DEPRECIATION OF FIXED ASSETS-1

DEPRECIATION

Definition.

Depreciation is the decrease in value of assets or the fall in value of assets.

What factors cause Depreciation?

  1. Physical deterioration or wear and tear, caused by sun, wind, dust, resting, frequent use of an asset, and other weather elements.
  2. Economic factors. Asset becomes outdated even though it is in good physical condition.
  3. Time factors. Physical and economic factors caused by being outdated or out of fashion or style.
  4. Depletion factors. Natural resources, mining, oil wells.
  5. Amortization factors. Includes goodwill, trademarks, copyrights.

METHODS OF CALCULATING DEPRECIATION

There are three methods of calculating depreciation. These are:

  1. Straight line method / equal installment / cost price.
  2. Diminishing balance method or declining / reducing balance method.
  3. Revaluation method.

1. STRAIGHT LINE METHOD

Equal amount of an asset charged each year for depreciation.

OR

Using this method, a certain percentage of the original cost of the asset is taken each year.

The money amount is the depreciation for the year, and the cost of the fixed asset less the total depreciation is equal to the net book value.

Example:

A machine is purchased for TSHS 6,000 on 1 June 2000. It is to be depreciated by the straight line method at 10% each year. The firm’s financial year ends on 31 December.

Calculation of Depreciation:

= cost price × 10/100 = 600

The depreciation for each year is 600.

ecolebooks.com
Cost price at 1st January 20006,000
less:Depreciation for Dec 2000600
5,400
less:Depreciation for Dec 2001600
4,800
less:Depreciation for Dec 2002600
Net book value at 31/12/20024,200

2. DIMINISHING / REDUCING BALANCE METHOD

Amount of depreciation charged according to the book value of the asset.

With this method, a certain percentage of the reduced (or diminishing) balance at the start of each year is taken as the depreciation for the year.

Example:

A machine is purchased for Tshs 6,000 on 1st January 1991. It is to be depreciated by the reducing balance method at 12% each year. The firm’s financial year ends 31st December.

The machine will depreciate as follows:

Cost at 1st 19916,000
Less: Depreciation for 1991 (12% of 6000)720
Book value at 31st Dec 19915,280
Less: Depreciation for 1992 (12% of 5280)634
Book value at 31st Dec 19924,646
Less: Depreciation 1993 (12% of 4646)558
Book value at 31 Dec 19934,088

NOTE: The reducing balance method provides decreasing amounts of depreciation each year. The amount in the second year is less than in the first, in the third year it is less than the second, and so on.

3. REVALUATION METHOD OF DEPRECIATION

The two previous methods of calculating depreciation apply a certain percentage each year either to the cost of the asset (straight line method) or to the reduced balance.

A third method for calculating depreciation is to value the fixed assets each year, and the resulting fall in value during the year is the amount of depreciation for that year.

Example:

Office equipment is bought for Tshs 2,000 on 1st January 1995. It is revalued as follows:

  • 31st December 1995: Tshs 1,600
  • 31st December 1996: Tshs 1,350
  • 31st December 1997: Tshs 1,000

Therefore, depreciation amounts will be:

  • 1995: Tshs 400
  • 1996: Tshs 250
  • 1997: Tshs 350

NOTE: The revaluation method is often used for low-cost fixed assets such as stock of work store tools or small items of office equipment which are frequently added during the year end.

Other methods may include the following:

METHODS OF RECORDING DEPRECIATION

A. NEW METHOD / MODERN METHOD

  • Fixed assets are always shown at cost price, which remains constant.
  • The amount of depreciation is accumulated in the provision for depreciation account.
  • Only the amount of depreciation for the current year is charged to the profit or loss account.
  • Fixed assets are always shown at cost price.

B. OLD METHOD

Example:

A machine is purchased for Tshs 2,000 on 1st January 1991. It is to be depreciated by the straight line method at 10% each year for three years.

DR MACHINERY CR
DATEDETAILSFAMOUNTDATEDETAILSFAMOUNT
1-Jan-91Cash2,00031-Dec-91Depreciation200
31-Dec-91Balance c/d1,800
1-Jan-92Balance b/d31-Dec-92Depreciation200
31-Dec-92Balance c/d1,600
1-Jan-93Balance b/d31-Dec-93Depreciation200
31-Dec-93Balance c/d1,400
DR MACHINERY DEPRECIATION A/C CR
DATEDETAILSFAMOUNTDATEDETAILSFAMOUNT
31-Jan-91Machinery20031-Jan-91Profit and Loss A/C200
31-Dec-92Machinery20031-Dec-92Profit and Loss A/C200
31-Dec-93Machinery20031-Dec-93Profit and Loss A/C200

EXERCISE

1994 bought motor van costing 2,000,000. Depreciation is to be charged at the rate of 5% per annum using straight line method for five years respectively.

