DEPRECIATION 1 DEPRECIATION CONCEPT AND DEFINITION OF DEPRECIATION

DEPRECIATION 1

DEPRECIATION • CONCEPT AND DEFINITION OF DEPRECIATION • CAUSES OF DEPRECIATION 2

LEARNING OUTCOMES: At the end of the lesson, students should be able to: • understand the concept and definition of depreciation. • understand explain the causes of depreciation. • relate depreciation to National Education. 3

FIXED ASSETS • Assets acquired not for resale. • Help to earn revenue for more than 1 financial year. Examples : - A printing machine in a printing company. - A van in a courier service company. 4

DEFINITION OF DEPRECIATION • Applies only to fixed assets. • The whole cost of the fixed assets must be spread over its useful life. • The portion of the cost allocated to a particular accounting period is charged as an expense against revenue (Matching principle). • This portion of the cost is called Depreciation. 5

CAUSES OF DEPRECIATION v Physical Deterioration v Obsolescence v Depletion of an asset v Passage of Time 6

PHYSICAL DETERIORATION • Caused by physical wear and tear - rust, erosion, rot and decay Examples - office furniture - printing machines 7

OBSOLESCENCE • Fixed assets become out-of-date - when new model or more efficient tool come into existence. Examples - cars - computers Pentium IV 8

DEPLETION OF FIXED ASSETS • An asset that depletes over time as resources are extracted from it. Little Guilin Examples - Gold mines - Quarries - Little Guilin is a depleted granite quarry now turned into a beautiful lake. 9

PASSAGE OF TIME • Some assets confer upon their holders the exclusive rights to enjoy certain privileges for a fixed period of time. Examples - copyrights - patent rights - leases on land 10

NATIONAL EDUCATION • 10 -year depreciation policy on all vehicles including buses in Singapore. Very high depreciation. • Majority of people move around by bus. • Buses are in good condition and comfortable. • Few breakdowns, less traffic jam and air pollution. An excellent public transport. • No one owes us a living We must appreciate it and work hard for the nation. 11

HOMEWORK • GCE ‘O’ Level Principles of Accounts Nov 2000 Q 2(b). 12

STRAIGHT LINE METHOD OF DEPRECIATION 13

LEARNING OUTCOMES: At the end of the lesson, students should be able to: • understand the features of Straight Line Depreciation method. • understand the advantages and disadvantages of Straight Line Depreciation method. • calculate depreciation using Straight Line method. • record depreciation in the books using the Provision for Depreciation method. 14

METHODS OF DEPRECIATION • Straight-Line • Reducing Balance • Revaluation 15

STRAIGHT LINE METHOD • A fixed asset is depreciated by an equal amount per year. Example: If an asset is depreciated by $1, 000 in the first full year of usage, it will also be depreciated by $1, 000 in the second year; $1, 000 in the third year and this continues annually until it is fully depreciated. 16

STRAIGHT LINE METHOD • Advantages - Easy to calculate. - Easy to understand. • Disadvantage - Assumes fixed asset gives same amount of service annually throughout its useful life. 17

STRAIGHT LINE METHOD (I) A machine X costs $20, 000 is expected to last 4 years. At the end of the 4 th year, it can be sold for $2, 000 as scrap. ( Scrap value is the same as residual value. ) Depreciation per year = Original cost - Residual value Expected useful life = 20, 000 - 2000 4 = $4, 500 18

STRAIGHT LINE METHOD (I) A printing machine costs $17, 000 is expected to last 5 years. At the end of the 5 th year, it can be sold for $2, 000 as scrap. Depreciation per year = Original cost - Residual value Expected useful life = 17, 000 - 2, 000 5 = $3, 000 19

STRAIGHT LINE METHOD (II) An office equipment costs $5, 000 is expected to depreciate by 20% per annum. Depreciation per year = Rate of depreciation x Original cost = 20 X 5, 000 100 = $1, 000. 20

STRAIGHT LINE METHOD (II) An office equipment costs $25, 000 is expected to depreciate by 10% per annum. Depreciation per year = Rate of depreciation x original cost = 10 X 25, 000 100. = $2, 500 21

CALCULATION OF RATE OF DEPRECIATION: Depreciation of machine X = $500. Original cost of machine X = $5, 000. Rate of depreciation = Depreciation x 100% Original cost = 500 5, 000 = 10% X 100 22

STRAIGHT LINE METHOD Mach. Cost Scrap value Useful life Annual dep. Rate of dep. X $5, 000 Nil 10 years $500 10% Y $10, 000 $1, 000 5 years $1, 800 18% Z $8, 000 Nil 5 years $1, 600 20% 23

