Week 11 Depreciation of noncurrent assets Learning Objectives

Week 11 Depreciation of non-current assets Learning Objectives 1. Define depreciation 2. Calculate depreciation P 3

DEPRECIATION • A firm acquire long-term, physical economic resources (tangible non-current) to generate revenue • Most of these assets are depreciable • Depreciable assets are long-term tangible assets, the economic benefits which will expire over their useful lives • When a non-current asset (eg : Motor vehicle) is acquired by means of cheque Dr. Motor Vehicles Cr. Cash/Bank

DEPRECIATION • Allocation of the original cost of the purchased noncurrent assets over its useful lives • The recognition of the gradual using up of the cost of a non-current asset over all the accounting periods in which the non-currents assets are used • Depreciation is treated as expense, in order to reflect the cost of using a non-current assets in a certain accounting period • It should be noted that depreciation expense is not an item not involving the movement of cash

CAUSES OF DEPRECIATION • Physical deterioration • Wear and tear • Erosion, rust, rot and decay (eg : motor vehicles) • Economic factors • Obsolescence (eg : computer) • Inadequacy • Time • Depletion

METHODS OF CALCULATING DEPRECIATION • Straight line method • Reducing balance method • Revaluation method – expensive & not many • Depletion unit method – eg. quarry • Machine hour method – life of asset’s expected operating time • Sum of the years’ digits method • Units of output method

CALCULATING DEPRECIATION • 2 main methods are: 1. Straight line method 2. Reducing balance

STRAIGHT LINE METHOD • Equal portion of cost of the non-current asset treated as expense in each accounting period in which noncurrent asset is used • Amount of depreciation will be same for each accounting period

STRAIGHT LINE METHOD • If a lorry was bought for £ 22, 000, would be kept for four years, and then be sold for £ 2, 000, the depreciation to be charged each year would be: = Cost (£ 22, 000) – Estimated disposal value (£ 2, 000) Number of expected years of use (4) = £ 5, 000 depreciation each year four years. Dr. Depreciation expense (lorry) (SOCI) 5, 000 Cr. Provision for depreciation (lorry) (SFP) 5, 000

REDUCING BALANCE METHOD • Calculates depreciation expense for each accounting period by multiplying non-current asset book value with fixed percentage • Book value is also known as residual value • This method called declining balance method or diminishing balance method

REDUCING BALANCE METHOD If a machine is bought for £ 10, 000 and depreciation is to be charged at 20%, the calculations for the first three years would be as follows: £ Cost First year depreciation Second year depreciation (20% of £ 8, 000) Third year depreciation (20% of £ 6, 400) Cost not yet apportioned, end of year 3 10, 000 (2, 000) 8, 000 (1, 600) 6, 400 (1, 280) 5, 120

End of Week 11