.

Accumulated depreciation

The total amount of depreciation expense that has been recorded against an asset since it was acquired.

Financial position

A summary of a company's assets, liabilities, and equity at a specific point in time.

Causes of Depreciation

The primary reasons for an asset

’s loss of value over time, including physical wear and tear, obsolescence, and the passage of time.

Purpose of Depreciation

To allocate the cost of a tangible asset over its useful life and match the expense with the revenue it helps generate.

Depreciation Expense (Journal Entry)

A debit to Depreciation Expense and a credit to Accumulated Depreciation, reflecting the periodic allocation of an asset's cost.

Impact of Depreciation on Income Statement

Depreciation expense is recorded as an operating expense, reducing net income for the period.

Impact of Depreciation on Balance Sheet

Accumulated depreciation reduces the carrying amount of the asset, thus reducing the total asset value.

Capital Expenditure

Funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, or equipment. They increase an asset's useful life or productivity.

Revenue Expenditure

Costs incurred for the day-to-day running of the business or to maintain the earning capacity of an existing asset without increasing its useful life or productivity.

Straight-Line Depreciation Formula

(\text{Annual Depreciation Expense} = \frac{\text{Cost - Residual Value}}{\text{Useful Life}}).

Reducing-Balance Depreciation Formula

(\text{Annual Depreciation Expense} = \text{Carrying Amount (at beginning of year)} \times \text{Depreciation Rate}).

Asset Impairment

A permanent reduction in the value of an asset, where its carrying amount exceeds the recoverable amount.

Gain on Disposal of Asset

The amount by which the selling price of an asset exceeds its carrying amount, resulting in a profit on the sale.

Loss on Disposal of Asset

The amount by which the selling price of an asset is less than its carrying amount, resulting in a loss on the sale.

Capitalization (Accounting)

The process of recording an expenditure as an asset on the balance sheet, rather than an expense on the income statement, because it provides future economic benefits.

Historical Cost Concept

An accounting principle stating that assets should be recorded at their original purchase price and not adjusted for inflation or market value changes.

Depreciation Rate (Reducing Balance)

The fixed percentage applied annually to the carrying amount of an asset to calculate depreciation expense under the reducing-balance method.

Units of Production Method

A depreciation method that allocates the cost of an asset based on its actual usage or output over its useful life, rather than solely on the passage of time.

Contra-asset account

An asset account with a credit balance, used to reduce the book value of another asset on the balance sheet (e.g., Accumulated Depreciation).

Revaluation of Assets

The process of adjusting the carrying amount of an asset to its fair value, typically when its fair value significantly differs from its book value.

Fair Value

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Book Value of an Asset

The value of an asset as it appears on the balance sheet, calculated as its historical cost minus accumulated depreciation.

Impairment Loss Recognition

When an asset's carrying amount exceeds its recoverable amount, an impairment loss is recognized on the income statement, reducing asset value and periodic profit.

Disclosure of Accounting Policies (PP&E)

Companies are required to disclose the depreciation methods used, useful lives or depreciation rates applied, and the gross carrying amount and accumulated depreciation for each class of property, plant, and equipment.

Depletion

The process of allocating the cost of natural resources (such as timber, oil, and minerals) over the period in which they are extracted, similar to depreciation for tangible assets.

Initial Cost of a Tangible Asset

Includes its purchase price, import duties, non-refundable purchase taxes, directly attributable costs of bringing the asset to its working condition for its intended use, and often the estimated cost of dismantling and removing the asset.

Revaluation Surplus (OCI)

The gain arising from the revaluation of a fixed asset when its fair value increases above its carrying amount, recognized primarily in Other Comprehensive Income (OCI) and accumulated within equity.

Derecognition of an Asset

The process of removing a previously recognized asset from an entity's balance sheet, typically occurring upon its disposal (sale, exchange, abandonment) or when no future economic benefits are expected from its use or disposal.

Asset Register

A detailed record maintained by a business that lists all its non-current assets, including essential information such as acquisition date, original cost, depreciation method, current carrying amount, and accumulated depreciation.

Depreciation Base

The portion of an asset's cost that can be depreciated over its useful life, calculated as the asset's original cost minus its estimated residual value.