STRAIGHT LINE METHOD Mach. Cost Scrap value Useful life Annual dep. Rate of dep. X $1, 500 Nil 5 years $300 20% Y $5, 000 $500 10 years $450 9% Z $10, 000 $1, 000 18 years $500 5% 24

STRAIGHT LINE METHOD Mach. Cost Scrap value Useful life Annual dep. Rate of dep. X $10, 000 $1, 000 10 years $900 9% Y $1, 600 Nil 4 years $400 25% Z $1, 000 Nil 5 years $200 Next table y 20% z 25

MACHINE Y Original cost = $1, 600 Scrap value = nil Depreciation = $400 Depreciation = 400 = Original cost - scrap value Useful life 1, 600 - 0 Useful life = 1, 600 400 = 4 years 26

MACHINE Z Original cost = $1, 000 Useful life = 5 years Depreciation = $200 Depreciation = Original cost - scrap value Useful life 200 1, 000 = - scrap value 5 1, 000 - scrap value Scrap value = 0 27

STRAIGHT LINE METHOD Mach. Cost A $2, 000 Nil 8 years $250 12. 5% B $5, 000 $500 9 years $500 10% C $4, 000 Nil 5 years $800 20% Record depreciation Scrap value Useful life Annual dep. Rate of dep. A B C 28

MACHINE A Original cost = $2, 000 Scrap value = nil Depreciation = $250 Depreciation = 250 = Original cost - scrap value Useful life 2, 000 - 0 Useful life = 2, 000 250 = 8 years 29

MACHINE B Original cost = $5, 000 Scrap value = $500 Rate of Depreciation = 10% Depreciation = Rate of depreciation x Original cost = 10 x 5, 000 = $500 100 Depreciation = 500 = Original cost - scrap value Useful life 5, 000 - 500 Useful life = 4, 500 = 9 years 30

MACHINE C Useful life = 5 years Scrap value = nil Depreciation = $800 Depreciation = 800 = Original cost - scrap value Useful life Original cost 5 0 Original cost = 800 x 5 = $4, 000 31

RECORDING DEPRECIATION IN THE BOOKS - Provision for depreciation method Example: An office equipment was bought for $16, 000 on 1 Jan 1999. It is expected to have a useful life of 8 years with zero residual value. Using straight line depreciation method, show the records on your books for 2 years. 32

Office equipment 1999 Jan 1 Bank 1999 $16, 000 Dec 31 Bal. c/d $16, 000 2000 Jan 1 Bal. b/d $16, 000 2001 Jan 1 Bal. b/d $16, 000 B/S 33

Depreciation - office equipment 1999 Dec 31 Prov. for dep. 2000 Dec 31 Prov. for dep. $2, 000 1999 Dec 31 P&L a/c 2000 Dec 31 P&L a/c $2, 000 Provision for depreciation - office equipment P&L 1999 Dec 31 Bal. c/d $2, 000 Dec 31 Depreciation $2, 000 2000 $2, 000 Dec 31 Bal. c/d $4, 000 Jan 1 Bal. b/d Dec 31 Depreciation 2, 000 $4, 000 2001 Jan 1 Bal. b/d B/S $4, 000 34

P & L a/c for year ended 31 Dec 1999 Dec 31 Depreciation $2, 000 P & L a/c for year ended 31 Dec 2000 Dec 31 Depreciation $2, 000 Dep 35

Balance Sheet as at 31 Dec 1999 Fixed asset Office equipment $16, 000 Less Prov. for dep. 2, 000 $14, 000 Balance Sheet as at 31 Dec 2000 Fixed asset Office equipment $16, 000 Less Prov. For dep. 4, 000 O/E $12, 000 Dep 36

IMPORTANT FEATURES: • Fixed asset account shows original cost of asset. • Provision for Depreciation account shows accumulated depreciation of fixed asset. • Net book value of fixed asset (in Balance Sheet) is original cost less Provision for Depreciation. 37

HOMEWORK • Textbook Betsy Li p 319 Q 7. • GCE ‘O’ Level Principles of Accounts November 1998 Section B Q 7. 38

REDUCING (OR DIMINISHING) BALANCE METHOD OF DEPRECIATION 39

LEARNING OUTCOMES: At the end of the lesson, students should be able to: • understand the features of Reducing Balance Depreciation method. • understand the advantages and disadvantages of Reducing Balance Depreciation method. • calculate depreciation using Reducing Balance method. • record depreciation in the books using the Provision for Depreciation method. 40

