DEPRECIA

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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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