Depreciation of non-current assets- nature and calculations PDF

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MG1052 – Introduction to management accounting Week 20 notes

Depreciation of non-current assets: nature and calculations Depreciation – a reduction in the value of an asset over time Depreciation of tangible non-current assets (i.e. long term assets which can be touched, such as machinery, motor, vehicles, fixtures and buildings) -

Depreciation is an expense o Part of the original cost of a non-current asset that is consumed o Charged to the profit and loss account each year  Amount charged based on estimate of how much economic usefulness has been used up in that accounting period  Reduces net profit

Causes of depreciation - Physical deterioration: wear and tear through use or erosion and decay - Economic factors: o Obsolescence – becoming out of date o Inadequacy – asset no longer used because of the growth and changes in the size of the business - Time – where assets have a legal life fixed under a contract o E.g. patent (usually 16 years) when finished it has no value  Amortisation is used instead of depreciation for these assets - Depletion – where the assets are of a wasting character Land and Buildings - Land is not depreciated because it has an unlimited useful life - Buildings are depreciated as they can fall into disrepair or become obsolete Depreciation methods Straight line method - Cost of the asset minus the estimated disposal value, divided by the number of expected years of use Cost of the asset −estimated disposal value number of expected yearsof use

Reducing balance method - Calculated using a fixed percentage, on the net value of the asset

√

r=1−

Where:

n

s c

n = the number of years s = the net residual value (this must be a significant amount or answers will be absurd, since the depreciation rate would amount to nearly one) c = the cost of the asset r = the rate of depreciation to be applied Choice of method  The method chosen should be the one that allocates the cost to each period in accordance with the overall economic benefit from the use of the asset.  Therefore, if more benefit is derived from the asset in early years, then the reducing balance method is more appropriate.  However, if benefits are spread equally over the years, the straight line method is suitable. Revaluation method - Where items are valued each year and the difference is charged as depreciation used when there are lots of inexpensive items, e.g. beer barrels a) b) c) d) e)

Find its cost Estimate its years of use to the business Calculate and provide depreciation Make the adjustments when the asset is disposed of Calculate profit or loss on disposal

Depletion unit method - Where a charge is made dependent upon how much of the asset has been used up Cost of the asset X Number of units taken∈period Expected total contents∈units Machine hour method - Where a charge is made dependent on how many hours the machine has worked fir Sum of the years’ digits method - Where a proportion is charged on the basis of the life of the asset

Units of output method - charges according to the proportion of units produced, compared to the total units expected to be achieved

(Cost −salvage unit ) X (

Periods production ) Total expected production...