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ACCOUNTING FOR DEPRECIATION
Definition of Depreciation:
Depreciation is the process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner.
Cost allocation enables companies to properly match expenses with revenues in
accordance with the expense recognition principle.
Depreciation applies to three classes of plant assets: land improvements, buildings, and equipment
Factors Involved in the Depreciation Process:
Before establishing a pattern of charges to revenue, a company must answer three basic questions :
1. What depreciable base is to be used for the asset? 2. What is the asset’s useful life? 3. What method of cost apportionment is best for this asset?
Three factors affect the computation of depreciation, as shown in Illustration:
1. Cost. all expenditures necessary to acquire the asset and make it ready for intended use 2. Useful life. estimate of the expected life based on need for repair, service life, and vulnerability to obsolescence.
3. Salvage value: estimate of the asset's value at the end of its useful life
Depreciation Methods:
Depreciation is generally computed using one of the following methods:
1. Straight-line 2. Units-of-activity 3. Declining-balance 4- Sum -of-the- Years - Digits
1. Straight-line: An equal amount of depreciable cost is allocated to each period,
by means of this formula: {Historical Cost (HC) - Salvage Value(SV) } ÷ Estimated Useful Life (EUL) Example /1: ABC Company purchased a machine for IQD 10000 estimated useful life 5 years, no salvage value. The company use straight depreciation method. Required: Find the amount of depreciation for each year of the useful and record a journal entry for depreciation by using in direct method. Solution: Straight-line dep. = HC-SV ÷ EUL ….. 10000 - 0 ÷5 = 2000 IQD Depreciation expense, Machines 2000 Accumulated depreciation,Machines 2000 The table below summarized the book value and accumulated depreciation at the end of each year. Year Cost Depreciation Accumulated Depreciation Book Value 1 10000 2000 2000 8000 2 10000 2000 4000 6000
Required: Find depreciation for the first three years. Solution: Fixed depreciation rate = 1÷N = 1 ÷10 = 10% Double declining rate = 2x10% = 20% Year Book value at the beginning of the year
Depreciation rate Depreciation Amount Book value at the end of the year 1 10000 20% 2000 8000 2 8000 20% 1600 6400 3 6400 20% 1280 5120
4.Sum -of-the- Years – Digits:
A formula useful when calculating the denominator is N (N + 1)/2.
Example /4: Assume the Iraq company purchased an additional Car for digging purposes, he pertinent data concerning this purchase. the company decided to use Sum - of-the- Years – Digits Cost of Car $500, Estimated useful life 5 years Estimated salvage value $50, Solution: Depreciable Base (الكلفة الخاضعة لإلهالك) = ( cost – Salvage ) 500000 - 50000 =450000…….. N (N + 1)/2 = 5(5+1)/2= 15 Year Depreciable Base ×
Depreciation Rate per Year =
Depreciation Accumulated Depreciation
Book Value End of Year 1 450000 5/15 150000 150000 350000 2 450000 4/15 120000 270000 230000 3 450000 3/15 90000 360000 140000 4 450000 2/15 60000 420000 80000 5 450000 1/15 30000 450000 50000 total 15/15 450000 500000
