Introduction to

Accounting
Unit 8 :
Depreciation of Fixed
assets
After you have studied this chapter, you should

Understand the meaning of

depreciation
Be able to explain the need to
charge depreciation as an
expense
Understand the causes of
depreciation
Able to calculate depreciation
using different methods
Record the disposal of fixed
What is Depreciation?
D e p re cia tio n is a p a rt o f th e
o rig in a l
a m o u n t o f fix e d a sse t co n su m e d
d u rin g its p e rio d o f u se .
It is a n
e x p e n se fo r
se rv ice s
co n su m e d /
re n d e re d b y
th e fix e d
a sse t.
3
 What is Depreciation
Expense?
Because it is an expense,
depreciation is
charged to the P/L Account and

consequently reduces net profit

Depreciation

 Income Statement


 Net profit
What factors make assets
lose their values?
Depreciation is a loss in value of an
asset due to number of factors,
they are:
Due to use (wear and tear)
Due to technological changes.
Due to obsolesces.
Due to effusion of time.
Any loss in value of fixed assets
become an expenditure in the
Profit and Loss Account.

Provisions for Depreciation
Provision for depreciation is a
charge against Profit and Loss
account for a loss in value of
fixed assets
The double entry is:
Debit Profit and Loss Account
Credit Provision for depreciation



Remember…
Provision for depreciation is
accumulative.

So, to last years provisions

(Shown in the Trial balance),

current
years charge will be added and the

total
will be shown in the Balance Sheet

as a
deduction from the cost of the
HOW TO COMPUTE THE
AMOUNT OF DEPRECIATION?
Tocompute the amount of
depreciation, the following factors
are necessary:
The cost.
The scrap value.
The useful life.
The method.
The amount of depreciation for the
year

 Cost less Scrap Value
Methods of depreciation
 The most commonly used
methods are :
qStraight line method
qReducing Balance method
qSum Of Digits Method
qUsage Method
q
q
q

Straight line method
Under this method, the amount
charged to Profit and Loss
account for each year over its
useful life is an equal amount.

Ex. A Machine costing $10600
has a useful life of five years
and it can be sold as scrap for
$600 at the end of its useful life.
Required: compute the charge for
depreciation for each of the first
three years and show (1) the
profit and loss charge and (2)
the Balance Sheet
Disclosure.

 Machine
2005
Jan 1 cash 10600


Accumulated Provision for Depreciation

2005 2005
Dec 31 balance c/d 2000 Dec 31
 Profit and Loss $2000
 ======
2006 2006
Dec 31 Balance c/d 2000 Jan 1 balance b/d
$2000
 Dec 31 Profit and Loss $2000
 ======



 profit and loss



2005
Dec 31 Acc. prov. for Depr. Machinery $2000
2006

Dec 31 Acc. prov. for Depr. Machinery $2000

2007

Dec 31 Acc. prov. for Depr. Machinery $2000



 Income statement (extract) for
the year ending 31 December
2005 Depreciation $2000
2006 Depreciation $2000
2007 Depreciation $2000



Advantages of straight
line method
This method is very simple to
understand and easy to
calculate.
The value of the asset is reduced
to zero at the end of its lifetime.
The annual charge to the Profit
and Loss account is equal in all
years.

Disadvantages of straight
line method
When additions are made to assets,
calculations are required for each
asset having a different estimated
lifetime.
It does not take into account the
cost by way of interest on the
money invested.
Actual depreciation (wear and tear,
machine downtime, etc) in the
later years is likely to be more
than the earlier years, which is not
recognised by this method.
Reducing Balance Method

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E.g. A plant costing $6000 is
depreciated at 20% using the
Reducing Balance Method.
Required: Compute the charge for
each of the three years and
show the amount to be (1)
debited in the Profit and Loss
account (2) the Balance Sheet
of the three years disclosure for
each

 Balance sheet (extract)
As at 31 December 2005
Plant at cost $ 6000
Less: Accumulated Depr. $ (1200)

Net book value

$4800

Income Statement for the year


ending 31 December 2005

Depreciation expense: plant $1200


 Balance sheet
 As at 31 December 2006
Plant at cost $ 6000
Less: Acc-ed Depr. $ (2160)

(1200+960)

Net book value

$3800
 Income Statement for the year

ending 31 December 2006

Depreciation expense: plant $ 960



Advantages of reducing
balance method
Separate calculations are not
required for each addition in the
asset account.
The total of depreciation and
amount spent on repairs is
equated over the years.

