1. 1
Accounting Skill Session
FIXED ASSETS
Depreciation Accounting
Definition
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.
Depreciable Assets
Depreciable assets are assets which
(i) Are expected to be used during more than one accounting period;
(ii) Have a limited useful life;
(iii) Are held by an enterprise for use in the production or supply of goods and services (i.e.
not for the purpose of sale in ordinary course of business)
Applicability of the Accounting Standard 6
This accounting standard is applicable to all depreciable assets except, the following:
(i) Forests, plantations and similar regenerative natural resources;
(ii) Wasting assets including expenditure on the exploration for and extraction of minerals,
oils, natural gas and similar non-regenerative resources;
(iii) Expenditure on research and development;
(iv) Goodwill;
(v) Live stock- Cattle, Animal Husbandry
Calculation of depreciation
The amount of depreciation is calculated as under:
(i) Historical cost or other amount substituted for the historical cost of the depreciable asset
when the asset has been revalued;
(ii) Expected useful life of the depreciable asset; and
(iii) Estimated residual value of the depreciable asset.
Methods of depreciation
There are two methods of depreciation. These are:
i) Straight Line Method (SLM)
ii) Written down value Method (WDV)
Selection of appropriate method
It depends upon following methods:-
• Type of assets
• Nature of assets
• Circumstances of prevailing business
2. 2
Note- A combination of more than one standards may be used Accounting treatment-
selected depreciation methods should be applied consistently applied from period to
period
Change in depreciation methods:
• Compliance of statute
• Compliance of accounting standards
• For more appropriate presentation of the financial statements
Procedure to be followed in change of methods:-
• Depreciation should be recomputed applying new method from date of
acquisition/installation till date of change of method.
• Difference between total depreciation under two methods and accumulated
depreciation under the old method till date of change may be surplus or
deficiency.
• Resultant surplus credited to profit and loss a/c under head “depreciation written
back”.
• Resultant deficiency charged to profit and loss a/c.
Change in depreciation method should be treated as change in accounting policy (as per
AS 5) and its effect should be quantified and disclosed.
Change in estimated useful life
When there is change in estimated useful life of assets, outstanding depreciable amount
on the date of change in estimated useful life of asset should allocated over the revised
remaining useful life of assets.
Depreciation under GAAP
Three Steps of the Depreciation Process:
Find depreciable base of the asset
Original Cost XXXX
Less: Salvage Value XXXX
Depreciable Base XXXX
Estimate asset’s useful life
Three Important Notes About Depreciation: PP&E held for sale is not
depreciated
PP&E is not written up by an enterprise to reflect appraisal, market, or current
values which are above cost to the enterprise
Estimates of useful life and residual value, and the method of depreciation, are
reviewed only when events or changes indicate that the current estimates or
depreciation method no longer are appropriate
3. 3
Depreciation under IFRS
Current Authoritative Source–IAS 16
Same as GAAP except for two main differences:
Estimates of useful life and residual value, and the method of depreciation, are
reviewed at least at each annual reporting date
For a company currently using GAAP a change to IFRS could result in a greater
frequency of revisions in depreciation rates, which in turn could mean less
predictable depreciation expense
IFRS allows a company to choose between two different models in order to value
PP&E (property, plant & equipment) after it has been recognized on the books-
Cost model–this model is like GAAP where PP&E is carried at its cost less any
accumulated depreciation
Revaluation model–this model allows a company to revalue PP&E on its books to
fair value if fair value can be reliably measured
Example:
Facts: At the beginning of the year a company has a building with a carrying
value of $100,000 and a remaining useful life of 10 years that was recently valued
at $300,000
Under GAAP: depreciation expense for the year would be $10,000 (assuming
straight-line)
Under IFRS: depreciation expense for the year could be either $30,000 or $10,000
Three Important Notes About Depreciation:
If an item of PP&E is revalued, the entire class of PP&E to which the asset
belongs has to be revalued
Examples of separate classes: land, machinery, motor vehicles, office equipment
Items in a class of PP&E are revalued simultaneously to avoid selective
revaluation of assets
If an asset is revalued up, the increase is credited directly to equity under the
heading of revaluation surplus
An increase is recognized in P&L to the extent that it reverses a revaluation
decrease of the same asset previously recognized in P&L
When PP&E is revalued, any accumulated depreciation can be treated in one of
two ways.
Difference between AS-6, GAAP, IAS-16
AS-6 GAAP IAS-16
AS-6 allows the
depreciation on
revalued value of the
assets
US GAAP prohibits
revaluation.
