BAF 223: INTRODUCTION TO ACCOUNTIN II: DEPRECIATION NOTES

DEPRECIATION
Depreciation can be defined as that part of the original cost of fixed assets that are consumed during its
period of use in the business.
Depreciation can also be defined as the loss in the value due to of usage of an asset. Almost all business
assets have a given time duration for their existence and as they are used/ consumed their value keeps on
Declining.
CAUSES OF DEPRECIATION
Depreciation caused by the factors discussed below:
(i) Physical deterioration
(ii) Economic factors
(iii) Time
(iv) Depletion
i) Physical deterioration
Almost all assets are affected by wear and tear. Example motor vehicle, furniture used in the office, etc.
ii) Economic factors
These are factors that are not related to the physical condition of an asset but are largely due to economic
conditions e.g.
a) Obsolescence: this is when an asset becomes out of date. For example, the typewriters are fast
becoming obsolete and being replaced with computers. Thus even if it were new, it would be overtaken
by events. Technological advancements are the largest contributors to the obsolescence.
b) Inadequacy: this happens when an asset can no longer be used mainly due to growth of size of a
business. For example a start-up business in the transportation industry is using a small pick-up and as it
grows it may find large tracks more economical and convenient.
iii) Time
Time is also a key contributor to depreciation in the sense that even if an asset was left unused; its value
would fall considerably with passage of time.

iv) Depletion
This is the case of exhaustion of natural resources with time. As extraction of such assets continues they
become of lesser value e.g. mines oil fields, quarries, e.t.c.

DEPRECIATION AS AN EXPENSE

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Depreciation is an operating expense in the business that reflects the loss in value of an asset during a
given accounting period. Depreciation is recognized in line with such concepts as matching concept
whereby we match revenues of a particular period with the expenses incurred in the same period.
Methods of charging depreciation
There are two major methods of charging depreciation;
i) Straight line method ii) Reducing balance method
Other methods of depreciation are:
1. Revaluation method
2. Depletion unit method
3. Machine hours method
4. Sum of years digit method
Depreciation is arrived at by simply taking the total cost of the assets less any amounts received during its
disposal. The resulting figure ids known as the residue value.
The depreciation will be the difference between the cost and the amount received. The problem arises
when an asset is used for more than one accounting period. We therefore can only estimate how much to
allocate to each accounting period. The methods used are:
Straight line method
This method assumes that an asset is depreciated uniformly over its useful life. Useful life in this case is
taken in form of years.
Depreciation is calculated as follows:
Depreciation is arrived at by simply taking the total cost of the assets less any amounts received during its
disposal. The resulting figure ids known as the residue value.
The depreciation will be the difference between the cost and the amount received. The problem arises
when an asset is used for more than one accounting period. We therefore can only estimate how much to
allocate to each accounting period. The methods used are:
Straight line method
This method assumes that an asset is depreciated uniformly over its useful life. Useful life in this case is
taken in form of years.

Cost Estimated Disposal Value(Residual Value)

Depreciation is calculated as follows:
Number of expected years of use
The depreciation could also be calculated as a percentage of total cost. The percentage is calculated as
follows.
For example if the number of useful years is five years, we can calculate the percentage of depreciation
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each year as: x 100 = 20%
5

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EXAMPLE:
Rongo ltd bought furniture worth Sh. 200,000. The furniture was expected to last 8 years and would be
disposed of for Sh. 40,000 at the end of the eighth year. Show how depreciation to be allocated in each of
the accounting period for the 8 years using the straight line method of depreciation.
200,000−40,000
Depreciation = { } = Ksh 20,000; Each year the depreciation charge would be Sh
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20,000
If an asset is estimated not to have any residue value at the end of its life time, depreciation equals to the
total cost of the asset divided by its life time.
Reducing balance method:
In this method, the depreciation is charged at a fixed percentage over the remaining cost of an asset. It is a
method conveniently for assets that are assumed to have a higher depreciation rate over their first few
years of use. More so, advocates of this method argue that the cost of running an asset is not depreciation
only but also costs to do with maintenance and repairs.
They argue that during the first year, costs of repairs and maintenance will be minimal and hence charge
minimal depreciation during the first years to match the low repairs and maintenance cost. During later
years, depreciation charge will be minimal whereas repairs and maintenance will have increased
significantly. This will therefore tend to give a uniform cost of running an asset. However this is not
always the case.
Example
An equipment is bought for Ksh 300,000 and depreciation is to be charged at 25% on the reducing
balance method show the calculation of depreciation charge for the first years of use
1st year 300000 x 25% = 75000
2nd year (300000 - 75000)*25% = 56250
3rd year (225000 - 56250)*25% = 42187.
You will realize that:
During the first year depreciation was higher but then becoming smaller and smaller as the years go by.

