3. Calculating Depreciation Flashcards
What two things must be accounted for when an item of PPE is depreciated?
When an item of PPE is depreciated, two things must be accounted for:
- The charge for depreciation is an expense of the reporting period in the statement of profit or loss.
- At the same time, the asset is wearing out and being consumed, and so its cost in the statement of financial position must be reduced by the amount of depreciation charged.
Define carrying amount.
The carrying amount is the cost less accumulated depreciation less accumulated impairment losses.
Define accumulated depreciation.
Accumulated depreciation is the total amount of the asset’s depreciation amount that has been allocated to reporting periods to date.
What methods of depreciation are covered in ‘Accounting’?
What is the name for a change from one method to another?
- Straight line method
- Reducing balance method
A change from one method to another is considered a change in accounting estimate. There is no change in accounting policy, which remains to depreciate tangible non-current assets.
Why is it important for an accountant to consider the method of depreciation carefully?
Deciding which method of depreciation to use is an area in which the accountant must apply judgement.
The method used will determine the pattern of depreciation charged over the asset’s useful life and therefore affects profits and the carrying amount of the asset each year.
Define straight line depreciation?
Straight line depreciation is where the depreciable amount is charged in equal instalments to each reporting period over the useful life of the asset. (In this way, the carrying amount of the non-current asset declines at a steady rate, or in a ‘straight line’ over time.)
What is the formula for annual and monthly depreciation charge using straight line depreciation?
The annual depreciation charge is:
(Cost of asset - residual value) / Useful life of the asset in years
The monthly depreciation charge is:
(Cost of asset - residual value) / Useful life in years x 12)
Since straight line depreciation is charged monthly, you should make the second, monthly, calculation in the exam.
Define reducing balance depreciation.
Reducing balance depreciation is where the annual depreciation charge is a fixed percentage of the brought forward carrying amount of the asset.
Why might the reducing balance depreciation method be used?
What will be important to consider when using this method during the exam?
The reducing balance method might be used to allocate a greater proportion of the total depreciable amount to the asset’s earlier years and a lower proportion to its later years, as the benefits obtained by the business from using the asset decline over time.
Note: when calculating reducing balance depreciation in an exam you will not be concerned with the asset’s residual value nor how to calculate the percentage; just the carrying amount and the reducing balance percentage given to you.
How would you depreciate an asset if it was being sold on the first day of the year or last day of the year?
In an exam question, you will not have to calculate what amount of reducing balance depreciation should be charged monthly. You may make a simplifying assumption that the depreciation charge for a part year is the appropriate proportion of the annual charge. In an exam question in which the reducing balance method has been applied to an asset being disposed of, the disposal will either be:
- On the first day of the year in which case depreciation for the year does not need to be calculated.
- On the last day of the year, in which case you should calculate a whole years depreciation.
Explain how a business should apply a depreciation method consistently.
Under what circumstances can a business change depreciation method?
A business can choose which method of depreciation to apply to its property, plant and equipment.
Once this decision has been made, it should be applied consistently from reporting period to reporting period. A change in the method of depreciation is permitted if there is a change in the way in which the asset is used.
A business can depreciate different categories of non-current assets in different ways.
For example, if a business owns three cars, then each car would normally be depreciated in the same way (e.g., by straight line method); but another category of non-current asset, say photocopiers, might be depreciated using a different method (e.g. the reducing balance method).
Explain how subsequent expenditure on an asset should be depreciated?
When subsequent expenditure is incurred on an asset, it may be capitalised if it is probable that it will generate future economic benefits.
Capitalised subsequent expenditure should be depreciated separately from the initial asset unless it has a useful life and depreciation method that are the same as the initial asset.
Throughout this course, it is assumed that subsequent expenditure is depreciated over the remaining useful life of the initial asset unless it is stated otherwise.
Note: In the exam, it will not be required to depreciate subsequent expenditure using the reducing balance method.
Which type of expenditure should not be capitalised?
Subsequent expenditure incurred to maintain an existing asset, such as the costs of ongoing servicing or maintenance, is not capitalised and is instead charged as an expense to profit or loss when the expenditure is incurred. Subsequent expenditure that enhances an asset such as upgrades to machinery or an extension to a property will meet the criteria for capitalisation.
How should the method of depreciation be reviewed and how often?
How is a change in depreciation method effected?
The depreciation method used should be reviewed annually for appropriateness.
If there are any changes in the expected pattern of use of the asset (and hence economic benefit), then the method used should be changed.
The remaining carrying amount is depreciated under the new method, i.e., only current and future periods are affected. When the basis of depreciation is changed, the effect on current and future periods should be quantified and disclosed in the financial statements, and the reason for the change should be stated.