IAS-16 allows fair value
accounting (upwards) for fixed
assets as an alternatives
treatment.
4. 4
A change in
depreciation AS-6 is
treated as a change in
an accounting policy
Same as AS-6,US
GAAP is also treated
as a change in an
accounting policy
Under IAS-16 it is treated as a
change in estimates, which
affects the results of current
and future periods.
Findings
Facts: A company using IFRS (revaluation model) has a piece of equipment with a cost
of $10,000 and acc. depr. of $2,000. The equipment is revalued to a FMV of $20,000
Balance Sheet Presentation:
After Before
Equipment $10,000 $ 25,000
Less: acc depr 2,000 5,000
Carrying value $ 8,000 $ 20,000
OBJECTIVES
In general
• The introduction accounting standards there was uniformity in the accounts of
various companies within India.
• Converged Accounting Standards along with IFRS was introduced so that
accounts of India can be compared with companies of the world
Related to Depreciation
• It will charged according to the shelve life of fixed asset.
RECOMMENDATIONS
• There are two types of depreciation which are:-
• Straight Line Depreciation Method
• Written Down Value Method
It would be better if only one kind of depreciation method is followed all over the world
• There should be such accounting so that tax accounting and financial statement
accounting could be done together
• Slabs of tax accounting should be same with the financial statements.
5. 5
Accounting for Depreciation
Fixed assets other than land lose their ability over time to provide
services
Costs of equipment, buildings, and land improvements should be
transferred to expense accounts in a systematic manner during their
expected useful lives.
DEPRECIATION
Adjusting entry to record depreciation is usually made at the end of each
month or at the end of the year Fixed assets other than land lose their
ability over time to provide services
Adjusting Entry
Account Debit Credit
Depreciation expense $7,000
Accumulated depreciation - truck $7,000
Depreciation
Accumulated depreciation
Shows the amount that the asset has lost in value since
its purchase
Depreciation expense
Shows the amount that the asset has lost in value this
period.
Factors that cause a decline the ability of a fixed asset to
provide services may be identified as
Physical depreciation
Occurs from the wear and tear while in use and
from the action of the weather
Functional depreciation
Occurs when a fixed asset is no longer able to
provide services at the level for which it was
intended.
Factors in Computing Depreciation Expense
The fixed asset’s initial cost
6. 6
Its expected useful life
Its estimated value at the end of its useful life.
Depreciation Methods
Straight line
Declining balance
Units of production
Straight Line Method
Provides for the same amount of depreciation expense for
each year of the asset’s useful life
Annual depreciation expense =
Cost – Salvage value
Life
Example 1
A machine had a cost of $24,000, salvage value of $2,000 and
useful life of 5 years
Annual depreciation expense =
Cost – Salvage value
Life
= $24,000 - $2,000
5 years
= $4,400 annual depreciation
Adjusting entry
Account Debit Credit
Depreciation expense $4,400
Accumulated depreciation - truck $4,400
7. 7
Example 2
A machine had a cost of $30,000, salvage of $5,000 and useful life of
6 years. Compute depreciation under the straight line method?
What is depreciation expense in year 3?
Units of Production
This method provides for the same amount of depreciation
expense for each unit produced or each unit of capacity used
by the asset
Depreciation rate per unit = Cost – Salvage value
Estimated units
Depreciation Expense = Depreciation rate x annual units
Example 3
A machine had a cost of $24,000, salvage value of $2,000, estimated
total hours of production of 10,000 and annual hours used of 2,100
hours. Compute depreciation for the period under the units of
production method.
Example 3
Depreciation rate per unit = Cost – Salvage value
Estimated hour
= $24,000 - $2,000 = $2.20
10,000 hours
Annual depreciation expense = Hourly depreciation rate x annual hours
= $2.20 x 10,000 hours = $2,200
Example 4
A machine had a cost of $30,000, salvage value of $5,000, estimated
total hours in production of 5,000 and annual hours used of 900 hours.
Compute the depreciation expense for the period using the units of
production method
8. 8
DECLINING BALANCE METHOD
Provides for a declining periodic expense over the estimated useful life
of the asset.
