DEPRECIATION Flashcards
What is depreciation?
Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.
What is the objective of depreciation?
The objective of depreciation is to have each period benefitting from the use of the asset bear an equitable share of the asset cost.
How is depreciation shown in the financial statements?
Depreciation is an expense, and it may be part of:
- Cost of goods manufactured (product cost)
- Operating expense (period cost)
What are the instances wherein depreciation ceases?
Depreciation ceases when the asset is:
- fully depreciated
- sold
- Held for sale
- Classified as held for sale
What are the kinds of depreciation? Explain each.
- Physical depreciation - related to the asset’s wear and tear over time caused by:
a. passage of time
b. action of the elements
c. accidents
d. disease - Functional / Economic depreciation - arises from:
a. Inadequacy - arises when the asset is no longer useful to the entity because of an increase in volume of operations
b. Supersession - arises when a new asset becomes available and the new asset can perform the same function more efficiently and for substantially less cost.
c. Obsolescence - encompasses a and b above. It arises when there is no future demand for the product.
What are the factors to be considered in depreciation?
- Depreciable amount
- Residual Value
- Useful life
What is depreciable amount?
Cost of asset - residual value
What is residual value?
Residual value is the estimated amount that an entity would obtain from disposal of an asset after deducting the estimated cost of disposal assuming the asset were already of the age and condition expected at the end of its useful life.
When should residual value of an asset be reviewed?
At least at each financial year-end. If expectation differs from previous estimate, change shall be accounted for as a change in accounting estimate.
What is useful life?
Useful life is either the period over which an asset is expected to be available for use by the entity, or the number of production or similar units expected to be obtained from the asset by the entity. Useful life could be expressed in terms of:
- TIME PERIODS
- UNITS OF OUTPUT OR PRODUCTION
- SERVICE HOURS OR WORKING HOURS
What are the factors to be considered in determining useful life?
- Expected usage of the asset
- Expected physical wear and tear
- Technical/commercial obsolescence
- Legal limits
Differentiate Physical and Service life of an asset.
Physical life - refers to how long an asset will last
Service life - period of time an asset shall be used by an entity. This is USEFUL LIFE.
What are the methods of depreciation?
- Straight line
- Composite method
- Group method
- Working/service hours method
- Output/production method
- SYD
- Declining balance method
- Double declining balance
- Inventory/appraisal method
- Retirement method
- Replacement method
Explain the straight line method of depreciation.
Annual Depreciation = (Depreciable amount) / useful life in years
Depreciable amount = Cost minus residual value
Explain the composite method of depreciation.
Under the composite method, ASSETS THAT ARE DISSIMILAR in nature ARE GROUPED AND TREATED AS A SINGLE UNIT.
AVERAGE USEFUL LIFE AND COMPOSITE RATE IS COMPUTED, and is depreciated on that basis.
Annual depreciation = Depreciable amount / useful life
Composite rate = annual depreciation / total cost
The following accounting procedures are followed for composite method:
a. Depreciation is reported in a single accumulated depreciation account. The ACCDEP account is not related to any specific asset account.
b. The composite rate is multiplied by the total cost of the assets to get the periodic depreciation
c. When an asset is retired, no gain or loss is reported.
d. When the asset retired is replaced by a similar asset, the composite rate is still used to get the periodic depreciation.
Explain the group method of depreciation.
Under the composite method, ASSETS THAT ARE SIMILAR in nature ARE GROUPED AND TREATED AS A SINGLE UNIT.
Depreciation is similar to the straight line method, however, when asset is retired, depreciation SHOULD BE LIMITED TO THE REMAINING CARRYING AMOUNTS OF THE ASSET LESS SALVAGE PROCEEDS, if any.
Explain the working hours and output method of depreciation.
These two methods are called VARIABLE CHARGE METHODS, wherein depreciation is more a function of use rather than passage of time.
Annual depreciation = depreciable amount / working hours OR production in units
Explain the Sum of years method of depreciation.
SYD = Life*((life+1)/2)
Annual Depreciation = Depreciable amount / SYD
What happens when an asset has a useful life of 1.5years?
Multiply by 2 to get the useful life in half years.
Explain the declining balance method of depreciation.
A fixed or uniform rate is multiplied by the declining carrying amount of the asset in order to arrive at the annual depreciation. It is also known as FIXED RATE ON DIMINISHING CARRYING AMOUNT METHOD.
Rate = 1 - the “n”th root of (residual value/cost)
wherein “n” is the useful life of the asset
Annual Depreciation = Carrying amount * rate
The carrying amount of the asset at the last period should equal to its residual value.
Explain the double declining balance method of depreciation.
Double declining balance is similar to the straight line method, but DOUBLED.
The residual value is INITIALLY IGNORED, but DEDUCTED FROM THE CARRYING AMOUNT IN THE FINAL YEAR TO GET THE LAST DEPRECIATION.
Annual depreciation = Carrying amount * (1 / useful life * 2)
Annual depreciation in the final year = carrying amount - residual value
Explain the 150% declining balance method of depreciation.
150% declining balance is similar to the straight line method, but 150%.
The residual value is INITIALLY IGNORED, but DEDUCTED FROM THE CARRYING AMOUNT IN THE FINAL YEAR TO GET THE LAST DEPRECIATION.
Annual depreciation = Carrying amount * (1 / useful life * 1.5)
Annual depreciation in the final year = carrying amount - residual value
Explain the inventory/appraisal method?
The inventory method consists of merely estimating the value of the asset at the end of the period.
The difference between the carrying amount and the estimated value at year end is recognized as the depreciation for that year.
NO ACCUMULATED DEPRECIATION IS RECORDED USING INVENTORY METHOD. THE DEPRECIATION IS DIRECTLY CREDITED TO THE ASSET ACCOUNT
Dep Exp 1000
Asset 1000
This method usually applies to assets that are small and inexpensive.
Explain the retirement method.
Under the retirement method, no depreciation is recorded until the asset is RETIRED.
The amount of depreciation is THE ORIGINAL COST OF THE ASSET LESS SALVAGE PROCEEDS.
RETIRED METHOD USES FIRST IN FIRST OUT!!!
Explain the replacement method.
Under the replacement method, no depreciation is recorded until the asset is REPLACED.
The amount of depreciation is THE REPLACEMENT COST OF THE ASSET RETIRED LESS SALVAGE PROCEEDS.
If the asset retired is not replaced, the amount of depreciation is THE ORIGINAL COST OF THE RETIRED BUT NOT REPLACED ASSET LESS SALVAGE PROCEEDS.
REPLACEMENT METHOD USES LAST IN FIRST OUT!!!
How is a change in useful life accounted for?
It will be accounted for as a change in accounting estimate.
THE DEPRECIATION CHARGE FOR THE CURRENT AND FUTURE PERIODS SHALL BE ADJUSTED ACCORDINGLY.
How is a change in depreciation method accounted for?
It will be accounted for as a change in accounting estimate.
THE DEPRECIATION CHARGE FOR THE CURRENT AND FUTURE PERIODS SHALL BE ADJUSTED ACCORDINGLY.
