2. Learning Objectives
• To explain the term of depreciation
• To explain the need for depreciation
• To identify and explain the causes of depreciation
• To calculate depreciation expense using straight line @
reducing balance method
• To account for depreciation expense in the books
• To show the depreciation charges in the profit & loss a/c
• To show the accumulated depreciation charges in the
balance sheet
• Distinguish between capital & revenue expenditure
• Describe the effect on final a/c mainly net profit if Rev.
Exp. is wrongly treated as Cap. Exp. & vise versa
3. Introduction
• Fixed Asset is acquired @ bought by a business either
by cash @ credit.
• The value of the fixed asset recorded will not be the cost
itself but its book value i.e. the value of fixed asset at the
end of certain period.
• This is because we have to show the fact that the asset
has lost its value when it is being used by the business
in its daily operation.
• When business is using a fixed asset, it must record the
cost of the fixed asset in the balance sheet & the
expense related to the used of the fixed asset
(depreciation) is shown in the profit & loss a/c.
• To determine the cost of fixed asset, the concept of
capital & revenue expenditure is applied.
4. Definition & Need of Depreciation
As defined by the MASB 14:
Depreciation is =
“ The allocation of the depreciable amount of an asset over its
useful life”
• Depreciation for the accounting period is charged to the net
profit & loss a/c.
Reasons for charging depreciation
a) To find net profit @ loss for an actg period, the revenue for the
period is matched against the costs incurred in earning that
revenue.
b) Unless depreciation on fixed assets is charged, the value of
these assets may be overstated in the balance sheet.
c) By charging depreciation against profits, the net profit available
for distribution is reduced & the results is that fund are retained
in the business.
5. Causes Of Depreciation
a) Wear and tear - The physical using up of a fixed asset, i.e.
corrosion, rot, rust, decay. Although repairs &
maintenance may extend the life of the asset, they
can never keep the asset working indefinitely.
b) Obsolescenc - The fixed assets becoming out of date or obsolete
e because of new technological advancements.
c) Physical - Floods, dampness or excessive heat @ cold may
factors make a fixed asset lose its value.
d) Defluxions of - Certain assets such as patents & copyrights have a
time fixed time limit of ownership.
e) Depletion - Wasting assets such as mines or quarries is being
depreciated because of the decrease in value.
6. Factors In Determining Depreciation
The following costs have to be considered when
determining depreciation:
a) Cost of asset
i. Purchase price of the asset
ii. Transportation cost to get the asset to the
purchaser’s premises
iii. Insurance on the purchase of the asset
iv. Taxes on the purchase of asset
v. Installation cost of assets
b) Useful life of the asset
c) Scrap value/salvage value @ residual value of the asset.
7. Methods Of Depreciation
a) Straight line method:
The amount of depreciation for each accounting period
will be the same.
The annual depreciation is calculated by taking the
depreciable amount (cost less estimated scrap value)
divided by the estimated useful life; or cost multiplied
by percentage.
b) Reducing Balance Method
A greater amount of depreciation is being charged in
the earlier accounting years & smaller amount in the
later accounting years.
Annual depreciation is calculated by multiplying the
book value with a certain percentage
8. Accounting Entries For Fixed Asset
& Depreciation Expense
a) To record acquisition of fixed asset
Dr. Fixed Asset XX
Cr. Bank/Creditor XX
b) To record depreciation expense for the year
Dr. Depreciation expense XX
Cr. Provision for depreciation XX
c) To close depreciation to profit and loss
Dr. Profit and Loss XX
Cr. Depreciation expense XX
9. Profit and Loss & Balance Sheet
Presentation
Profit and Loss for the year ended…..
Expenses:
Depreciation xx
Balance Sheet as at……
Fixed Asset:
Cost xx
Less: Provision for Depreciation (xx)
Book Value xx_
10. Capital & Revenue Expenditure
Introduction
Expenditure relating to the acquisition of fixed assets is treated
as capital expenditure.
Expenditure for the maintenance of fixed assets is treated as
revenue expenditure.
If revenue is incorrectly capitalised, expenses will be
understated and assets will be overstated.
Definition
Capital Expenditures
Expenditures that increases the assets value because of the
improvement on the capacity or efficiency
Revenue Expenditures
Expenditures that will not improved the asset’s value but they are
expenses incurred running of the business operation daily.
11. Capital expenditure & treatments
Increase the value of the fixed assets in the Balance Sheet, thus
the capital of the organization.
It must be added to the cost of the fixed asset on the debit side of
the fixed assets a/c.
The capital expenditure items are:
a) Freight charges, b) sales taxes, c) legal costs, d) installation
costs, extensions or additions to buildings, e) replacing a new
motor or engine to a vehicle that would extend the vehicle’s useful
life, f) cost to acquire the fixed asset, g) any other cost to bring the
fixed asset ready for its intended use.
Whenever a capital expenditure is wrongly classified as revenue
expenditure, the effects are:
a) Expense are overstated, and therefore the net profit is
understated
b) The fixed asset and thus capital of organization is understated
12. Revenue expenditure & treatments
It will be debited to expense a/c, thus chargeable to the
trading profit & loss a/c.
It reduce the net profit & treated as operating expenses,
The revenue expenditure items are:
a) repainting an office block, b) replacing a broken
window screen, c) motor vehicle registration & insurance,
d) fuel for motor vehicle
If revenue expenditures wrongly classified as capital
expenditures, the effects are:
a) Expenses are understated, & therefore the net profit is
overstated.
b) The fixed assets and thus capital of the organization is
understated
