DEPRECIATION is always a non cash expense

AND CARRYING AMOUNT

Depreciation is a method of spreading the cost of a non-current asset over its expected useful
life (economic life), so that an appropriate portion of the cost is charged in each accounting
period.
Depreciation: The systematic allocation of the depreciable amount of an asset over its useful life.
Depreciable amount: The cost of an asset less its residual value.

Residual value/ Salvage value: The expected disposal value of the asset (after deducting disposal
costs) at the end of its expected useful life.

Useful life: The period over which the asset is expected to be used by the business entity.

METHODS OF CALCULATING DEPRECIATION

 Straight-line method
 Reducing balance method
 Sum-of-the-digits method
 Depreciation by the number of units produced
 MACRS

Straight line depreciation

Where the depreciable amount is charged in equal amounts to each reporting period over the
expected useful life of the asset.
Cost of asset less expected residual value
Depreciation charge for the year=
Expecteduseful life ( years)

With the straight-line method, the annual depreciation charge is the same for each full financial
year over the life of the asset (unless the asset is subsequently re-valued during its life).

A machine cost Rs. 250,000. It has an expected economic life of five years and an expected
residual value of Rs. 50,000 at the end of that time.
Annual depreciation is:

250,000−50,000
Depreciation charge = 5
=40,000 per year
Reducing balance method
Where the annual depreciation charge is a fixed percentage of the carrying amount of the asset at
the start of the period.

Depreciation charge for the year=Carrying amount at the start of the year∗¿ %

The annual depreciation charge is highest in Year 1 and lowest in the final year of the asset’s
economic life.
If percentage is not given it can be calculated using the formula given below:
Residual Value
x=
√
n

Cost of theasset
−1

Practice Question
A machine cost Rs. 100,000. It has an expected life of five years, and it is to be depreciated by the
reducing balance method at the rate of 30% each year.
Annual depreciation and carrying amount over the life of the asset will be as follows.

Year Carrying amount Annual depreciation Carrying amount

at start of year charge (at (30% of at end of year
the reducing balance)
1 100,000 (100,000* 30%)= 70,000
30,000 is depreciable
amount
2 70,000 (70,000*30%) 70,000- 21000=
21,000 49,000
3 49,000 49000 *30%= 49000-14700=
14,700 34300
4 34300 34300*30%= 24010
10290
5 24010 24010*30%= 16807 it is called its
7203 salvage value

Year Carrying amount Annual depreciation Carrying amount

at start of year charge (at (40% of at end of year
the reducing balance)
1 250,000
2
3
4
5 19440
 Sum-of-the-digits method
Where depreciation is calculated by multiplying the depreciable amount by a fraction where
numerator is the remaining life of the asset at the start of the period and the denominator is the
sum of all the years’ useful life at the start of ownership.

This is another method of depreciation that charges the highest amount in the first year and the
lowest amount in the final year.

Example: Sum of the digits

A machine cost Rs. 500,000 and was expected to have a useful life of 5 years.
Annual depreciation over the life of the asset will be as follows.
Step 1: Calculate the sum of the digits (the denominator in the fraction)
Year
2
3
4
5
Sum of the digits 15
Step 2: Calculate the annual depreciation charge in each year

(Remaining useful life/ Sum of the digit) * with its cost= depreciation of that respective year

Year Remaining useful life at the start of the year Annual depreciation charge

5
1 5 ∗500,000=166,667
15

4
2 4 ∗500,000=133,333
15

3
3 3 ∗500,000=100,000
15

2
4 2 ∗500,000=66,667
15

1
5 1 ∗500,000=33,333
15
If useful life is 10 years then 1+2+3+4+5+6+7+8+9+10 = 55

Useful life is 70 years

Formula: Sum of the digits

n(n+1)
Sum of the digits= 2

Where:
n = the useful life at the start of ownership

5 year useful life

n(n+1) 5(5+1) 30
Sum of the digits= = = =15
2 2 2

n(n+1) 10(10+1) 110

10 years sum of the digit is = = = =55
2 2 2

Depreciation by number of units produced

Where depreciation is calculated by expressing the useful life of an asset in terms of its expected
total output and allocating the annual charge to depreciation based on actual output.

