chapter 20: depreciation of non-current assets

Question 1

what is depreciation?

Answer 1

the estimated loss in value of a non-current asset during a financial period

Question 2

define book value

Answer 2

the cost price less provision for depreciation

Question 3

define provision for depreciation

Answer 3

the accumulated depreciation written off on a non-current asset up to a certain date

Question 4

what effect does depreciation have on non-current assets?

Answer 4

• reduces the value of non-current assets during their economic life so assets aren’t overstated
• it matches the loss in value of a non-current asset to the benefits gained by these assets in a particular year.

Question 5

what are the causes of depreciation?

Answer 5

physical deterioration: physical condition of asset worsens due to wear and tear, rust or decay.
time factor: most assets are expected to be used only for a certain period of time, hence the value keeps decreasing as it approaches the end of it’s useful life
obsolescence and inefficiency: value of an asset decreases when a new,better and more efficient asset is introduced
depletion: value of assets decrease as materials are extracted from them or used up

Question 6

what are the reasons for depreciation?

principles: M/A AND P

Answer 6

matching and accrual principle
- when calculating profit/loss, revenue earned through the use of the non-current asset during the financial period must be matched against expenses incurred during the same financial period

prudence principle
- charging depreciation ensures the correct book value of the non-current assets is recorded in the books when we deduct the provision for depreciation amount from the cost price
- prudence is also applied when we charge depreciation as an expense so that profits aren’t overstated

Question 7

explain the straight line method

Answer 7

this method charges the same amount of depreciation each year
good- equal amounts of depreciation makes comparison between years realistic
bad- impractical since non-current assets don’t lose the same value each period.

Question 8

explain the revaluation method

Answer 8

calculates depreciation as the difference between the biginning value and the end value of the non-current asset during the accounting period
good- useful when it’s difficult to maintain detailed records of the asset
bad- revalued amount is based on the individual’s own opinions

Question 9

explain the book value method

Answer 9

charges high amounts of depreciation during early years of asset usage and lower amounts of depreciation in the subsequent years of asset usage.
good- useful where the greater benefits from the use of the asset will be gained during the early years of its life
bad- asset value value under this method never reaches 0

Question 9

what is the difference between the straight line method and the reducing balance/book value method?

Answer 9

book value
- same amount for depreciation each year
- calculated on cost price
- asset value could reach 0

reducing balance/book value method
- different amount for depreciation each year
- calculated on book value
- asset value will never reach 0