SUBJECT: FINANCIAL ACCOUNTING

CLASS:� SS 2

DATE:

TERM: 1st TERM

�

TOPIC: DEPRECIATION OF FIXED ASSETS

CONTENT

Methods of providing for depreciation

REDUCING BALANCE METHOD (or DIMINISHING BALANCE METHOD)

Under this method, a fixed percentage is written off the reducing (or diminishing) balance of the asset yearly.

This method charges higher depreciation in the early years of the asset and lower in the later � years

The depreciation rate (%) to be applied is computed using the formula below:

S��

��Depreciation rate (%) � =� � 1 � - � � � C

where:

��n =� � No. of� years

s� = � Scrap value

c� = � Cost

Illustration:

A machine costing N10,000 will realize N256 in four years time. Show the yearly depreciation to be charged for each of the four years using diminishing balance method.

SOLUTION:

S��

��Depreciation Rate (%)� � = � 1 � - � � C

256

��= � 1 - � � 10,000

��= � 1� -� � 10

��=� � � � 0.6

��=� � � � 60%

The depreciation charge applicable to each of the four years will be:

��Cost � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 10,000

��Year 1 � � � Depreciation = (60% X 10,000)� � � � � � � � � 6,000

��REDUCED BALANCE (i.e. NBV)� � � � � 4,000

��Year 2� � � Depreciation = (60% X� 4,000) � � � � � � � � � 2,400

��REDUCED BALANCE (i.e. NBV) � � � � � 1,600

��Year 3� � � Depreciation = (60% X 1,600) � � � � � � � � � � � 960

��REDUCED BALANCE (i.e. NBV)� � � � � � � 640

��Year 4 � � Depreciation = (60% X 640)� � � � � � � � � � � � � 348

��SCRAP VALUE ( i.e. NBV) � � � � � � � � � � � � 256

�

ADVANTAGES OF THE DIMINISHING BALANCE METHOD

It is widely used.
Depreciation is more scientifically provided for.
It recognizes the efficiency of an asset by charging higher amounts in the early years and lower amounts in the later years.
Higher depreciation amounts and low maintenance cost in the early years even out with low depreciation amounts and higher maintenance cost in the later years

�

DISADVANTAGES OF THE DIMINISHING BALANCE METHOD

Calculating the rate of depreciation may be difficult
It is not ideal for all fixed assets. For example it cannot be used for loose tools.

�

SUM OF THE YEARS DIGIT

Under this method, the years in the life of the asset are represented with digits and are added. The fraction of the asset cost is then charged to the years in reverse order.

�

Illustration:

A machine cost N10,000 and has a life span of four years after which it can be sold for N256. Calculate the yearly depreciation charge for each of the four year using the sum of the years digit method.

�

SOLUTION:

Amount� =� Cost� -� Scrap Value

=� N10,000� -� N256

��= � N9,744

��No. of years� =� 4

��Add up the years thus:� 1 + 2 + 3 + 4 = 10

i.e. Sum of the four years� =� 10

�

��Reverse the digit for each of the year

��Year � � � � � � � � � � � � Digit

��1� � � � � � � � � � � � � � � � 4

��2� � � � � � � � � � � � � � � � 3

��3� � � � � � � � � � � � � � � � 2

��4� � � � � � � � � � � � � � � � 1

��Calculation of depreciation charge:

��Year 1 � =� �4� � X � 9,744 � � � � � = � N3,898

��10

�

��Year 2 � =� �3 � � X � 9,744� � � � � =� � N2,923

��10

�

��Year 3 � = � 2 � � X � 9,744� � � � � =� � N1,949

��10

�

��Year 4 � =1� � X� � 9,744� � � � � =� � N974

�

��10

N.B

The sum of the years digit is similar in some respect to the diminishing balance method as it charges higher depreciation in the early years of the asset.

Therefore the advantages and disadvantages of the sum of the years digit are the same as for the Diminishing Balance Method.