Disadvantages of Reducing Balance
Method
The book value of the asset will
never become zero under this
method
It is very difficult to ascertain the
correct rate of depreciation to
write off the asset during its
lifetime.

Sum of the years’ digits
method
Under this method, the digits or
the remaining useful life of the
asset is calculated.
The digits are added up to get the
sum of digits.
The corresponding ratio of digits
is then obtained.



Amachinery costing $12,000, which will be

used for 5 years, will be depreciated as

follows:

 From purchase the asset will last for 5

years
 From the 2nd year the asset will last for 4
years
 From the 3rd year the asset will last for 3
years
 From the 4th year the asset will last for 2
years
 From the 5th year the asset will last for 1
year
 Depreciation expense
1st year 5/15 of $12,000 is charged=
4000
2nd year 4/15 of $ 12,000 is charged=

3200
3rd year 3/15 of $ 12,000 is charged=

2400
4th year 2/15 of $ 12,000 is charged=

1600
5th year 1/15 of $ 12,000 is charged=

800
Usage Method

Usage method calculates the

number of hours for which an
asset has been used throughout
its entire lifetime.
The usage is calculated every
year at a particular rate.

 A machine is expected to be able
to produce 10,000 widgets over
its useful life. It has cost of
$6,000 and its expected salvage
value is of $1,000.
Year 1 – 1,500 widgets are
produced
Year 2 – 2,500 widgets are
produced

 period’s
production
(Cost – salvage value) x total ex-ed

prod-n


 Year 1: $6,000 – $1,000

$5,000x 1,500 = $750 depreciation
 10,000
Year 1: $5,000x 2,500 = $1,250
depr-n.
 10,000
Fixed asset disposal
When we sell a non-current asset,
we want to remove it from our
ledger.
So, we take the cost of the asset
from our asset account.
We also must take out the
accumulated provision that the
asset has.
If we get profit or loss on sale, we
must calculate it and post to the
Profit and Loss account.
 Reason for accounting
entries
Whenever a business
disposes/sells/trade-in an

old asset, an Asset disposal

account will be opened to

ascertain profit or loss on disposal

which will be transferred to Profit

and Loss account.
The entries raised in the books of
account will depend on the way
the business is maintaining its
records.
Ifthe fixed asset account is kept
at cost , the following entries will
be raised:
Transfer the cost of the asset
being disposed to disposal
account.
Debit : Fixed Asset Disposal
Account
Credit: Asset Account

With the provisions related to the
asset being disposed,
Debit: Provision for depreciation and
Credit: Fixed disposal Account.
With the sale proceeds or the
trade-in value
Debit: Bank/New asset and
Credit: Fixed Asset Disposal Account.


If the Credit side of the fixed asset
disposal is greater than the Debit
side, it is a profit on disposal with
this profit,
Debit: Fixed Asset Disposal account and
Credit: Profit and Loss Account.
If the Debit side of the Fixed Asset
Disposal is greater than the
Credit side ,it is a loss on
disposal, with this loss,
Debit: Profit and Loss Account and
 Worked example
A company has a machinery whose
cost is $5,000 and its
accumulated depreciation is
$2000. The machinery was agreed
to be sold for $3,500.
 Machinery Disposals

Machinery $5,000 Accum. Dep.

$2,000
Profit and Loss $500 Cash

$3,500 $ 5,500
$ 5,500
 Income Statement
Gross profit xxx
Add Gain on sale of
Machinery $500
 Worked example
A company has a machinery whose cost is
$5,000 and its accumulated depreciation
is $2000. The machinery was agreed to
be sold for $1,500.
 Machinery Disposals

 Machinery $5,000 Accum. Dep.

$2,000
 Cash $1,400
 P&L $1,600
 $5,000 $5,000
 ====
 Income Statement
Gross profit xxx
Less Loss on sale of
Machinery $1,400

Where Fixed Assets are Kept
at Net Book Value
 There will be no provision for
depreciation account.
 i.e. The provision for depreciation is
charged to the fixed asset account and
the fixed Asset Account shows a Net
book Value at the end of each
Accounting period;
 The entries in such a situation are:
 With the net book value of the asset
being disposed
 Debit: the Asset disposal Account and
 Credit: the Asset Account.
Good luck for your mid-term
exam!
Y o u ca n
d o it

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