How depreciation follows the matching principle Explain with example PDF

Preview

Summary

Finance fundamentals...

Description

1. How depreciation follows the matching principle? Explain with example. Answer: Depreciation is a reduction in value of an asset due to wear and tear over time. A provision should generally be made for depreciation of fixed assets. The method entails dividing the cost of the asset (minus its salvage value) by its estimated useful life. The most common depreciation methods include: a. Straight-line. b. Double declining balance. c. Units of production. d. Sum of years digits For example, if a fixed asset costs $30,000, is expected to last 10 years, and its "salvage value" is $3,000, using the straight line method, the annual depreciation would amount to be: Annual Depreciation Expense= (Price of Asset- Salvage Value)/ Useful life in years = (30000- 3000)/10 = $ 2700 The matching principle is one of the basic underlying guidelines in accounting. The matching principle directs a company to report an expense on its income statement in the same period as the related revenues. It requires that the asset's cost be allocated to depreciation expense over the life of the asset. In effect, the cost of the asset is divided up with some of the cost being reported on each of the income statements issued during the life of the asset. The expense is recognized throughout an asset's useful life. The calculation of depreciation expense follows the matching principle, which requires that revenues earned in an accounting period be matched with related expenses. For example, Bangladeshi Patriot Ltd. buys a new piece of equipment for BDT 100,000 in 2018. This machine has a useful life of 10 years. This means that the machine will produce products for at least 10 years into the future. According to the matching principle, the machine cost should be matched with the revenues it creates. Thus, the machine is depreciated over its 10-year useful life instead of being fully expensed in 2018....