3.4 HL Flashcards
what is depreciation?
Depreciation is the decrease of the value a fixed asset over time. It is a non-cash expense that is calculated in the balance sheet.
what are the two cases of depreciation of an asset?
Wear and tear – when fixed assets are repeatedly used its value reduces as more money is needed to maintain them (i.e. computers, cars, machinery)
Obsolescence – when new and improved fixed assets are introduced in the market, the current fixed assets lose their value and become obsolete; they are eventually removed (i.e. software, computers, new version of cars)
what are the two methods to calculate depreciation?
the straight-line method and the units of production method.
what is the straight line method?
The straight-line method is a simple and widely used method that spreads out the value of the asset equally over time deducing a given CONSTANT amount of depreciation of the asset’s value annually.
what are the three variables for the straight line method?
The expected useful life of the asset
The original cost of the asset
The residual or scrap value of the asset
what is the formula for the straight line method that gives you annual depreciation?
anual depreciation=
orginacal cost- residual value
——————————————–
expected useful life of asset
what is the net book value?
it is how much you paid for the asset minus the deprecation. The straight line only gives you the amount it decreases, not he final vale of deprecated asset. aka it is a way of writing out how the depreciation is affection the value of the assets through a table.
what is a residual value?
is the estimated value of a fixed asset at the end of its lease term or useful life.
why is the length of time between purchase of the asset and the end of the year important is the line method?
beacuse if it is given, you will need to put it into you calculation, you do this by timing your original equation by the moths between the phrase and the new year over 12.
what are the advantages of the straight line method?
Simplest depreciation method to calculate as it is a predictable expense
Can be applied to all long-term assets. However, it’s mostly suitable for less expensive assets (i.e. furniture). They can be written-off within the asset’s useful life
Widely acceptable and usable accounting method
what are the disadvantages of the straight line method?
Does not reflect accurately the difference in usage of an asset from one period to the other. For example, machinery, as it does not consider loss of efficiency or repair of the asset.
Does not necessary match costs with revenues in different types of long-term assets. It could ‘inflate’ the value of some assets that loose more value in the first years (i.e. cars)
Might not be appropriate for some depreciable assets due to changes in technology (i.e. computers)
what is the unit of production method?
The units of production method calculates depreciation based on the units of usage.
This means that the depreciation expense will be higher during years when the asset is used more and lower during years when the asset is used less.
For example, cars, printers and other machinery.
what are the five pieces of information you need to calculate the unit of production method?
Original Cost of the asset (what was paid for the asset when purchased)
The salvage (residual) value of the asset
The estimated number of possible units to be produced on the assets’ useful life. This is normally calculated using historical data (of production)
Expected useful life of the asset before it needs to be replaced
The total number of units that were produced in the year
what are the two steps to calculating the unit of production method?
Units of production rate = (Cost of asset – Salvage value) / Estimated units of production
Calculate the depreciation expense:
Depreciation expense = Units of production rate × Actual units produced
what are the advantages of the unit of production method?
This is a more realistic method. Specially for businesses that use machinery.
More accurate for non-current assets that directly depreciate due to “wear and tear” rather that with time.
Useful for manufactures that experience a change in production due to changes in demand consumption
