Chapter 20 Depreciation - method of depreciation

20.1 Depreciation
Q What is depreciation?

A Fixed assets have a limited useful life. When an asset is purchased and used over a period of
time, it loses value. The purpose of depreciation is to spread this cost of asset over its limited
useful life.

Q Why do we provide depreciation?

A Accruals concepts – allocating the cost of assets less estimated residual value over its useful
life.

Q How do we calculate depreciaton?

A The most commonly method of calculating depreciation are:

o Straight line method
o Reducing balance method

20.2 Straight line method

Q What is straight line method of depreciation?

A Depreciation of equal amount over its estimated useful life

Q How do we calculate depreciaton using straight line method?

Cost – estimated residual value

A Formula: Annual depreciation =
No of years in use

Example 1

A firm acquired a motor car for RM5,000. It will be kept for 4 years and then sold for RM1,000.

Required
Calculate the annual depreciation.

Solution to Example 1

Cost = RM5,000
Residual value = RM1,000
Years in use =4

Annual depreciation = 5,000 – 1,000

4
= RM1,000

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20.3 Reducing balance method
Q What is reducing balance method of depreciation?

A Depreciation based on fixed percentage on net book value at the beginning of the year

Q How do we calculate depreciaton using reducing balance method?

A Formula: Annual depreciation = depreciation rate x net book value (NBV)

Where : NBV = cost less total depreciation to date

Example 2

Encik Faisal acquired a motor car for RM20,000 on 1 January 20X1. He decided to depreciate it at the
rate of 60% using the reducing balance method.

Required:
Calculate the annual depreciation.

Solution to Example 2

Annual depreciation = depreciation rate x net book value (NBV)

Cost at the start of 20X1 20,000

Depreciation for year 20X1 (60% x 20,000) 12,000
Net book value at the end of 20X1 8,000
Depreciation for year 20X2 (60% x 8,000) 4,800
Net book value at the end of 20X2 3,200
Depreciation for year 20X3 (60% x 3,200) 1,920
Net book value at the end of 20X3 1,280
Depreciation for year 20X4 (60% x 1,280) 768
Net book value at the end of 20X4 512

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20.4 Summary

Depreciation

Definition

allocating the cost of assets less

estimated residual value over its
useful life.

Methods of depreciation

Straight line method Reducing balance method

Cost-estimated residual value o Annual depreciation = % x Net book value

o Annual depreciation =
No of years in use
or
o Annual depreciation = % x Cost

20.5 Exercises
Question 1

A firm acquired a motor car for RM20,000 on 1 January 20X1. It will be kept for 3 years and then sold
for RM4,320. Calculate the depreciation for each of the 3 years using:
(a) Straight line method
(b) Reducing balance method at a rate of 40%

Question 2

A firm acquired a motor car for RM12,800 on 1 January 20X1. It will be kept for 4 years and then sold
for RM800. Calculate the depreciation for each of the 4 years using:
(a) Straight line method
(b) Reducing balance method at a rate of 50%

Question 3

ABC Enterprise has a year end of 31 December, and depreciates their motor vehicles at a rate of 20% per
annum using straight line method.
The following were the purchases of assets for the 3 years ended 31 December:

Date of purchase Details Cost (RM)

1 Jan 20X1 Motor vehicle (1) 10,000
1 Jul 20X2 Motor vehicle (2) 20,000
1 Mar 20X3 Motor vehicle (3) 30,000

Required:
Calculate the depreciation for the year ended 31 December 20X1, 20X2 and 20X3.

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Question 4

XYZ Enterprise has a year end of 31 December, and depreciates their machinery at a rate of 25% per
annum using reducing balance method.
The following were the purchases of assets for the 3 years ended 31 December:

Date of purchase Details Cost (RM)

1 Jul 20X1 Machinery (1) 10,000
1 Jan 20X2 Machinery (2) 20,000
1 Jul 20X3 Machinery (3) 30,000

Required:
Calculate the depreciation for the year ended 31 December 20X1, 20X2 and 20X3

20.6 Answers
Question 1

a) Cost = RM20,000
Residual value = RM4,320
Years in use =3

Annual depreciation = 20,000 – 4,320

3
= RM5,227 per year

b) Annual depreciation = depreciation rate x net book value (NBV)

Cost at the start of 20X1 20,000

Depreciation for year 20X1 (40% x 20,000) 8,000
Net book value at the end of 20X1 12,000
Depreciation for year 20X2 (40% x 12,000) 4,800
Net book value at the end of 20X2 7,200
Depreciation for year 20X3 (40% x 7,200) 2,880
Net book value at the end of 20X3 4,320

Question 2

a) Cost = RM12,800
Residual value = RM800
Years in use =4

Annual depreciation = 12,800 – 800

4
= RM3,000 per year

b) Annual depreciation = depreciation rate x net book value (NBV)

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 Cost at the start of 20X1 12,800
Depreciation for year 20X1 (50% x 12,800) 6,400
Net book value at the end of 20X1 6,400
Depreciation for year 20X2 (50% x 6,400) 3,200
Net book value at the end of 20X2 3,200
Depreciation for year 20X3 (50% x 3,200) 1,600
Net book value at the end of 20X3 1,600
Depreciation for year 20X4 (50% x 1,600) 800
Net book value at the end of 20X4 800

Question 3

Motor vehicle (1) Motor vehicle (2) Motor vehicle (3)

Date of purchase 1 Jan 20X1 1 Jul 20X2 1 Mar 20X3
Cost 10,000 20,000 30,000 Total
year ending 31 Dec 20X1 (W1) 2,000 - - 2,000
year ending 31 Dec 20X2 (W2) 2,000 (W4) 2,000 - 4,000
year ending 31 Dec 20X3 (W3) 2,000 (W5) 4,000 (W6) 5,000 11,000
Working Motor vehicle (1) Motor vehicle (2) Motor vehicle (3)
year ending 31 Dec 20X1 (W1) 10,000 x 20% - -
year ending 31 Dec 20X2 (W2) 10,000 x 20% (W4) 20,000 x 20% x 6/12 -
year ending 31 Dec 20X3 (W3) 10,000 x 20% (W5) 20,000 x 20% (W6) 30,000 x 20% x 10/12

Question 4

Machinery (1) Machinery (2) Machinery (3)

Date of purchase 1 Jul 20X1 1 Jan 20X2 1 Jul 20X3
Cost 10,000 20,000 30,000 Total
year ending 31 Dec 20X1 1,250 - - 1,250
year ending 31 Dec 20X2 2,188 5,000 - 7,188
year ending 31 Dec 20X3 1,641 3,750 3,750 9,141
Working Machinery (1) Machinery (2) Machinery (3)
year ending 31 Dec 20X1 (W1) 10,000 x 25% x 6/12 -
year ending 31 Dec 20X2 (W2) 8,750 x 25% (W4) 20,000 x 25% -
year ending 31 Dec 20X3 (W3) 6,562 x 25% (W5) 15,000 x 25% (W6) 30,000 x 25% x 6/12

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