Depreciation Flashcards
Depreciation
The allocation of the cost of a non-current asset over its useful working life
Classified as an expense
Why is depreciation applied?
Done to satisfy accrual basis assumption: matching revenues earned to expenses incurred in a period to determine profit accurately
Cost of a NCA
Original purchase price plus any one-off costs getting the asset into a revenue earning capacity
Accumulated depreciation
The total amount of depreciation written off during the life of existing NCA’s
Effect of depreciation on the accounting equation
Increase of acc dep in NCA, which decreases assets
Increase expenses, which decreases OE (reduced net profit)
Straight line method (SLM)
Depreciation expense = (Cost - Scrap value) / Useful life
Same expense amount every period
Reducing balance method (RBM)
Dep expense = (Cost - accdep) x Dep rate (%)
Allocates more depreciation expense in the early years of an asset’s life and less depreciation in later years
Why does RBM exist?
Done to match level of expense recorded in each period to the revenue earning pattern of asset to determine accurate profit figure (accrual)
Similarity between depreciation methods
Total depreciation expense at the end of the expected useful life is the same.
Choosing a depreciation method
Depends on which method best satisfies the demands of relevance QC and period assumption
If asset expected to earn more revenue in early years and less in later due to wear/tear & less productivity, use RBM (generally vehicles and machinery)
If asset helps to earn revenue consistently over its useful life, use SLM (shop fittings, office furniture, display equipment)
