Depreciation

Depreciation

The allocation of the cost if an asset. It represents the loss of future economic benefits. Due to wear & tear, usage & obsolescence, the asset ceases to provide the same amount of economic benefit.

Applies to non-current assets, and declines in value.

Nature

An expense in the income statement. Accumulated depreciation is reducing the value of the asset. (negative asset). Accumulated depreciation is subtracted from assets in the balance sheet.

Purpose of depreciation

To make sure profits is not overstated (income statement), and non current assets are not overstated (balance sheet).

Straight line method +’s and -’s.

+:

• simple to use.

• suitable for assets like furniture and buildings.

• suitable for service, retail and merchandising.

-’s:

• does not consider degree of usage.

• does not consider later repairs in its useful life.

• does not consider the age of the asset.

• does not consider efficiency of asset.

Reducing balance method +’s and -’s

+’s:

• useful for assets such as machinery, and motor vehicles. because greater depreciation is written off in early years.

• the older the less useful, therefore the depreciation is less.

-’s:

• more complex to calculate.

• does not suit all types of assets.

wear & tear

non current assets that are mechanical & electrical, decline in value due to wear & tear. using the assets reduces efficiency.

commercial obsolescence

when equipment has no further use (is obsolete) due to its decline in the market demand for the goods and services in the production of which the asset is used.

technical obsolescence

when the asset becomes out of date & inefficient due to new technologies. affects computer software.

relevance (recognition criteria)

Information is capable of making difference in the decisions made by users. The relevance of information is affected by MATERIALITY. Information is material if its omitting, misstating or obscuring could influence the decisions that users make on the basis of financial information (about an entity).

faithful representation (recognition criteria)

An entity’s financial information should be complete, neutral and free from mistakes to the extent possible. For an asset or liability to be recognised, it must be able to be measured and quantified in monetary terms.

Sale of Asset

1. record depreciation dr, accum dep cr

2. record sale of asset dr, asset cr

3. record accum dep dr, sale of asset cr

4. record cash dr, sale of asset cr

5. record sale of asset with either gain/loss

6. close depreciation and gain/loss with profit/loss account

carrying value

historic cost - accum dep. If CV is higher than sale cost, it was under depreciated - gain on sale. If CV is lower than sale cost, it was under depreciated - loss on sale.