3. Calculating Depreciation Flashcards
What two things must be accounted for when an asset is depreciated?
When an asset 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 cost of the asset less its depreciation charge to date (accumulated depreciation) is known as the assets carrying amount
It is also referred to as net-book value (NBV) or written down value (WDV)
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 are the two key methods of depreciation?
- Straight line method
- Reducing balance method
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 depreciation charge using straight line depreciation?
(Cost of asset - residual value) / Useful life of the asset in years or months
In an exam, how else might they give information on the length of time the straight line depreciation is to be applied without giving you the useful life directly
Aside from giving the useful lifetime in years, they may give it as a % where the useful life is 1/% (assuming no residual value)
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 over straight line depreciation?
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.
Outline the shortcut for calculating the carrying value if an asset depreciated via the reducing balance basis
How do we account for capital expenditure incurred to enhance an asset after its initial purchase?
Where expenditure is incurred to enhance an asset after its initial purchase (subsequent expenditure), this is added to the asset’s cost and depreciated over the asset’s remaining useful life
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.
Explain how a business should apply a depreciation method consistently.
How should the method of depreciation be reviewed and how often?
How is a change in depreciation method effected?
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.
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.