REDUCING BALANCE METHOD • The amount of depreciation per year diminishes with every successive year. Example: - If an asset is depreciated by $2, 000 in the first full year of usage, it will be depreciated by less than $2, 000 (eg $1, 600) in the second year; and even less (eg $1, 300) in the third year. This continues until it is fully depreciated. 41

REDUCING BALANCE METHOD • Advantage - Overall expenses ( including repairs and maintenance) charged for the use of a fixed asset would be fairly constant. • Disadvantages - Difficult to calculate. - Assets are always left with a small value at the end of useful life. 42

REDUCING BALANCE METHOD Depreciation per year = Rate of depreciation X Net book value at beginning of accounting period Net book value = Original cost - Accumulated depreciation is the sum of the yearly depreciation. 43

REDUCING BALANCE METHOD A machine Y costs $10, 000 is depreciated at 20% per annum on the reducing balance method. Show depreciation for the first 3 years. Depreciation Year 1 Year 2 Year 3 20 100 Net Book Value X 10, 000 = $2, 000 $10, 000 -2, 000=$8, 000 X 8, 000 = $1, 600 $10, 000 -3, 600= $6, 400 X 6, 400 = $1, 280 $10, 000 -4, 880=$5, 120 44

REDUCING BALANCE METHOD An office equipment costs $15, 000 is depreciated at 10% per annum on the reducing balance method. Show depreciation for the first 3 years. Net Book Depreciation Value Year 1 Year 2 Year 3 10 X 15, 000 = $1, 500 10 X 13, 500 = $1, 350 10 X 12, 150 = $1, 215 100 $13, 500 $12, 150 $10, 935 45

REDUCING BALANCE METHOD Complete the missing items in the table: Annual depreciation for the year ended 31 Dec 2000 Mach Cost Date of purchase X $5, 000 1. 1. 2000 $500 10% Y $10, 000 1. 1. 1999 $1, 275 15% Z $12, 000 1. 1. 1998 $972 10% NEXT TABLE y Rate of depreciation z 46

REDUCING BALANCE METHOD Machine Y Cost = $10, 000 Date of purchase = 1. 1. 1999 Rate of depreciation = 15% Yr ended Depreciation Net Book Value 15 31. 12. 1999 100 X 10, 000 = $1, 500 $10, 000 -1, 500=$8, 500 15 X 8, 500 = $ 1, 275 31. 12. 2000 100 $10, 000 -2, 775= $7, 225 47

REDUCING BALANCE METHOD Machine Z Cost = $12, 000 Date of purchase = 1. 1. 1998 Rate of depreciation = 10% Yr ended 31. 12. 1998 Depreciation 10 X 12, 000 = $1, 200 10 X 10, 800 = $ 1, 080 31. 12. 1999 100 10 X 9, 720 = $972 31. 12. 2000 100 Net Book Value $12, 000 -1, 200=$10, 800 $12, 000 -2, 280=$9, 720 $12, 000 -3, 252=$8, 748 48

REDUCING BALANCE METHOD Complete the missing items in the table: Annual depreciation Date of purchase for the year ended Mach Cost 31 Dec 2000 Rate of depreciation X $6, 000 1. 1. 1999 $765 15% Y $8, 000 1. 1. 1998 $1, 024 20% Z $15, 000 1. 1. 1997 $1093. 50 10% X Recording depreciation Y Z 49

REDUCING BALANCE METHOD Machine X Cost = $6, 000 Date of purchase = 1. 1. 1999 Rate of depreciation = 15% Yr ended Depreciation 15 31. 12. 1999 100 X 6, 000 = $900 15 X 5, 100 = $765 31. 12. 2000 100 Net Book Value $6, 000 -900=$5, 100 $6, 000 -1, 665= $4, 335 50

REDUCING BALANCE METHOD Machine Y Cost = $8, 000 Date of purchase = 1. 1. 1998 Rate of depreciation = 20% Yr ended 31. 12. 1998 31. 12. 1999 31. 12. 2000 Depreciation 20 X 8, 000 100 Net Book Value = $1, 600 $8, 000 -1, 600=$6, 400 20 X 6, 400 = $ 1, 280 100 20 X 5, 120 = $1, 024 100 $8, 000 -2, 880=$5, 120 $8, 000 -3, 904=$4, 096 51

