Depreciation

NBV

A non-current asset is reported in the BS at its NBV. It represents the estimated future economic value of the NCA. NBV is the original cost of a NCA less its Accumulated depreciation [ NBV=Original cost - Accumulated depreciation ]

Accumulated depreciation

Accumulated depreciation refers to the total depreciation to-date. It is an approximation of the reduction in economic value of the NCA. It is a contra-asset account and is presented as a deduction against the original cost of a NCA on the BS

Land ?

All NCA are depreciable. However, land is an exception as it can have limited or unlimited useful life. Land is depreciated when it has a limited lease period but it is not depreciated when it is freehold.

Why the same depreciation method should be used from yr to yr ?

Consistency concept. According to this concept, the accounting methods used by the business must be consistent from period to period so that its financial performance can be meaningfully compared across financial periods. Thus, once the method of depreciation is determined, it should be applied consistently to NCA of similar class from yr to yr. This is in line with consistency concept. Inconsistency in the use of accounting methods may result in misleading figures in the financial statements. However a business may change its accounting methods if new methods provide more accurate info about the transactions.

What is depreciation ?

Depreciation is defined as the allocation of the cost of a non-current asset over its estimated useful life. It is considered as part of the cost of non-current asset that has been used up to earn income. Thus, depreciation is an expense that is reported in the Income Statement for each financial period.

Steps in recording Sale of NCA

Dr. Sale of NCA Cr. NCA Dr. Accumulated depreciation Cr. Sale of NCA Dr. Cash Cr. Sale of NCA (Gain) - Other income in IS Dr. Sale of NCA Cr. P&L (Loss) - Less exp in IS Dr. P&L Cr. Sale of NCA

How is depreciation accounted for ?

Journal Entry : Dr. Depreciation ( increase exp ) Cr. Accumulated depreciation ( increase contra-asset )

Effects of the straight-line method

Since an equal amt of depreciation is allocated over the life of the asset, the depreciation and profit for the yr remain constant every yr

Effects of the reducing-balance method

Since higher depreciation expense is allocated to the earlier part of its life & diminishes in subsequent yrs, the depreciation decreases over the yrs causing the profit to increase over the yrs

Why different depreciation method is used for different NCA ?

The method of depreciation adopted is to best match the pattern of deriving benefits from the using of the NCA.

The reducing-balance method

When it is used, a higher depreciation amt is charged in the earlier financial periods and a lower amt is charged in the later financial periods of the useful life of a NCA. This method assumes that the NCA provides more benefits in the earlier yrs of its useful life than in its later yrs. [ Annual depreciation= Rate of depreciation per annum x NBV ]

The straight-line method

When it is used, an equal amount of depreciation is recorded for each financial period over the useful life of the NCA. This method assumes that the NCA provides benefits uniformly throughout its useful life [Annual Depreciation = ( Original Cost - Scrap Value ) / expected useful life in yrs ] [ Annual Depreciation = Rate of depreciation per annum x original cost ]

Explain the need for depreciation of NCA

• Matching Concept The accounting for depreciation is in accordance with the matching concept where a portion of the cost of the NCA is matched against the income earned from using the NCA. • Prudence It is also in accordance with the prudence concept, that is, to state the NCA at NBV ie Cost - Accumulated depreciation so as to avoid overstating the value of asset

Causes of depreciation ?

• physical deterioration caused by wear and tear • obsolescence / outdated due to new inventions & technological advancement • passage of time - legal limits on the use of the asset which causes the NCA to decrease in value over time • Depletion of asset over time when the benefits of the NCA are consumed by the business