Cost of asset−Residual Value

Depreciation charge for the year= ∗Output this year
asset
Expected total output of life
its

Practice Question:
A machine cost Rs. 500,000. It is expected to produce 5,000,000 units over its useful life. 47,850
units were made in the first year of production. The depreciation charge in the first year of
ownership is:
Rs .500,000
×47,850=Rs . 4,875
5,000,000
An item of equipment cost Rs. 1,260,000. It has an expected useful life of six years and an
expected residual value of Rs. 240,000. Using the straight-line method of depreciation:
What is the annual depreciation charge? What will be the carrying amount of the asset after four
years?

2 The financial year of a company is 1st January to 31st December. A non-current asset was
purchased on 1st May for Rs. 60,000. Its expected useful life is five years and its expected residual
value is zero. It is depreciated by the straight-line method. What will be the charge for depreciation
in the year of acquisition if a proportion of a full year’s depreciation is charged, according to the
period for which the asset has been held?

3 A non-current asset cost Rs. 64,000. It is depreciated by the reducing balance method, at the
rate of 25% each year. What is the annual depreciation charge in Year 1, Year 2 and Year 3?
4 A motor vehicle cost Rs.400,000. It has an expected residual value after 5 years of Rs.40,000.
What will be the annual charge for depreciation each year if the sumof- the-digits method of
depreciation is used? What will be the carrying amount of the asset at the end of Year 2?

5 An office property cost Rs. 5 million, of which the land value is Rs. 2 million and the cost of the
building is Rs. 3 million. The building has an estimated life of 50 years. What is the annual
depreciation charge on the property, using the straight-line method?
 Modified accelerated cost recovery system (MACRS)
For tax purposes, the depreciation of business assets are depreciated in a different manner.
Because the objectives of financial reporting sometimes differ from those of tax legislation, firms
often use different depreciation methods for financial reporting than those required for tax
purposes. Depreciation for tax purposes is determined by using the modified accelerated cost
recovery system (MACRS); a variety of depreciation methods are available for financial
reporting purposes. All depreciation methods require you to know an asset’s depreciable value
and its depreciable life.
Under the basic MACRS procedures, the depreciable value of an asset (the amount to be
depreciated) is its full cost, including outlays for installation. Even if the asset is expected to
have some salvage value at the end of its useful life, the firm can still take depreciation
deductions equal to the asset’s full initial cost.
Recovery period
The appropriate depreciable life of a particular asset as determined by MACRS.
Baker Corporation acquired a car having 5 years life, for an installed cost of $40,000, Using the applicable
percentages from MACRS. Baker calculates the depreciation of the car in each year?
 Non-current assets and depreciation
A depreciation charge for non-current assets is calculated, and included in the statement of
comprehensive income.
The carrying amount of non-current assets in the statement of financial position is reduced by
accumulated depreciation on those assets.

Depreciation should be charged as an expense in the statement of comprehensive income each

year over the life of the asset.
Depreciation of a new asset commences from the date that an asset is available for use.
Most non-current assets must be depreciated, although there are some exceptions to this rule. For
example, land is not depreciated because it has an indefinite useful life.

Accounting for depreciation

The double entry for depreciation is carried out using two accounts (for each category of non-
current asset).
Depreciation double entry
Debit Credit
Depreciation expense X
Accumulated depreciation X

The balance on the depreciation expense account is taken to the statement of comprehensive
income as an expense for the period.
The accumulated depreciation account contains all of the depreciation recognised to date.
When the final statement of financial position is prepared, it is deducted from the cost of the
assets. The non-current asset figure in the statement of financial position is made up of two
figures, the cost less accumulated depreciation.
The balance on the accumulated depreciation account is carried forward as a (credit) balance at
the end of the period and appears in the statement of financial position as a deduction from the
cost of the non-current assets. The figure that appears in the statement of financial position is
known as the carrying amount (or net book value).
Carrying amount of a non-current asset
Rs.
Non-current asset at cost X
Less accumulated depreciation (X)
Carrying amount (net book value) X This figure appears on the face of
the statement of financial position

Accounts in the ledger for non-current assets and accumulated depreciation

There are separate accounts in the general ledger for each category of noncurrent assets (for
example, an account for land and buildings, an account for plant and machinery, an account for
office equipment, an account for motor vehicles, and so on) and the accumulated depreciation for
each of these categories of non-current assets.
This means that each category of non-current assets can be shown separately in the financial
statements.
An item of equipment cost Rs. 40,000 at the beginning of Year 1. It has an expected life of 5
years. The annual depreciation charge is Rs. 8,000.
Complete the following ledger accounts for Years 1 and 2 and calculate the carrying amount of
the asset at the end of each period.
a equipment account
b accumulated depreciation of equipment account
c depreciation of equipment account