DEPRECIA
TIO
N
DEFINITION
HKSSAP defines depreciation as the ‘allocation of the depreciable amount of an asset over its estimated life’.
THE OBJECTIVE OF DEPRECIATION
According to the matching concept, revenues should be matched with expenses in order to determine the accounting profit.
The cost of the asset purchased should be spread over the periods in which the asset will benefit a company.
Causes of Depreciation
Product Obsolescence Physical Deterioration
Depreciable Assets
•The assets are acquired or constructed with the intention of being used and not with the intention for resale.
•HKSSAP regards assets as depreciable when they•Are expected to be used in more than one accounting period.
•Have a finite useful life, and•Are held for use in the production or supply of goods and services, for rental to others, or for administrative purposes.
Non-Depreciable Asset
Freehold Land◦ It has an indefinite useful life, and it retains its value
indefinitely.
Leasehold Land (Long Lease)◦ It has an unexpired lease period not less than 50 years
Investment Property◦ Which construction work and development have been
completed◦ Which is held for its investment potential, any rental income
being negotiated at arm’s length.
Estimated Useful Life – Number of years or time
periods for which the company can use the asset
Depreciation – An estimate of the use or deterioration of an asset
Asset Cost – Amount paid for an asset including freight charges
CONCEPT OF DEPRECIATION
Residual Value (Salvage Value) - Expected cash value at the end of an
asset’s useful life.
14-7
Straight-Line MethodDistributes the same amount of expense to each period of time.
Depreciation expense = Cost -- Residual value each year Estimated useful life in years
Ajax Company bought equipment for $2,500. The company estimates that the equipment’s period of useful life will be 5 years. After 5 years the residual value is $500. Calculate depreciation expense and complete a depreciation schedule.
($2,500 -- $500) 5
100% = 100%# of yrs. 5= $400 = 20%
Example:
Units-of-Production Method
Depreciation determined by how much the company uses the asset.
Depreciation expense = Cost -- Residual value per unit Total estimated units produced
Depreciation = Unit x Units amount depreciation produced
($2,500 -- $500) 4000 = $.50=
Depreciation expense = Book value of equipment x Depreciation each year at beginning of year rate
Accelerated method which computes more depreciation expense in the early years of the asset’s life. Uses up to
twice the straight-line rate.
DECLINING-BALANCE METHOD
Rate = 100% 5 years
x 2 = 40%
MACRS DepreciationRequired method to use for tax depreciation in USA only
Originally developed to offer accelerated depreciation for economic growth
Dt = dtB Where: Dt = depreciation charge for year t B = first cost or unadjusted basis dt = depreciation rate for year t (decimal)
Where: Dj = depreciation in year j ∑ Dj = all depreciation through year t
BVt = B - ∑Djj = 1
j = t
Get value for dt from IRS table for MACRS rates
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