REDUCING BALANCE METHOD Machine Z Cost = $15, 000 Date of purchase = 1. 1. 1997 Rate of depreciation = 10% Yr ended Depreciation 10 X 15, 000 = $1, 500 31. 12. 1997 100 10 31. 12. 1998 100 X 13, 500 = $1, 350 Net Book Value $15, 000 - 1, 500 = $13, 500 $15, 000 - 2, 850 = $12, 150 31. 12. 1999 10 100 X 12, 150 = $ 1, 215 31. 12. 2000 10 X 10, 935= $1, 093. 50 $15, 000 -5, 158. 50=$9, 841. 50 100 52 $15, 000 - 4, 065 = $10, 935

RECORDING DEPRECIATION IN THE BOOKS - Provision for depreciation method Example: An office equipment was bought for $10, 000 on 1 Jan 1999. It is depreciated at 10% per annum on the reducing balance method. Show the records on your books for 2 years. 53

REDUCING BALANCE METHOD A machine costs $10, 000 is depreciated at 10% per annum on the reducing balance method. Depreciation (10%) Net Book Value 31. 12. 1999 10 x 10, 000 = $1, 000 100 $10, 000 -1, 000=$9, 000 31. 12. 2000 10 x 9, 000 = $900 100 $10, 000 -1, 900 = $8, 100 54

Office equipment 1999 Jan 1 Bank $10, 000 2000 Jan 1 Bal. b/d $10, 000 2001 Jan 1 Bal. b/d $10, 000 1999 Dec 31 Bal. c/d $10, 000 2000 Dec 31 Bal. c/d $10, 000 B/S 55

Depreciation - office equipment 1999 Dec 31 Prov. for dep. 2000 Dec 31 Prov. for dep. $1, 000 $900 1999 Dec 31 P&L a/c 2000 Dec 31 P&L a/c $1, 000 $900 Provision for depreciation - office equipment P&L 1999 Dec 31 Bal. c/d $1, 000 Dec 31 Depreciation $1, 000 2000 $1, 000 Dec 31 Bal. c/d $1, 900 Jan 1 Bal. b/d Dec 31 Depreciation 900 $1, 900 2001 Jan 1 Bal. b/d B/S $1, 900 56

P & L a/c for year ended 31 Dec 1999 Dec 31 Depreciation $1, 000 P & L a/c for year ended 31 Dec 2000 Dec 31 Depreciation $900 Dep 57

Balance Sheet as at 31 Dec 1999 Fixed asset Office equipment $10, 000 Less Prov. for dep. 1, 000 $9, 000 Balance Sheet as at 31 Dec 2000 Fixed asset Office equipment $10, 000 Less Prov. For dep. 1, 900 O/E $8, 100 Dep 58

IMPORTANT FEATURES: • Fixed asset account shows original cost of asset. • Provision for Depreciation account shows accumulated depreciation of fixed asset. • Book value of fixed asset (in Balance Sheet) is original cost less Provision for Depreciation. 59

HOMEWORK • Textbook Betsy Li - p 318 Q 4 - p 320 Q 9 60

REVALUATION METHOD OF DEPRECIATION 61

LEARNING OUTCOMES: At the end of the lesson, students should be able to: • understand the features of Revaluation method of Depreciation. • understand the advantages and disadvantages of Revaluation method of Depreciation. • calculate depreciation using Revaluation method. • record depreciation in the books using the Provision for Depreciation method. 62

REVALUATION METHOD • The fixed asset is revalued at the end of every accounting period. • Depreciation is the difference between the value of the fixed asset at the beginning and end of the accounting period. • The amount of depreciation varies every year. 63

REVALUATION METHOD Example: - An asset can be depreciated by $1, 000 in the first full year of usage, it can be depreciated by a different amount in the second year (eg $500 ); and a different amount in the third year (eg $1, 200 ) depending on the valuation at the end of the accounting period and the cost or valuation at the beginning of the accounting period. 64

REVALUATION METHOD • Advantage - Fixed asset is shown at current or realisable value. • Disadvantage - Time consuming and costly to value the fixed asset. 65

REVALUATION METHOD (I) Cost of printing machine on 1 Jan 2000 = $15, 000. Market value on 31 Dec 2000 = $13, 000. Depreciation of printing machine for FY 2000 = cost on 1 Jan 2000 – market value on 31 Dec 2000 = 15, 000 – 13, 000 = $2, 000 66

REVALUATION METHOD (I) Market value of printing machine on 1 Jan 2000 = $22, 000. Market value on 31 Dec 2000 = $19, 000. Depreciation of printing machine for FY 2000 = Market value on 1 Jan 2000 – Market value on 31 Dec 2000 = 22, 000 – 19, 000 = $3, 000 67