Book value
= Cost – Accumulated depreciation
Steps
Compute the DB rate = 100/Life of asset
For double declining balance
Multiply rate time 2
Depreciation expense =
Beg. book value X Rate
Rule: the book value may never by less than the salvage value of
the asset
Example 5:
A machine had a cost of $24,000, salvage value of $2,000,
estimated life of five year. Compute depreciation
Year Cost Accumulated
Depreciation
Book value at the
beginning of year
Rate Depreciation Book value end of
year
1 $24,000 $24,000 40% $9,600 $14,400
2 $24,000 9,600 14,400 40% 5,760 8,640
3 $24,000 15,360 8,640 40% 3,456 5,184
4 $24,000 18,816 5,184 40% 2,073.60 3,110.40
5 $24,000 20,889.60 3110.40 1,110.40 2,000
Example 5:
Example 6: A machine had a cost of $30,000, salvage value of $5,000,
estimated life of 6 years. Compute depreciation using the
double declining balance method.
9. 9
Revision of Depreciation
Revising the estimates of the residual value and the useful life is normal
Used to determine depreciation expense in future periods
Example 7
Assumed a fixed asset purchased for $130,000 was originally estimated
to have a useful life of 30 years and a residual value of $10,000. The
asset has been depreciated for 10 years by the straight line method.
At the end of ten years, the asset’s book value of $90,000. During 11th
year, it is estimated that the remaining useful life is 25 years and that
the residual value is $5,000.
Compute depreciation expense for the 11th
year using the new
information provided.
Example 7
Depreciation expense=
= $130,000-$10,000
30
= $ 4,000.00 per year before changes
Accumulated Depreciation balance
=$4,000 X 10 years
= $40,000
Book value
= $130,000.00 – $40,000 = $90,000
Example 7
New depreciation expense =
Book value – new salvage
Remaining life
= ($90,000-$5,000)
25
10. 10
= $ 3,400.00 per year for remaining years
Disposal of Fixed Assets
Discarding of Fixed Assets
When asset has no residual value and is fully depreciated.
Example 8
Asset with a cost of $25,000 and fully depreciated is discarded
Account Debit Credit
Accumulated Depreciation $25,000
Fixed Asset $25,000
SELLING OF FIXED ASSETS
Three things can happen
Sale at book value
No gain or loss
Sale below book value
Loss is recognized
Sale after book value
Gain is recognized
11. 11
SELLING AT BOOK VALUE
Example 9:
Asset with cost of $25,000 and Accumulated Depreciation
of $10,000 is sold for $15,000 cash.
Account Debit Credit
Cash $15,000
Accumulated depreciation $10,000
Fixed Asset $25,000
SELLING PRICE ABOVE BOOK VALUE
Gain is recognized
Example 10:
Asset with cost $25,000, Accumulated Depreciation of $10,000
is sold for $20,000 cash.
Account Debit Credit
Cash $20,000
Accumulated depreciation $10,000
Fixed Asset $25,000
Gain on disposal of asset $5,000
SELLING PRICE BELOW BOOK VALUE
Loss is recognized
Example 11: Asset with cost of $25,000, Accumulated Depreciation of
$10,000 is sold for $12,000 cash.
Account Debit Credit
Cash $12,000
Accumulated depreciation $10,000
Loss on disposal of asset $ 3,000
Fixed Asset $25,000
12. 12
EXCHANGING SIMILAR ASSETS
Old equipment is often traded in for new equipment having a
similar use.
The seller allows the buyer an amount for the old equipment
traded in called TRADE IN ALLOWANCE.
The remaining balance – the amount owed is either paid in cash
or recorded as a liability – called BOOT
GAIN ON EXCHANGES
Not recognized for financial reporting purposes.
When trade-in allowance exceeds the book value of an asset traded in
and no gain is recognized, the cost recorded for the new asset can be
determined in either of two ways:
Cost of new asset = List price + Unrecognized gain
Cost of new asset = Cash given + book value of old Not recognized
for financial reporting purposes.
Example 12
New equipment is purchased with a list price of $5,000, trade in
allowance of old is $1,100, cost of old equipment is $4,000, accumulated
depreciation $3,200. Record the entry. New equipment is purchased
with a list price of $5,000, trade in allowance of old is $1,100, cost of old
equipment is $4,000, accumulated depreciation $3,200. Record the
entry.
Example 12
Account Debit Credit
Fixed Asset – new $800
Accumulated Depreciation $3,200
Fixed Asset – old $4,000
13. 13
LOSSES ON EXCHANGE
For financial reporting purposes, losses are recognized on exchanges of
similar fixed assets.
If trade in is less than the book value of the old equipment, there is a loss
Example 14
New equipment is purchased with a list price of $5,000, trade in allowance
of old is $700, cost of old equipment is $4,000, accumulated depreciation
$3,200. Record the entry.
Account Debit Credit
Fixed Asset – new $700
Accumulated depreciation $3,200
Loss on exchange of asset $100
Fixed Asset – old $4,000
