4. Accounting for Depreciation

Question 1

What two aspects should be considered when accounting for depreciation?

Answer 1

There are two basic aspects of accounting for depreciation to remember:
1. A depreciation charge is made in the statement of profit or loss in each reporting period for every depreciable non-current asset. Nearly all non-current assets are depreciable, the most important exception being freehold land.
2. The total accumulated depreciation on a non-current asset build up as the asset gets older. The total accumulated depreciation is always getting larger, until the non-current asset is fully depreciated.

Question 2

How do you account for depreciation?

What is the journal entry?

Answer 2

Accounting for depreciation is as follows:
1. Set up an accumulated depreciation account for each separate category of non-current asset, for example plant and machinery, land and buildings, fixtures and fittings, motor vehicles. In a computerised system, the ledger code allocated to the accumulated depreciation will immediately follow the cost of the asset in order that the cost and accumulated depreciation for the same asset is presented consecutively when the initial trial balance is extracted.

With the depreciation charge for the period:

Debit - Depreciation expense (statement of profit or loss)
Credit - Accumulated depreciation account (statement of financial position)

The balance on the accumulated depreciation account is the total accumulated depreciation. This is always a credit balance brought forward in the ledger account.

The non-current asset cost accounts are unaffected by depreciation.

In the statement of financial position, the balance on the accumulated depreciation account is set against the non-current asset cost accounts to derive the carrying amount of the non-current assets.

Question 3

How would you adjust the initial trial balance for depreciation and how would this be done? (4)

Answer 3

Because the final depreciation calculation is often accounted for after the initial trial balance has been extracted, the only figure for accumulate depreciation on the initial trial balance is the one for the balance brought forward. We need to calculate the depreciation for the current period and adjust the initial trial balance to take account of the depreciation charge to calculate the final trial balance.

1) Calculate the amount of depreciation to be charged.
2) Prepare the year-end journal tot record depreciation expense (an impairment loss if relevant).
3) Enter the journal in the adjustments columns.
4) Adjust the initial trial balance to take account of the adjustments and prepare the financial statements.