FRF7
Syllabus B. ACCOUNTING FOR TRANSACTIONS IN FINANCIAL STATEMENTS B1. Tangible non-current assets

# ACCA FR F7 Syllabus B. ACCOUNTING FOR TRANSACTIONS IN FINANCIAL STATEMENTS - B1e. Depreciation - Notes5 / 7

### Syllabus B1e)

Compute depreciation based on the cost and revaluation models and on assets that have two or more significant parts (complex assets).

### Depreciation

Where assets held by an enterprise have a limited useful life, it is necessary to apportion the value of an asset used in a period against the revenue it has helped to create.

Therefore, with the exception of land held on freehold or very long leasehold, every non-current asset has to be depreciated.

A charge is made in the income statement to reflect the use that is made of the asset by the business.

This charge is called depreciation.

The need to depreciate non-current assets arises from the accrual assumption.

If money is spent on an asset, then the amount must be charged against profits.

#### Some key terms are:

• Depreciation

the allocation of the depreciable amount of an asset over its estimated useful life.

• Useful life

the period over which a depreciable asset is expected to be used by the enterprise; or the number of production or similar units expected to be obtained from the asset by the enterprise.

• Depreciable amount

cost/revalued amount less residual value

• Residual value

the amount the asset is expected to be sold for at the end of its useful life. It is also known as scrap value

#### 2 Methods of Depreciation

1. Straight line method

2. Reducing balance method

#### 1) Straight line method

The depreciation charge is the same every year.

• Formula

(Cost of asset - residual value) / expected useful life of asset

OR

(Cost - Residual value) × %

This method is suitable for assets which are used up evenly over their useful life, e.g. fixtures and fittings in the accounts department.

#### Illustration

A non-current asset costing \$60,000 has an estimated life of 5 years and a residual value of \$7,000.

Required:
(a) Calculate the annual depreciation charge.
(b) Calculate the cost, accumulated depreciation and net book value (NBV) for each year of the assets life.

• a) (\$60,000 - \$7,000) / 5 years = \$10,600 depreciation charge per year

• b)

 Year Cost Accum. Depn NBV 1 60,000 10,600 49,400 2 60,000 21,200 38,800 3 60,000 31,800 28,200 4 60,000 42,400 17,600 5 60,000 53,000 7,000

#### 2) Reducing balance method

This method is suitable for those assets which generate more revenue in earlier years than in later years; for example machinery in a factory where productivity falls as the machine gets older.

Under this method the depreciation charge will be higher in the earlier years and reduce over time.

• Formula:

Depreciation rate (%) × Net Book Value (NBV)

Net book value (NBV) = cost  - accumulated depreciation to date

This method ignores residual value.

#### Illustration

After 5 years, it is expected to be sold for scrap for \$2,000.
The depreciation rate is 35% on a reducing balance basis.

Required:
Calculate depreciation expense, accumulated depreciation and net book value of the machine for these five years using the reducing balance basis.

• Solution

 Year Cost/NBV b/d Depn Rate (%) Depn Expense Accum. Depn NBV c/d 1 17,000 35% 5,950 5,950 11,050 2 11,050 35% 3,868 9,818 7,182 3 7,182 35% 2,514 12,332 4,668 4 4,668 35% 1,634 13,966 3,034 5 3,034 35% 1,062 15,028 1,972

#### Double-Entry for Depreciation

Depreciation has a dual effect which needs to be accounted for:

1. It reduces the value of the asset in the statement of financial position.

2. It is an expense in the income statement.

#### The double-entry for depreciation is:

• Dr Depreciation expense (I/S)
Cr Accumulated Depreciation (SFP)

with the depreciation charge for the period.