Depreciation

CHAPTER 27
 Concept of depreciation

• Systematic allocation of the depreciable amount of an

asset over the useful life

• Cost allocation in recognition of the useful life of an

item of
property, plant and equipment.

• The objective is to have each period benefitting from the

use of the asset bear an equitable share in the asset cost
 Depreciation in the financial
statements

• Expense  charged to Cost of goods

manufactured, or
 charged to Operating
expense
 Depreciation period

• Depreciation begins when the asset is available for

use and ceases when asset is derecognized.
• Depreciation continues even when the asset
is temporarily idle.
• When asset is classified as “Held for sale” depreciation
shall be discontinued.
 Kinds of depreciation

Physical Functional or economic

• Wear and tear • Inadequacy (volume)
• Passage of time • Supersession (efficiency)
• Action of the elements • Obsolescence (no future
• Casualty or accident demand, catch all)
• Disease or decay
 Factors of depreciation

• Depreciable amount (cost less residual value)

• Residual value (estimated net amount obtainable at the
end of the asset’s life)
• Useful life (period over which the asset is expected to be
available for use, or the number of production or similar
units expected to be obtained from the asset by the entity.
 no. of yrs/ units of production/ service hours)
Factors in determining useful life

• Expected usage of the asset

• Expected physical wear and tear
• Technical or commercial obsolescence
• Legal limits (e.g. expiry date)

Note : Service life (useful life) vs physical life

 Depreciation Methods

Decreasing charge Other Methods

Equal or Variable charge or or accelerated or
uniform charge use factor or diminishing balance
activity method methods
methods  Inventory or
 Sum of the year’s
appraisal
 Straight line  Working hours digits  Retirement
or service hours  Declining
 Composite  Replacement
 Output or balance
 Group production  Double declining
method balance
 Straight line method

• The SLM is adopted when the principal cause

of depreciation is passage of time.
• Considers depreciation as a function of time
rather than usage.
• At the end of the useful life of the asset, the
carrying amount should equal the residual value.
• Simple and easy to use
 Composite and Group Method

• Practical for entities with lots of individual depreciable

assets.
• Composite Method – dissimilar assets are grouped and
treated as a single unit.
• Group Method – similar assets are grouped and
treated
as a single unit.
• The average useful life & the composite or group rate
are
computed, and the assets are depreciated on that basis.
 Composite and Group Method

• Composite life =. total depreciable amount

total annual depreciation

• Composite rate = total annual depreciation

total cost
 Composite and group method

Accounting procedures
1. Depreciation is reported in a singe accumulated depreciation account.
2. The composite or group rate is multiplied by the total cost of the assets
in the group to get the periodic depreciation.
3. When an asset in a group is retired, no gain or loss is reported. Asset is
credited for the cost of asset and accum depreciation is debited for
the cost less the salvage value.
4. When asset is retired and replaced by a similar asset, the
replacement is
debited to the asset and credited to cash/other acct.
Subsequently, the composite/group rate is multiplied by the balance of the
asset to get the periodic depreciation.
Variable charge or Activity Method

• Depreciation is more a function of use rather than time.

• Depreciation is related to the estimated production capability
of the asset expressed in rate per unit of output or per hour
of use.
• Working hours method => depreciation rate per hour
= depreciable amount / useful life in service hours
• Output or production method => depreciation rate per unit
= depreciable amount/ estimated useful life in units of
output
Decreasing charge or
accelerated method

• Provide higher depreciation in the earlier years and

lower in the later years of the useful life of the asset.
• Based on the philosophy that new assets are
generally capable of producing more revenue in the
earlier years than in later years.
• Repairs also tend to increase with the age of the
asset.
Decreasing charge or
accelerated method

• Sum of year’s digits – multiplying the depreciable amount by a

series of fraction (numerator is the digit of the useful
life/denominator is the sum of the digits in the useful life of the
asset)
Formula for SYD = Life [(Life + 1)/2]
• Declining balance method – a fixed or uniform rate is multiplied by
the declining CA of the asset to arrive at the annual depreciation.
Also known as fixed rate or diminishing CA method.
rate = 1 – nth* root of (residual value /cost) *useful life
Decreasing charge or
accelerated method

• Double declining balance – under this method, the straight

line rate is simply doubled to get the fixed rate. Also known
as 200% declining balance method.
Other Methods

• Inventory Method – merely estimating the value of the asset

at the end of one of the period. The difference between
balance of the asset account less value at the end of the
year is the depreciation.
No accumulated depreciation is maintained for this
method, the asset is directly credited for the depreciation.
Ideal for small and relatively inexpensive items.
Other Methods

Retirement method – no depreciation is recorded until the

asset is retired. Depreciation is equal to the original cost of the
asset retired minus salvage proceeds.
Replacement method- no depreciation is recorded until the
asset is retired and replaced
Change in useful life

• Useful life of asset shall be reviewed at each financial

year- end and if significantly different from previous
estimate, the change shall be treated as a change in
estimate.
• Current and future depreciation charges shall be adjusted
for the change.
Change in depreciation method

• Depreciation method shall reflect the pattern on which the

asset’s economic benefits are expected to be consumed
by the entity.
• Method shall be reviewed at each financial year-end, and if
a new pattern of economic benefits exist, the method shall
be changed to reflect such.
• The change in method shall also be accounted as a change
in accounting estimate and shall affect current and future
depreciation charges.