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(b) The reducing balance method of depreciation is used instead of the straight line method when it is considered fair to allocate a greater proportion of the total depreciable amount to the earlier years and a lower proportion to the later years, on the assumption that the benefits obtained by the business from using the asset decline over time.

In favour of this method it may be argued that it links the depreciation charge to the costs of maintaining and running the asset. In the early years these costs are low and the depreciation charge is high, while in later years this is reversed.

3.14 Accumulated depreciation

Accumulated depreciation is the amount set aside as a charge for the wearing out of non-current assets. There are two basic aspects of accumulated depreciation to remember.

(a) A depreciation charge is made in the income statement in each accounting period for every depreciable non-current asset. Nearly all non-current assets are depreciable, the most important exceptions being freehold land and non-current investments.

(b) The total accumulated depreciation on a non-current asset builds up as the asset gets older. The total accumulated depreciation is always getting larger, until the non-current asset is fully depreciated.

The ledger accounting entries for depreciation are as follows.

(a) There is an accumulated depreciation account for each separate category of non-current assets, for example, plant and machinery, land and buildings, fixtures and fittings.

(b) The depreciation charge for an accounting period is a charge against profit. It is accounted for as follows.

DEBIT Income statement (depreciation expense)

CREDIT Accumulated depreciation account (statement of financial position) with the depreciation charge for the period.

(c) The balance on the statement of financial position depreciation account is the total accumulated depreciation. This is always a credit balance brought forward in the ledger account for depreciation. (d) The non-current asset accounts are unaffected by depreciation. Non-current assets are recorded in

these accounts at cost (or, if they are revalued, at their revalued amount).

(e) In the statement of financial position of the business, the total balance on the accumulated depreciation account is set against the value of non-current asset accounts (ie non-current assets at cost or revalued amount) to derive the carrying value of the non-current assets.

This is how the non-current asset accounts might appear in a trial balance:

DR CR

Freehold building – cost 2,000,000

Freehold building – accumulated depreciation 500,000

Motor vehicles – cost 70,000

Motor vehicles – accumulated depreciation 40,000

Office equipment – cost 25,000

Office equipment – accumulated depreciation 15,000

And this is how they would be shown in the statement of financial position:

Non current assets

Freehold building 1,500,000

Motor vehicles 30,000

Office equipment 10,000

Key term

3.15 Example: Depreciation

Brian Box set up his own computer software business on 1 March 20X6. He purchased a computer system on credit from a manufacturer, at a cost of $16,000. The system has an expected life of three years and a residual value of $2,500. Using the straight line method of depreciation, the non-current asset account, accumulated depreciation account and I & E account (extract) and statement of financial position (extract) would be as follows, for each of the next three years, 28 February 20X7, 20X8 and 20X9.

NON-CURRENT ASSET: COMPUTER EQUIPMENT

Date _$ Date _$

(a) 1.3.X6 Accounts payable 16,000 28.2.X7 Balance c/d 16,000

(b) 1.3.X7 Balance b/d 16,000 28.2.X8 Balance c/d 16,000

(c) 1.3.X8 Balance b/d 16,000 28.2.X9 Balance c/d 16,000

(d) 1.3.X9 Balance b/d _16,000

In theory, the non-current asset has now lasted out its expected useful life. However, until it is sold off or scrapped, the asset will still appear in the statement of financial position at cost (less accumulated depreciation) and it should remain in the ledger account for computer equipment until it is eventually disposed of.

ACCUMULATED DEPRECIATION

Date $ Date $

(a) 28.2.X7 Balance c/d 4,500 28.2.X7 I & E account 4,500 (b) 28.2.X8 Balance c/d 9,000 1.3.X7 Balance b/d 4,500 _____ 28.2.X8 I & E account 4,500 9,000 9,000 (c) 28.2.X9 Balance c/d 13,500 1.3.X8 Balance b/d 9,000 _____ 28.2.X9 I & E account 4,500 13,500 13,500 1.3.X9 Balance b/d 13,500

The annual depreciation charge is

years 3 2,500) _ $(16,000 = $4,500 pa

At the end of three years, the asset is fully depreciated down to its residual value (16,000 – 13,500 = 2,500). If it continues to be used by Brian Box, it will not be depreciated any further (unless its estimated residual value is reduced).

INCOME STATEMENT (EXTRACT)

Date _$

(a) 28 Feb 20X7 Depreciation 4,500

(b) 28 Feb 20X8 Depreciation 4,500

(c) 28 Feb 20X9 Depreciation 4,500

STATEMENT OF FINANCIAL POSITION (EXTRACT) AS AT 28 FEBRUARY

20X7 20X8 20X9

$ $ $

Computer equipment at cost 16,000 16,000 16,000

Less accumulated depreciation 4,500 9,000 13,500

3.16 Example: Allowance for depreciation with assets acquired part-way

through the year

Brian Box prospers in his computer software business, and before long he purchases a car for himself, and later for his chief assistant Bill Ockhead. Relevant data is as follows.

Date of purchase Cost Estimated life Estimated residual value

Brian Box car 1 June 20X6 $20,000 3 years $2,000 Bill Ockhead car 1 June 20X7 $8,000 3 years $2,000

The straight line method of depreciation is to be used.

Prepare the motor vehicles account and motor vehicle depreciation account for the years to 28 February 20X7 and 20X8. (You should allow for the part-year's use of a car in computing the annual charge for depreciation.) Calculate the carrying value of the motor vehicles as at 28 February 20X8.

Solution

(a) (i) Brian Box car Annual depreciation

years 3 2,000) _ $(20,000 = $6,000 pa Monthly depreciation = $500

Depreciation 1 June-20X6 – 28 February 20X7 (9 months) $4,500

1 March 20X7 – 28 February 20X8 $6,000

(ii) Bill Ockhead car Annual depreciation

years 3

2,000) _

$(8,000 _{= $2,000 pa}

Depreciation 1 June 20X7 – 28 February 20X8 (9 months) $1,500

(b) MOTOR VEHICLES

Date $ Date $

1 Jun 20X6 _{Payables (or cash)}

(car purchase) 20,000 28 Feb 20X7 Balance c/d 20,000 1 Mar 20X7 Balance b/d 20,000

1 Jun 20X7 _{Payables (or cash)}

(car purchase) 8,000 28 Feb 20X8 Balance c/d 28,000 28,000 28,000 1 Mar 20X8 Balance b/d 28,000

MOTOR VEHICLES – ACCUMULATED DEPRECIATION

Date $ Date $ 28 Feb 20X7 Balance c/d 4,500 28 Feb 20X7 I & E account 4,500

1 Mar 20X7 Balance b/d 4,500 28 Feb 20X8 Balance c/d 12,000 28 Feb 20X8 I & E account 7,500 (6,000+1,500) 12,000 12,000 1 Mar 20X8 Balance b/d 12,000 STATEMENT OF FINANCIAL POSITION (WORKINGS) AS AT 28 FEBRUARY 20X8

Brian Box car Bill Ockhead car Total

$ $ $ $ $ Asset at cost _{20,000 8,000} 28,000 Accumulated depreciation Year to 28 Feb 20X7 _{4,500 –} Year to 28 Feb 20X8 _{6,000 1,500} 10,500 1,500 12,000 Carrying value _{9,500 6,500} 16,000