Depreciation

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    Fixed assets such as buildings, machinery ,etc do not last forever. When the amount received by disposal of a fixed asset is deducted from the cost of purchasing it, the difference is known as depreciation. Depreciation is the price we pay for using the fixed asset over time. E.g a van was bought for $5000 and used for 5 years. It was sold for $1000. That is to say its value had depreciated by $4000 over 5 years.

    Depreciation is treated an an expense and thus charged to the profit and loss account as an expense. It reduces net profit.

    Depreciation might occur due to many reasons e.g wear and tear, depletion (mines, etc), obsolescence, inadequacy , etc.

    Recorded as

    Debit the profit and loss account

    Credit the provision for depreciation account.

    CALCULATING DEPRECIATION

    Straight line method.

    Aka fixed installment method.

    Purchasing cost – selling cost

    No. Of years used

     

    In this method , fixed amount is deducted each year

     

    Reducing balance method

     

    Each year the percentage to be deducted remains the same but he amount changes.

    Say for example a van of value $5000 is to be depreciated by 20% each year the depreciation for first 3 years would be :

    Cost:                           $5000

    Less 20% depreciation        $1000 yr 1

     

    Cost :                          $4000

    Less depreciation 20%        $800   yr 2

     

    Cost                            $3200

    Less depreciation 20%        $640   yr 3

     

     

     

    Consider the following example.

    Mr.Daniyal bought a cellphone for $4000. Estimated life of the cellphone is 5 years.scrap value : $500.

    He wants to calculate the depreciation each year . use both methods to calculate the depreciation.  Take 40% per annum for reducing balance method.

     

     

    Straight line method

     

    4000-500       =          $700 per annum

    5

    Balance after 5 years  $500

     

    Reducing balance method

    4000x (40%) =          $1600                                     yr 1

    2400x(40%)  =          $960                                       yr 2

    1440x(40%)  =          $576                                       yr 3

    864x(40%)    =          $345.6                                    yr 4

    518.5x(40%) =          $207.4                                    yr 5

     

    Balance after 5 years : $311.1