CHAPTER 8 - Depreciation

7/28/2019 CHAPTER 8 - Depreciation

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DEPRECIATION


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DEFINITION

Depreciation can be defined as the process of

allocating the cost of a fixed asset (non-currentasset) over its useful life in a rational andsystematic manner.


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CAUSES OF DEPRECIATION

Wear and tear: Physical deterioration of a non-currentasset caused by its used, rust, rot and decay.

Obsolescence : When an asset has become out of date.

Passage of time : When asset falls in value as time goesby.

Depletion : Fall in value of an asset (land) due toextraction of raw material from it.

Inadequacy : When an asset can no longer cater for thegrowing demand perhaps due to its size etc.


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METHODS OF CALCULATING

DEPRECIATIONTheoretically, asset is depreciated until the value of the

asset is zero. In practice, a value of RM 1 is left in thebalance sheet to indicates that even though the assethas been fully depreciated, it is still being used in thecompany.

There are two main methods of calculating

depreciation:Straight Line Method

Reducing Balance Method


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STRAIGHT LINE METHOD

Under this method depreciation expense is the sameevery year.

Annual depreciation can be calculated using the

following formula:Depreciation = Original cost Salvage /scrap value

No. of expected useful life

OR

Depreciation = Depr. ratio (%) x Original cost of

fixed asset


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REDUCING BALANCE METHOD

Under this method the annual depreciation isdeclining until the cost of the asset becomes zero.

Depreciation is calculated based on the net bookvalue.

Depr. = Depr. Ratio (%) x Net Book Value (NBV) of

fixed asset/Non-Current Asset

NBV = Cost

Accumulated Depreciation


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JOURNAL ENTRIESJournal entries to record depreciation:

Debit Depreciation AccountCredit Accumulated Depreciation/Provision

for Depreciation Account

(Being depreciation provided for a non-current asset)


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LEDGER ENTRIESLedger Entry:

Depreciation Account

xx/xx/xx Prov. for depr. xxx xx/xx/xx To IS xxx

xxx xxx

Prov. For Depreciation a/c

xx/xx/xx Bal. c/d xxx xx/xx/xx Depr. xxx

xxx xxx


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CAPITAL VS REVENUE

EXPENDITUREExpenditure :

Refer to a payment or the acceptance of an

obligation to make a future payment.Can be divided into 2 categories:

1. Capital Expenditure

2. Revenue Expenditure


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Capital Expenditure Revenue Expenditure

Payments for the purchase ofan asset, which providesbenefits to the business forseveral accounting periods.

Examples: Purchase price of fixed asset

Installation cost

Renovations or addition to

fixed assets Taxes on purchase of fixed

assets

Insurance during transit.

Expenditures that providebenefits only during thecurrent accounting period.

Examples:

Repairs and maintainance

Petrol

Road tax

Depreciation

Insurance expenses


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DIFFERENCE BETWEEN

CAPITAL EXPENDITURE REVENUE EXPENDITURE

Expenditure to buy or to add

value on fixed assets, which

last for a long term usuallymore than one accounting

period and permanently

increase the profit making

capacity of the business.

Appears in the Balance

Sheet as part of the value or

cost of an asset.

Expenditure for runningon a day-to-day basis.

Normally used up in lessthan one accountingperiod.

Appears in the Income

Statement as an expenses


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Illustration:

Classify the following between capital or revenue expenditure.

Expenditure

1. Buying motor van

2. Petrol costs for motor van

3. Repairs to motor van

4. Putting extra headlights on motor van

5. Buying machinery

6. Electricity costs of using machinery

7. Spent RM2,000 on machinery, RM 1,200 for an

item added to the machine and RM 800 for repairs.

8. Painting outside of a new building

9. Three years later repainting outside of the same

building.

Types of expenditure

1. CE

2. RE

3. RE

4. CE5. CE

6. RE

7. CE:

RM1,200

RE:RM 800

8. CE

9. RE

CHAPTER 8 - Depreciation

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