REVALUATION METHOD (I) Complete the missing items: Mach Cost or value on 1. 1. 2000 Market value on 31. 12. 2000 Depreciation for FY 2000 X $6, 000 $4, 800 $1, 200 Y $3, 200 $2, 500 $700 Z $5, 600 $4, 000 $1, 600 68

REVALUATION METHOD (I) Complete the missing items: Mach Cost or value on 1. 1. 2000 Market value on 31. 12. 2000 Depreciation for FY 2000 X $9, 000 $6, 200 $2, 800 Y $6, 300 $4, 500 $1, 800 Z $7, 500 $5, 500 $2, 000 69

REVALUATION METHOD (II) This method is normally used for loose tools where it is difficult to estimate the rate of depreciation. The value of the asset may be inflated by new purchases and this has to be taken into account when calculating depreciation. Depreciation expense = Value of asset at the beginning - Value of asset at the end + Any new purchases 70

REVALUATION METHOD (II) On 1 Jan 2000 loose tools in the workshop were valued at $2, 000. During the year, tools worth $1, 000 were bought. On 31 Dec 2000, the estimated market value of the tools was $2, 600. Depreciation expense = Value of tools - Value of tools + New purchases on 1 Jan 2000 on 31 Dec 2000 = 2, 000 - 2, 600 + 1, 000 = $400 71

REVALUATION METHOD (II) On 1 Jan 2000 loose tools in the workshop were valued at $3, 500. During the year, tools worth $1, 500 were bought. On 31 Dec 2000, the estimated market value of the tools was $3, 000. Depreciation expense = Value of tools - Value of tools + New purchases on 1 Jan 2000 on 31 Dec 2000 = 3, 500 - 3, 000 + 1, 500 = $2, 000 72

RECORDING DEPRECIATION IN THE BOOKS - Provision for depreciation method Example: An office equipment was bought for $8, 000 on 1 Jan 1999. It is depreciated on the revaluation method. The market values of the office equipment are shown below. Show the records on your books for 2 years. Market value as at 31. 12. 1999 Market value as at 31. 12. 2000 $6, 800 $5, 800 73

REVALUATION METHOD Yr 1 Depreciation = cost on 1. 1. 1999 - Market value on 31. 12. 1999 = $8, 000 - $6, 800 = $1, 200 Yr 2 Depreciation = Market value on 1. 1. 2000 - Market value on 31. 12. 2000 = $6, 800 - $5, 800 = $1, 000 74

Office equipment 1999 Jan 1 Bank $8, 000 2000 Jan 1 Bal. b/d $8, 000 2001 Jan 1 Bal. b/d $8, 000 1999 Dec 31 Bal. c/d $8, 000 2000 Dec 31 Bal. c/d $8, 000 B/S 75

Depreciation - office equipment 1999 Dec 31 Prov. for dep. 2000 Dec 31 Prov. for dep. $1, 200 $1, 000 1999 Dec 31 P&L a/c 2000 Dec 31 P&L a/c $1, 200 $1, 000 Provision for depreciation - office equipment P&L 1999 Dec 31 Bal. c/d $1, 200 Dec 31 Depreciation $1, 2000 Dec 31 Bal. c/d $2, 200 Jan 1 Bal. b/d $1, 200 Dec 31 Depreciation 1, 000 $2, 200 2001 Jan 1 Bal. b/d B/S $2, 200 76

P & L a/c for year ended 31 Dec 1999 Dec 31 Depreciation $1, 200 P & L a/c for year ended 31 Dec 2000 Dec 31 Depreciation $1, 000 Dep 77

Balance Sheet as at 31 Dec 1999 Fixed asset Office equipment $8, 000 Less Prov. for dep. 1, 200 $6, 800 Balance Sheet as at 31 Dec 2000 Fixed asset Office equipment $8, 000 Less Prov. For dep. 2, 200 O/E $5, 800 Dep 78

IMPORTANT FEATURES: • Fixed asset account shows original cost of asset. • Provision for Depreciation account shows accumulated depreciation of fixed asset. • Book value of fixed asset (in Balance Sheet) is original cost less Provision for Depreciation. 79

COMPARE THE 3 METHODS OF DEPRECIATION Depreciation amount per successive year Depreciation mtds Straight Line Constant Increase X X Reducing Balance Revaluation * Decrease X X X *Depreciation can either be constant, decrease or increase with every successive year depending on the valuation of the fixed asset at the end of the accounting period. 80

HOMEWORK • Textbook Betsy Li p 318 Q 6. • GCE ‘O’ Level Principles of Accounts June 1997 Q 3(b) & (c). 81

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