Financial Accounting

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Lecture – 18

Depreciation

“It is a systematic allocation of the cost of a depreciable asset to expense over its useful life”.

Financial Accounting

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Lecture – 18

Classification of Fixed Asset Land Building Plant and machinery Furniture Equipment Vehicles

Financial Accounting

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Lecture – 18

• No depreciation is charged on Land.

• Amount paid for Leased Land is charged over the lease term.

• It is called amortization.

Financial Accounting

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Lecture – 18

Policies for Recording Fixed Asset

• Minimum value of item which will be recorded as asset.

• Depreciation method to be used.

Financial Accounting

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Lecture – 18

Methods of Depreciation

• Straight Line Method

• Written Down Value Method (WDV)

Financial Accounting

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Lecture – 18

• Cost of Asset – Price at which the asset was initially recorded.

• Written Down Value / Book Value – Cost minus Accumulated Depreciation.

Financial Accounting

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Lecture – 18

Journal Entries

• Purchase of asset

Debit Asset Account (relevant classification)

Credit Cash / Bank / Payable Account

• Charging of Depreciation

Debit Depreciation Account (P & L)

Credit Accumulated Dep.

Financial Accounting

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Lecture – 18

Written Down Value Method

Calculation of Rate

• Rate = 1 – n RV / C

• “RV” = Residual Value

• “C” = Cost

• “n” = Life of Asset

Financial Accounting

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Lecture – 18

• Residual Value – is the price at which the asset is expected to be sold at the end of its useful life.

Financial Accounting

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Lecture – 18

Calculation of Rate

• Cost = 100,000

• Residual Value (RV) = 20,000

• Life = 3 years

Financial Accounting

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Lecture – 18

• Rate = 1 – 3 20000/100000

= 42%

Financial Accounting

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Lecture – 18

Year 1

Cost 100,000

Depreciation100,000 x 42% (42,000)

WDV (Closing Balance) 58,000

Year 2

WDV (Opening Balance) 58,000

Depreciation 58,000 x 42% (24,360)

WDV (Closing Balance) 33,640

Year 3

WDV (Opening Balance) 33,640

Depreciation 33,640 x 42% (14,128)

WDV (Closing Balance) 19,511

Financial Accounting

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Lecture – 18

Disposal of Asset

Cost of Asset = 100,000

Life Of the Asset = 5 Years

Depreciation Method = Straight Line

Residual Value = Rs. 10,000

Sale Price After Five Years= Rs. 15,000

Financial Accounting

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Lecture – 18

Did we lose Rs. 85,000 (100,000 – 15,000) on the disposal of this asset?

Financial Accounting

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Lecture – 18

Method of Depreciation = Straight line

Total Depreciation in Five Years = 18,000 x 5

= 90,000

Book Value After Five Years = 100,000 - 90,000

= 10,000

Profit on Disposal = 15,000 – 10,000

= 5,000

Financial Accounting

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Lecture – 18

Recording of Disposal

Recording of Disposal

Debit Fixed Asset Disposal A/c 100,000

Credit Fixed Asset Cost A/c 100,000

(with the cost of asset)

Debit Accumulated Dep. A/c 90,000

Credit Fixed Asset Disposal A/c 90,000

(with the depreciation accumulated to date)

Debit Cash / Bank / Receivable A/c 15,000

Credit Fixed Asset Disposal A/c 15,000

(with the price at which asset is sold)

[note: one group to appear at a time]

Financial Accounting

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Lecture – 18

Disposal of Asset Account

Fixed Asset Disposal Account

DEBIT CREDIT

Cost Account 100,000 Acc. Dep. Account 90,000

Cash / Bank 15,000

100,000 105,000

P & L Account 5,000

105,000 105,000Total Total

Financial Accounting

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Lecture – 18

• Policy for Charging Depreciation

(1) depreciation can be charged on the basis of use,

OR

(2) full year’s depreciation is charged in the year of purchase and no depreciation is charged in the year of sale.

Financial Accounting

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Lecture – 18

Example

• An asset is purchased for Rs. 500,000 on Nov. 01, 2001.

• Depreciation rate is 10% p.a.

• The Asset is sold on Apr. 30, 2004.

• Financial Year is July 1 to June 30

Question

• Calculate the WDV For both policies

Financial Accounting

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Lecture – 18

Depreciation is Charged on the Basis of USe

Year On the Basis of Use Rs.

1-11-2001 Cost 500,000

2001-2002 Dep. 500,000 x 10% x 8 / 12 (33,333)

30-6-2002 WDV 466,667

2002-2003 Dep. 466,666 x 10% (46,667)

30-6-2003 WDV 420,000

2003-2004 Dep. 420,000 x 10% x 10 / 12 (35,000)

30-4-2004 WDV 385,000

Financial Accounting

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Lecture – 18

Full Dep. In the Year of Purchase

Year Full Dep. in year of Purchase Rs.

1-11-2001 Cost 500,000

2001-2002 Dep. 500,000 x 10% (50,000)

30-6-2002 WDV 450,000

2002-2003 Dep. 450,000 x 10% (45,000)

30-6-2003 WDV 405,000

2003-2004 Dep. 00 in the year of sale 00

30-6-2004 WDV 405,000

Financial Accounting

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Lecture – 18

Contents of Fixed Assets Register

• Different record for each class of assets

• Date of purchase

• Detailed particulars of asset

• Location of asset

• Record of depreciation