DOUBLE ENTRY RECORDING OF DEPRECIATION

Example 1
A company maintains its fixed assets at cost. Depreciation provision accounts, one for each type
of asset, are in use. Machinery is to be depreciated at the rate of 15% per annum, and fixtures at
the rate of 5% per annum, using the reducing balance method. Depreciation is to be calculated on
assets in existence at the end of each year, giving a full year’s depreciation even though the asset
was bought part of the way through the year. The following transactions in assets have taken
place:
 20X5 1 January Bought Machinery Sh. 280,000, fixtures Sh. 29,000
1 July Bought Fixtures Sh. 62,000
 20X6 1 October Bought Machinery Sh. 350,000
1 December Bought Fixtures Sh. 13,000
The financial year end of the business is 31 December.

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You are Required to show:
(a) The machinery account.
(b) The fixtures account.
(c) The two separate provision for depreciation accounts.
(d) The fixed assets section of the balance sheet at the end of each year, for the years ended
31 December 20X5 and 20X6.
Example 2
A business with its financial year end being 31 December buys two vans on 1 January 20X1, No
1 for Sh. 800,000 and No 2 for Sh. 500,000. It also buys another van, No 3, on 1 July 20X3 for
Sh. 900,000 and another, No 4, on 1 October 20X3 for Sh. 720,000. The first two vans are sold,
No 1 for Sh. 229,000 on 30 September 20X4, and No 2 for scrap for Sh. 5,000 on 30 June 20X5.
Depreciation is on the straight line basis, 20 per cent per annum, ignoring scrap value in this
particular case when calculating depreciation per annum.

Required:
Show the extracts from the assets account, provision for depreciation account, disposal account
and profit and loss account for the years ended 31 December 20X1, 20X2, 20X3, 20X4, and
20X5, and the balance sheets as at those
date
BAF 223/206 ACCOUNTING FOR DEPRECIATION COMPREHENSIVE EXAMPLE

Alice Burke started business of renting out Plants and Equipment in January 1, 2019 as such she
prepares her financial statements on 31 December each year and maintains a Plant and
Equipment register at cost. She provides depreciation for the full year on Non-current assets
which are in use at the end of the year, and none in the year of disposal. She started the business
with two items of plant and equipment PPE 1 and PPE2 bought at Sh. 16,000,000 and
16,400,000 respectively.

At 1 May 2021, PPE2 was damaged by high voltage in normal use which was compensated by
insurance for Sh. 9,840,000. On 1 June 2021 Alice bought two more Plant and Equipment; PPE3
and PPE4 worth Sh. 10,000,000 each and sold Plant and Equipment PPE1 at Sh. 9,400,000. 10
February 2022 through bank account, Alice Burke acquired a Plant and Equipment, PPE5 for
18,800,000. PPE3 was stolen from the maintenance garage on November, 2023, compensation is
still awaited. Depreciation is provided using straight line basis on cost at 20% per annum.

Required:
(i) Prepare Computations for Depreciation expenses to be charged to the Statement of
financial income for the years: 2019, 2020, 2021, 2022 and 2023.
(ii) Prepare the ledger accounts for Plant and Equipment from 2019 to 2023 recording all
relevant transactions.

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 (iii) Prepare the ledger account recording the Provision for Depreciation for the Plant and
equipment for the years: 2019, 2020, 2021, 2022 and 2023.
(iv) Why is depreciation charged?
(v) Is it possible that realizable value may exceed market value or fair value of a non-
current asset? Explain.
PROPERTY, PLANT AND EQUIPMENT SCHEDULE:
This was formerly referred to as the fixed asset movement schedule. It is a tabular representation of the
movement of tangible assets cost within a given accounting period the schedule also shows movement of
depreciation for all tangible assets within the given accounting period IAS 16 property plant and
equipment requires that the schedule be shown in the published account of companies.

The format is as shown below:

Property plant and equipment schedule Property plant and equipment schedule

FIXTURE,
FREEHOL PLANT & FURNITUR
D MACHINER E& TOTA
COST/ VALUATION PROPERTY Y FITTINGS L
KSH KSH KSH KSH
1 Opening Balance b/d (1/1/01) xxx xxx xxx xxx
2 Additions xxx xxx xxx xxx
3 Revaluation Gains xxx - - xxx
4 Re-Classification - (xxx) xxx xxx
5 Disposals (xxx) (xxx) (xxx) (xxx)
6 Closing Balance c/d (31/12/01) xxx xxx xxx xxx
7 Depreciation/Amortization:
8 Opening Balance b/d (1/1/01) xxx xxx xxx xxx
9 Change for the year xxx xxx xxx xxx
1
0 Revaluation Gains (xxx) (xxx) (xxx) (xxx)
1
1 Eliminated on Disposal (xxx) (xxx) (xxx) (xxx)
1
2 Closing Balance (31/12/01) xxx xxx xxx xxx
N.B.V as at 1/1/01(1-8) (1 - 8) xxx xxx xxx xxx
N.B.V as at 31/12/01(6-12) (6 - 12) xxx xxx xxx xxx

NOTES:

 The opening Balance represents the cost of the assets at the beginning of the Financial Year.
 Reclassification is where an assets has changed its form from one to another e.g. from a plant to
Fixtures
 Eliminated on Disposal means the asset is actually disposed of.
 Net Book Value (NBV) as at 1/1/01 means at the beginning: Total Assets – Total Depreciation
 The numbers shown in the first column are to assist in calculations.