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DEPRECIATION

Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. It begins when the asset is available for use and continues until the asset is derecognized. There are several methods for calculating depreciation, including straight line, declining balance, and units of production. Factors that determine an asset's useful life include expected usage, wear and tear, and technological or market obsolescence. The depreciation method and useful life estimates may be changed if expectations differ significantly from prior estimates.

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88 views4 pages

DEPRECIATION

Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. It begins when the asset is available for use and continues until the asset is derecognized. There are several methods for calculating depreciation, including straight line, declining balance, and units of production. Factors that determine an asset's useful life include expected usage, wear and tear, and technological or market obsolescence. The depreciation method and useful life estimates may be changed if expectations differ significantly from prior estimates.

Uploaded by

Alexander Dimalipos
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© © All Rights Reserved
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Depreciation

 defined as the systematic allocation of the depreciable amount of an asset


over the useful life.
 An expense. It may be part of the cost of goods sold manufactured or an
operating expense.
Depreciation period
 Begins when an asset is available for use.
 Ceases when the asset is derecognized.
 Therefore, depreciation does not cease when the asset becomes idle or is retired
from active use unless the asset is fully depreciated. However, under usage
methods of depreciation the depreciation charge can be zero while there is no
production.

Kinds of depreciation
Physical depreciation
 related to the depreciable asset’s wear and tear and deterioration over a
period.
 results to the ultimate retirement of the property or termination of the service
life of the asset.
Functional or economic depreciation
 arises from inadequacy, supersession and obsolescence.
FACTORS OF DEPRECIATION
 Depreciable amount
 Residual value
 Useful life
Factors in determining useful life
(a) Expected usage of the asset. Usage is assessed by reference to the asset’s
expected capacity or physical output.
(b) Expected physical wear and tear, which depends on operational factors such as
the number of shifts for which the asset is to be used and the repair and
maintenance programme, and the care and maintenance of the asset while idle.
(c) Technical or commercial obsolescence arising from changes or improvements in
production, or from a change in the market demand for the product or service
output of the asset.
(d) Legal or similar limits on the use of the asset, such as the expiry dates of related
leases

DEPRECIATION METHOD
1. Equal or uniform charge methods
o Straight line
o Composite
o Group
2. Variable charge or use-factor or activity methods
o Working hours or service hours
o Output or production method
3. Decrease charge or accelerated or diminishing balance methods
o Sum of years ‘digits
o Declining balance method
o Double declining balance method
4. Other methods
o Inventory or appraisal
o Retirement method
o Replacement method

STRAIGHT LINE METHOD – passage of time.


 Depreciable amount = Cost – residual value
 Annual depreciation = depreciable amount divided by useful life in
years
Straight line rate
 100% divided by the life of an asset in years
COMPOSITE AND GROUP METHOD
Accounting procedures
a. Depreciation is reported in a single accumulated depreciation account. Thus,
the accumulated depreciation account is not related to any specific asset
account.
b. The composite or group rate is multiplied by the total cost of the assets in the
group to get the periodic depreciation.
c. When an asset in the group is retired, no gain or loss is reported.
The asset account is credited for the cost of the asset retired and the
accumulated depreciation account is debited for the cost minus salvage
proceeds.
d. When the asset retired is replaced by a similar asset, the replacement is
recorded by debiting the asset account and crediting cash or other
appropriate account.
Subsequently, the composite or group rate is multiplied by the balance of the
asset account to get the periodic depreciation.
VARIABLE CHARGE OR ACTIVITY METHODS – function of use rather than
passage of time.
Working hours method
 depreciation rate per hour is computed by dividing the depreciable amount by
the estimated useful life in terms of service hours.
 The depreciation rate per hour is then multiplied by the actual hours worked in
one period to get the depreciation for that period.
Output or production method
 A depreciation rate per unit is computed by dividing the depreciable amount
by the estimated useful life in terms of units of output.
 Depreciation rate per unit is then multiplied by the yearly output to get the
annual depreciation.
DECREASING CHARGE OR ACCELERATED METHODS
Sum of years‘ digits
 Depreciation is computed by multiplying the depreciable amount by a series of
fractions whose numerator is the digit in the useful life of the asset and whose
denominator is the sum of the digits in the useful life of the asset.
 Fractions are developed by getting the sum of the digits in the useful life of the
asset.
 SYD = life ( Life + 1 divided by 2)
Declining balance method
 Fixed or uniform rate is multiplied by the declining carrying amount to arrive at
annual depreciation
 Fixed rate is determined following a mathematical formula

Double declining balance method


 Straight line rate is doubled to get the fix rate
INVENTORY METHOD
 Depreciation is computed as the difference between the balance of the
asset account and the value at the end of the year.
 Applied to assets which are small and relatively inexpensive
RETIREMENT AND REPLACEMENT METHOD
 Under the retirement method of depreciation, no depreciation is
recorded until the asset is retired.
 The amount of depreciation is equal to the original cost of the asset
retired minus salvage proceeds.
 Under the replacement method, no depreciation is recorded until the
asset is retired and replaced.
 The amount of depreciation is equal to the replacement cost of the
asset retired, minus salvage proceeds.
 If the asset retired is not replaced, the original cost of the asset retired
but not replaced is recognized as depreciation.
 The retirement and replacement method may be used in much the
same situations as the inventory method.
 Such methods are suitable when a large number of similar items are
employed by the entity and the items are constantly being retired and
replaced.
 These methods are frequently used by public utility entities which have
a large number of virtually identical items that are being installed,
retired and replaced such as poles, lines, meters and telephone
receivers.
CHANGE IN USEFUL LIFE
The useful life of an item of property, plant and equipment shall be reviewed at least
at each financial year-end and if expectations are significantly different from previous
estimate, the change shall be accounted for as a change in accounting estimate.
Therefore, the depreciation charge for the current and future periods shall be
adjusted.
CHANGE IN DEPRECIATION METHOD
The depreciation method shall be reviewed at least at each financial year-end and if
there has been a significant change in the expected pattern of economic benefits
embodied in the asset, the method shall be changed to reflect the new pattern.
When such a change in depreciation method is necessary, the change shall be
accounted for as a change in accounting estimate, and the depreciation charge for
the current and future periods shall be adjusted.

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