DR MOTOR VANCR
DateParticularsFolioAmountDateParticularsFolioAmount
Jan-94Cash2,000,00031/12/1994Depreciation25,000
31/12/1994Balance c/d1,975,000
Jan-95Balance b/d31/12/1995Depreciation25,000
31/12/1995Balance c/d1,950,000
Jan-96Balance b/d31/12/1996Depreciation25,000
31/12/1996Balance c/d1,925,000
Jan-97Balance b/d31/12/1997Depreciation25,000
31/12/1997Balance c/d1,900,000
Jan-98Balance b/d31/12/1998Depreciation25,000
31/12/1998Balance c/d1,875,000
Jan-99Balance b/d31/12/1999Depreciation25,000
31/12/1999Balance c/d1,850,000
DR MOTOR VAN DEPRECIATION A/C CR
DateParticularsFAmountDateParticularsFAmount
31/12/1994Motor Van25,00031/12/1994To P&L25,000
31/12/1995Motor Van25,00031/12/1995To P&L25,000
31/12/1996Motor Van25,00031/12/1996To P&L25,000
31/12/1997Motor Van25,00031/12/1997To P&L25,000
31/12/1998Motor Van25,00031/12/1998To P&L25,000

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EXTRACTED BALANCE SHEET AS AT 31st DEC

LIABILITIESASSETS
FIXED ASSET
1994 motor van2,000,000
Less. Depreciation25,0001,975,000

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EXERCISE

The general Emma has PLANT AND MACHINE as an asset bought on 30th June 1995 for cash 700,000. He asks you to help show the depreciation of that asset in relevant account statements. The depreciation method is reducing balance method at a rate of 20% for four years.

WORKING

PLANT AND MACHINE at cost700,000
Less depreciation 31/12/1995 (700,000 × 20/100 × ½)70,000
Balance of machine at book value630,000
Less depreciation 31/12/1996 (630,000 × 20/100 × ½)63,000
Balance of machine at book value567,000
Less depreciation 31/12/1997 (567,000 × 20/100 × ½)56,700
Balance of machine at book value510,300
Less depreciation 31/12/1998 (510,300 × 20/100 × ½)51,030
Balance plant and machine at book value459,270
DR PLANT AND MACHINE A/C CR
DateParticularsAmountDateParticularsAmount
1/6/1995Cash700,00031/12/1995Depreciation70,000
31/12/1995Balance c/d630,000
1/7/1996Balance b/d31/7/1996Depreciation63,000
31/7/1996Balance c/d567,000
1/8/1997Balance b/d31/8/1997Depreciation56,700
31/8/1997Balance c/d510,300
1/9/1998Balance b/d31/9/1998Depreciation51,030
31/9/1998Balance c/d459,270
DR DEPRECIATION FOR PLANT AND MACHINE A/C CR
DateParticularsAmountDateParticularsAmount
31/6/1995Plant and machines70,00031/12/1995To P&L A/C70,000
31/07/1996Plant and machines126,00031/07/1996To P&L A/C126,000
31/08/1997Plant and machines100,80031/08/1997To P&L A/C100,800
31/09/1998Plant and machines80,64031/09/1998To P&L A/C80,640

EXTRACTED BALANCE SHEET AS AT 1995

LIABILITIESASSETS
FIXED ASSETS
1995 Plant and machine700,000
Less depreciation70,000630,000

DR PLANT AND MACHINE A/C CR

DateParticularsAmountDateParticularsAmount
1/6/1995Cash700,00031/12/1995Depreciation70,000
31/12/1995Balance c/d630,000

DR DEPRECIATION FOR PLANT AND MACHINE A/C CR

DateParticularsAmountDateParticularsAmount
31/6/1995Plant and machines70,00031/12/1995To P&L a/c70,000

DR EXTRACT PROFIT AND LOSS ACCOUNT ASSET FOR THE YEAR ENDED 31 12 1989 CR

DateParticularsAmount
31/12/1989Depreciation furniture20,000
31/12/1990Depreciation furniture20,000
31/12/1991Depreciation furniture20,000
31/12/1992Depreciation furniture20,000

BALANCE SHEET AS AT 31 12 1989

LIABILITIESASSETS
FIXED ASSETS
1989 Furniture150,000
Less: Depreciation20,000130,000

DR FURNITURE A/C CR

DateParticularsAmountDateParticularsAmount
1/1/1989Cash150,00031/12/1989Depreciation20,000
31/12/1989Balance c/d130,000
1/1/1990Balance b/d31/12/1990Depreciation20,000
31/12/1990Balance c/d110,000
1/1/1991Balance b/d31/12/1991Depreciation20,000
31/12/1991Balance c/d90,000

DR PROFIT AND LOSS ACCOUNT ASSET FOR THE YEAR ENDED 31 12 1989 CR

DateParticularsAmount
31/12/1989Depreciation furniture20,000
31/12/1990Depreciation furniture20,000
31/12/1991Depreciation furniture20,000
31/12/1992Depreciation furniture20,000



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  • Ed8057642c3077e0185746f02f965259

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