EVALUATION QUESTIONS

Explain the following methods of depreciation:�

(a)� reducing balance method� (b) sum of the years digit

Write short notes on the following:

(a)� Depreciation� � � (b) Salvage value � � (c) Obsolescence

�

REVALUATION METHOD

Under this method the asset is revalued each year, any difference being charged to the profit and loss account.

�

This method is good for assets which cannot be easily depreciated because of their nature e.g. loose tools (i.e. bolts, nuts, hammer, chisel, screws) livestock, farm crops/plantations e.t.c.The value of the assets at the beginning and end of the year will be estimated and used in the calculation of the depreciation.

�

Illustration:

On 1st January 2005, the value of loose tools was N25,000. Purchases of loose tools during the year was N7,000. On 31st December 2005, the loose tools were revalued at N24,000

Required:� Calculate the depreciation on loose tool for the year.

�

SOLUTION:

Balance of loose tools 1 Jan 2005 � � � � � � � � � � 25,000

Add : Purchases of loose tools in 2005 � � � � � � � 7,000

��32,000

��Less:� Balance of loose tools 31 Dec 2005� � � � 24,000

��Depreciation on loose tools for 2005� � � � � 8,000

�

ADVANTAGES OF THE REVALUATION METHOD

It is suitable (or ideal ) for loose tools, livestock e.t.c.

�

DISADVANTAGES OF THE REVALUATION METHOD

It cannot be used for all classes of assets.
Revaluation of assets on yearly basis may be cumbersome

�

DEPLETION UNIT METHOD (or PRODUCTION UNIT METHOD )

This method is used for wasting assets such as quarry, mine, timber, and other assets ( like machines) whose useful life can be estimated in hours.

�

Illustration

A machine costing N100,000 can work for 800 hours. If it works for 120 hours in 2005 and 200hours in 2006. Calculate the depreciation charges for each year.

SOLUTION

Calculation of Depreciation on Machine

��2005 � � � � � � � 120 � X� N100,000� � � � � = � N15,000

��800

�

��2006 � � � � � � � 200� � X� N100,000 � � � � = � N25,000

��800

�

EVALUATION QUESTIONS

List five methods of providing for depreciation of assets.
Mention three characteristics of depreciable assets

�

GENERAL EVALUATION

What is depreciation
�Explain the following methods of calculating depreciation (i) staight line� (ii) reducing balance � � (iii) sum of the years digit
What is the difference between depreciation and amortization
State ten uses of the general journal
Explain the principle of double entry system

�

READING ASSIGNMENT

Simplified and Amplified Financial Accounting Page 151 - 167

�

WEEKEND ASSIGNMENT

A machine cost N12,000 and has a useful life of 4 years and an expected disposal �� valueof N400

Using the straight line method, the annual depreciation is (a) N3,100 (b) N3,000

(c)N2,900 (c) 2,300

The accumulated depreciation at the end of year three using the straight line method��

Is (a) N6,900 (b) N8,700 (c) N9,300 (d) N9,600

Using the reducing balance method and ignoring residual value, what will be the depreciation charge for year 2 at 20% (a) N3,000 (b) N2,900 (c) N2,400 (d) N1,920
Using the reducing balance method and ignoring residual value, what is the net book value at the end of year 2 (a) N10,480 (b) N10,080 (c) N9,680 (d) N7,680

5..�� Which of the following is true of the straight line method of depreciation (a) accurate depreciation charges are made yearly (b) the scrap value is zero (c) yearly depreciation charge decreases (d) yearly depreciation charges are constant

�

THEORY

List four advantages enjoyed by a firm that charges depreciation of fixed assets in its final account
A motor car cost N51,200. It will be kept for 5 years and then sold at an estimated figure of N12,150. Show the calculations of the figures for depreciation for each year using�

��(a)�� Straight line method

��(b)� � � Reducing balance method at 25% rate of depreciation

Lesson Notes By Weeks and Term - Senior Secondary School 2