Chapter 6 - Depreciation Of Non Current Assets Flashcards
What is depreciation
Depreciation is the estimate of the amount of the loss in value of non current asset over its useful life. It is necessary to record the amount of loss in value. This is done by:
Showing an expense - depreciation charge in the statement of profit or loss
Showing the non current asset at its carrying amount - cost price less accumulated depreciation in the statement of financial position
Calculating depreciation
Two common methods are:
Straight line method
Diminishing balance method (reducing balance method)
Straight line method
Cost of asset - estimated residual sale proceeds / usfuel life of asset
Cost price = £2000
Useful life = 4 years
Estimated residual value = £400
This equals £400 per year, ie 20% per annum on cost
Diminishing balance method
With this method, a fixed percentage is written off the diminished balance which is referred to as the carrying amount of the asset each year.
The diminished balance is the cost of the asset less the accumulated depreciation.
Bookkeeping entries for depreciation
The usual procedure is to have three accounts in the general ledger:
Non current asset at cost account - records the cost price of the asset
Depreciation charges account - records the amount of depreciation for the asset for the year
Accumulated depreciation account - records the amount of depreciation to date
Depreciation and financial statements
The way in which financial statements are adjusted to take note of depreciation is recognised in the accruals principle of accounting
Statement of profit or loss:
Depreciation amount calculated for each class of non current asset is listed amongst the expenses in the statement of profit or loss. Double entry records are as follows:
Debit statement of profit or loss
Credit depreciation charges account
Statement of financial position:
Non current asset is shown at cost price in the debit column and accumulated depreciation in the credit column
Depreciation - extended trial balance
Accumulated depreciation for the year is calculated and credited for each non current asset in the adjustments column. Total accumulated depreciation for the year from both non current assets is debited in the adjustments column.
The separate credit entries of accumulated depreciation is charged to the statement of financial position in the credit column.
The combined debit entry of accumulated depreciation is charged to the statement of profit or loss as depreciation charges.
Depreciation: a non cash expense
Depreciation is a non cash expense as no payment is made for depreciation. In cash terms, depreciation causes no outflow of money. However it is important we must show depreciation in the statement of profit or loss and the accumulated depreciation in the statement of financial position.
As depreciation is a non cash expense a business would need to create a separate fund of cash which can be used to replace the asset at the end of its life.
Disposal of non current assets
When a non current asset is sold or disposed of it is necessary to bring together:
The original cost of the asset, accumulated depreciation over the life of the asset, disposal proceeds.
These are transferred from the appropriate accounts in the general ledger of the double entry system to an asset disposal account. The disposals account will enable us to calculate the gain or loss on disposal of the asset caused by over or under depreciation.
Over = gain under = loss
The double entry transactions are:
Original cost of the asset - debit asset disposals account, credit non current asset account
Depreciation to date - debit accumulated depreciation account, credit asset disposals account
Disposal proceeds - debit bank/cash account, credit asset disposals account
Loss on disposal - debit statement of profit or loss, credit asset disposals account
Gain on disposal - debit asset disposals account, credit statement of profit or loss
Journal entries for disposal
A journal entry is made to record all general ledger transfers in connection with the disposal of non current assets. This journal entry records in a book of prime entry:
The original cost of the asset being debited to asset disposals account
The accumulated depreciation being credited to asset disposals account
The disposal proceeds being credited to asset disposals account
The amount of over or under depreciation being credited or debited to the statement of profit or loss
Part exchange of non current assets
Instead of disposing of an old non current asset for cash, it is quite common to part exchange it for a new asset.
Once the part exchange allowance has been agreed, the bookkeeping entries for disposal are detailed earlier except that instead of disposal proceeds there will be:
Debit non current asset account with the amount of the part exchange allowance
Credit asset disposals account with the amount of the part exchange allowance
