Depreciation Assignment Help
Assets like buildings, machinery, equipment, furniture & fixtures, computers, cars, trucks, etc. are having their life for more than one year, but will not last indefinitely. The monetary value of these asset decreases over time due to use, wear and tear or obsolescence. During each accounting period (year, quarter, month, etc.) a portion of the cost of these assets is being used up. The portion which is being used up is measured as depreciation.
Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. It is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. It includes amortization of assets whose useful life is predetermined. In accountancy, depreciation refers to two aspects of the same concept:
1. the decrease in value of assets (fair value depreciation) and
2. the allocation of the cost of assets to periods in which the assets are used (depreciation with the matching principle).
Depreciation is charged in each accounting period by reference to the extent of the depreciable amount, irrespective of an increase in the market value of the assets. Assessment of depreciation and the amount to be charged in respect thereof in an accounting period are usually based on the following three factors:-
1. Historical cost or other amount substituted for the historical cost of the depreciable asset when the asset has been revalued;
2. Expected useful life of the depreciable asset; and
3. Estimated residual value of the depreciable asset.
The calculation and reporting of depreciation is based upon two accounting principles:
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1. Cost Principle: It requires that the Depreciation Expense reported on the income statement and the asset amount that is reported on the balance sheet, should be based on the historical (original) cost of the asset.
2. Matching Principle: This principle requires that the asset's cost be allocated to Depreciation Expense over the useful life of the asset.
There are several methods of allocating depreciation over the useful life of the assets like straight-line method, reducing balance method, Annuity depreciation, sum-of-years-digits method, Units-of-production method etc. Those most commonly employed in industrial and commercial enterprises are the straight-line method and the reducing balance method. The management of a business selects the most appropriate method(s) based on various important factors e.g., (i) type of asset, (ii) the nature of the use of such asset and (iii) circumstances prevailing in the business. A combination of more than one method is sometimes used. In respect of depreciable assets which do not have material value, depreciation is often allocated fully in the accounting period in which they are acquired.
Straight-line Method: It is the simplest and most often used method. In this method, the company estimates the salvage value (scrap value) of the asset at the end of the period during which it will be used to generate revenues (useful life). The company will then charge the same amount to depreciation each year over that period, until the value shown for the asset has reduced from the original cost to the salvage value.
Annual Depreciation Expense=(Cost of Fixed Asset-Residual Value)/Useful Life of Asset
Reducing Balance Method: Under this method, a fixed rate/ percentage is charged as depreciation from the cost of asset until the cost becomes nil. Depreciation ceases when either the salvage value or the end of the asset's useful life is reached.
To illustrate, let’s take an example:-
Suppose a business has an asset with $1,000 original cost, $100 salvage value and 5 years of useful life.
Under Straight-line Method, Annual Depreciation Expense= (1000-100)/5= $180 per year for 5 years.
Suppose depreciation rate under Reducing Balance Method be 40%, then
Annual Depreciation:
1st year= $1000*40%= $400,
2nd year= $(1000-400)*40%= $240
3rd year= $(1000-400-240)*40%= $144
4th year= $(1000-400-240-144)*40%= $86.40
Book Value of Asset at the end of 4th year= $(1000-400-240-144-86.40) = $129.60
5th year= Lower of $129.60*40%= $51.84 or $(129.60-100) = $29.60.
So, depreciation for 5th year would be $29.60 instead of $51.84 since if $51.84 is charged as depreciation, the book value of asset ($129.60-$51.84 = $77.76) will become lesser than salvage value ($100) which is not allowed.
