DEPRECIATION

LEARNING UNIT 3: DEPRECIATION

Introduction

  • Definition: Non-current assets are resources controlled by the entity (for longer than one year) due to past events, expected to provide future economic benefits.

  • Most non-current assets undergo value changes over their lifespan:

    • Some may gain value.

    • Others may lose value.

  • The decline in value is termed depreciation.

Depreciable Assets

1. Depreciation Overview

  • Purpose: To reflect fair value of assets in financial statements at year-end.

  • Adjustment Needed: Depreciation is a year-end adjustment for non-current assets to show their ‘net realizable value’—a realistic trade value.

  • Calculation Method: A standard method of depreciation calculates the year-end depreciation.

  • Carrying Value: The adjusted value of an asset, consisting of the original cost minus accumulated depreciation.

1.1 Methods of Depreciation

  1. Straight Line Method:

    • Depreciation is calculated at a fixed rate based on the cost price of the asset.

    • The estimation can also be derived from the asset’s useful life.

    • Residual Value: Expected scrap or trade-in value deducted from the initial cost to find depreciable value.

  2. Diminishing Balance Method:

    • Depreciation is calculated on the carrying value, which is the original cost minus accumulated depreciation.

    • A depreciation rate is used to deduce annual depreciation.

    • Residual Value: Same as in the straight-line method, deducted to find depreciable value.

1.2 Accounting Entries for Depreciation

  • The depreciation account is an expense and is closed against the profit and loss account at year-end.

  • Accumulated Depreciation:

    • Holds total depreciation written off for an asset until fully depreciated, sold, or scrapped.

    • Maintains a credit balance as it represents the asset's credit side.

    • Shown in the Statement of Financial Position as a ‘negative asset.’

The Asset Register

  • Internal Documentation: Depreciation is tracked internally using Journal Vouchers.

  • Asset Register: Contains all essential details of a depreciable asset from purchase to disposal.

  • Legislation: Businesses must keep records of depreciable assets for at least five years as per SARS requirements.

2. The Four Steps of Asset Disposal

  1. Remove Initial Cost Price from books:

    • Debit Asset Disposal account, Credit Asset account.

  2. Remove Accumulated Depreciation from books:

    • Debit Accumulated Depreciation account, Credit Asset Disposal account.

  3. Record Selling Price:

    • Debit Bank (for cash sales), Debtors Control (credit sales), or Creditors Control/HP Loan (trade-in) and Credit Asset Disposal account.

  4. Calculate Profit/Loss on Disposal:

    • Debit/Credit Asset Disposal account and Credit/Debit Profit/Loss on Disposal account.

Journal Entries for Asset Disposal

  1. Transfer Cost Price to Asset Disposal:

    • Debit Asset Disposal xxxx

    • Credit Asset account xxxx

  2. Record Depreciation for Disposal (if disposed of during the financial year):

    • Debit Depreciation xxxx

    • Credit Accumulated Depreciation: Asset xxxx

  3. Transfer Accumulated Depreciation to Asset Disposal:

    • Debit Accumulated Depreciation: Asset xxxx

    • Credit Asset Disposal xxxx

  4. Record Sale at Selling Price:

    • Debit Debtors Control/Drawings/Creditors Control xxxx

    • Credit Asset Disposal xxxx, Output VAT xxxx

  5. Record Profit/Loss on Sale of Asset:

    • Asset Disposal xxxx, Profit on Sale of Asset xxxx OR Loss on Sale of Asset xxxx.

Special Considerations in Disposals

2.1 Disposals at Beginning of Year

  • Necessary amounts to track:

    • Selling price.

    • Initial cost price.

    • Accumulated depreciation at date of sale.

2.2 Disposal of an Asset from a Pool

  • When one asset is sold, remaining assets continue to depreciate, requiring annual adjustments.

2.3 Disposals Midway through the Financial Year

  • Essential to note the disposal date for accurate depreciation calculation up to that point.

  • Depreciation adjustments are made only at year-end or upon asset sale.

Terminology

  • Depreciation:

    • An expense account reflecting the loss in value of property, plant, and equipment computed at year-end.

  • Accumulated Depreciation:

    • Total reduction in value of property, plant, and equipment over the period held.

  • Carrying Amount:

    • Value of an asset at a specific time calculated as:

    • Carrying Amount = Cost – Accumulated Depreciation.