Depreciation

What is depreciation ?

� Depreciation is the process of allocating the cost of property and equipment over its
estimated life.
� It is the process of slowly charging a portion of the cost of property and equipment to
expense called depreciation expense.
� The purpose of depreciation is to ensure that all the years that benefited from the use of the
property and equipment will have its corresponding share (depreciation expense) on the
cost of the property and equipment.
� As the property and equipment is used on a yearly basis, the accumulated amount of its
depreciation charges will reach its estimated life. When that happens, the cost of the
equipment and the total depreciation charges will now be equal. When this happens, the
equipment is said to be fully depreciated.
How is depreciation expense computed?

� The most common depreciation method is the straight line method.

� It is called straight line method because there is a fixed annual amount of depreciation
expense, which, when graphed, will show a straight line, hence the name straight line
method).
� The formula for the straight line method is

� Cost – salvage value

� Estimated useful life
Compute the depreciation expense of the
following property and equipment
1. Equipment costing P35,000 was bought on January 2, 2020. The equipment has no salvage
value and is estimated to have a useful life of 5 years.
2. Furniture costing P50,000 was bought on July 2, 2020. The furniture has no salvage value
and is estimated to have a useful life of 10 years.
3. Machinery costing P84,000 was bought on January 2, 2020. Its salvage value is P4,000 and
its estimated life is 10 years.
4. Car costing P600,000 was bought on March 1, 2020 with an estimated life of 10 years and
a salvage value equal to 10% of its original cost.
Rules for computing depreciation expense

1. If you use the straight line method where the divisor is number of years, the amount that
you computed represent the annual depreciation expense.
2. If the property and equipment was used for less than one year on its first year of use, then
you need to apportion the annual depreciation expense with the number of months used, by
using this formula.
Annual depreciation x No. of months used/12
Adjusting entry for depreciation expense

� An equipment costing P780,000 was bought on September 1, 2020 with an estimated life
of 4 years.
� Computation of depreciation expense:
� 780,000 /4 years =P195,000/year
� No. of months used (Sept 1 to Dec 31) =4 months
� P195,000 x 4/12
� =P65,000 depreciation expense for first year. Note: For the subsequent years, you will
charge the one year depreciation expense
� Entry: Dr Depreciation expense 65,000
� Cr Accumulated depreciation 65,000
What is accumulated depreciation?

*Annual charges for depreciation expenses are credited to accumulated depreciation account.
*The accumulated depreciation constantly increases as annual depreciation charges are added
to it. Thus, a small balance for accumulated depreciation indicate that the property and
equipment is still new. A big balance of accumulated depreciation indicate that the property
and equipment (to which the A/D relate) is old and nearing retirement.
What kind of account is accumulated
depreciation?
� Accumulated depreciation is a contra asset account.
� It is presented in the balance sheet as a deduction from the related property and equipment
account.
� Using our example in Slide 6, the balance sheet presentation is
� Equipment, at cost P780,000
� Less Accumulated depreciation 65,000
� Net book value P 715,000
What is net book value?

� Net book value represents the undepreciated amount of the equipment cost
� Net book value has a reverse relationship with accumulated depreciation. As the
accumulated depreciation increases, net book value decreases.
What happens if a fully depreciated equipment
is still used?
*Since the amount of depreciation charges is just an estimate, it is possible that the equipment
could outlive its estimated life.
*If a fully depreciated equipment is still in use, there is no more cost to depreciate, then
depreciation charges stop. It would be better to live a nominal amount of P1 or P100 to
indicate that the fully depreciated equipment is still used.