Advanced Bookkeeping – Depreciation

Previous Lesson Revision Complete the trial balance extract. Capital or revenue expenditure. Capital or revenue income.

Aims of the Session Depreciation. Non-current assets register. Bookkeeping for depreciation. Depreciation on the extended trial balance. Disposal of non current assets.

Depreciation The estimate of the amount of the loss in value of a non- current asset over its useful life. Shows an expense on the statement of profit or loss. Shows on the balance sheet as accumulated depreciation to offset the cost price of the asset. Isn’t an actual transaction but an accounting treatment – accruals principle.

Depreciation Yes, but I thought I was an depreciating all the time I thought I was an asset to the business

Factors Causing Depreciation Wear and tear. Passage of time. Depletion. Economic reasons inadequacy or obsolescence. Includes buildings The only exception is freehold land, unless a quarry or mine.

Depreciation Calculations All are estimates. Common methods are: Straight line. Diminishing balance. A business may use more than one method depending on the asset. Vehicles might be set using the diminishing balance as it reduces faster in the early years of use, but something like office furniture may be straight line. It’s an arbitrary thing, so can vary from business to business, but in accordance with IAS 16 must be carried out annually, and reviewed annually too.

Straight Line If an asset has residual value at the end of its useful life this is deducted first, this is the depreciable amount Then the remaining amount is divided by its useful life. Cost of asset – estimated residual (scrap or salvage) sale proceeds Useful life of the asset £2000 – 400 = £400 per year 4 Or a fixed percentage is written off every year. If 25% is deducted every year then. £2000 x 25% = £500 every year Giving this particular asset a useful life of 4 years, with a nil value at the end. Different classes of asset may have a different rate, ie a car may have a useful life of 3 years, and a table 10 years.

Diminishing Balance Method A fixed percentage is written off the carrying amount every year. The reduced balance is the cost of the asset less the accumulated depreciation. For example 33.3% Original Cost £2000 Year 1 depreciation (33.3% of £2000) £667 Carrying amount end of year 1 £1,333 Year 2 depreciation (33.3% of £1,333) £444 Carrying amount end of year 2 889 Year 3 depreciation (33.3% of £889) 296 Carrying amount end of year 3 593 Year 4 depreciation (33.3% of £593) 193 Carrying amount at the end of year 4 400 There are formulas for working out the %, but this isn’t required at level 3, you will be given the percentage. The important thing to remember is to ignore any residual value. Businesses will have different policies on not only the method, but also whether they choose to depreciate on the year of acquisition, the year of disposable, and whether or not it’s a full year or part year. Part year calculations amount divided by 12 x months owned. Any estimated residual balance is ignored when calculating diminishing balance depreciation

Side by Side Comparison Year Original Cost Straight Line (assuming a residual balance of £400 and £400/year charge over 4 years useful life) Diminishing Balance (assuming a 25% charge, 4 years useful life and a residual balance of £400) £ Charge Accum. Dep Carrying Amount 1 2000 400 1,600 500 1,500 2 800 1,200 375 875 1125 3 1200 281 1156 844 4 1600 211 1367 633 Here you can see the differences in carrying amount by using the same purchase price, residual balance and useful life but using the different methods of depreciation. Residual balance is ignored.

Comparison Straight Line Diminishing Balance Depreciation Charge Same amount of depreciation each year. Different charges each year. Depreciation percentage or fraction Lower depreciation percentage of fraction required to achieve the same residual value. Higher depreciation percentage or fraction required to achieve the same result, never reached a nil balance. Suitability Assets to be kept for the whole of their useful lives eg office equipment. Assets that depreciate rapidly and not kept for the whole of their useful life.

The Non-Current Asset Register Keeps a record of non-current assets. Separates out each class of asset. Records information such as: Serial number, description. Date of acquisition. Original cost. Method & rate of depreciation. Carrying amount. Funding method. Disposal date. Disposal proceeds. It’s up to the business what is recorded. I’m not current Relevance and materiality, think of the waste paper bin from lesson 1, technically you would class it as a non-current asset, as you don’t expect to have to buy a new one every year, but the reality is it’s not material so would have been classed as an expense item, and not effect the statement of financial position. It would be usual for the non-current asset register to list all the individual assets and their depreciation, which is then transferred as one entry per class of asset into the double entry system.

Example and exercise. Numbles Nuptions and Tulkinghorn

Bookkeeping for Depreciation Journal entries are made for depreciation allowance. Recorded in the depreciation charge account as an expense (non- cash), therefore a debit. Recorded in the accumulated depreciation account as a credit. The ‘at cost’ account is not used. The depreciation charge is then sent to the profit or loss account. The accumulated depreciation will go to the balance sheet. Remind them of the journal from level 2 – notebook, records non-standard transactions, book of prime entry. This is merely an accounting treatment, no money goes out the business. Two accounts are depreciation charge (annual treatment) and accumulated deprecation, when we come to the ETB one will go to the profit or loss (charge) and accumulated to the BS (to offset the asset)

In Practise A business (not registered for VAT) buys new machinery for £2000 net on 1 Jan x4, it is depreciated at 20%/year using the straight line method. The business’ financial year runs from 1 Jan to 31 Dec, the first three years accounting records will look like this: Machinery at Cost Bank Dr Cr Dr Cr X4 Bank £2000 X4 Machinery at cost £2000 Here we can see the initial transaction, ignoring VAT, as per level 2 the bank is credited and the machinery at cost asset account is debited. First the business records the payment from the bank into the Machinery at Cost asset account. This doesn’t change through out the life of the asset.

In Practise Every year the depreciation charge is applied to the depreciation charge account and the accumulated depreciation account. Depreciation Charge/Provision Accumulated Depreciation Dr Cr Dr Cr X4 Machinery accumulated depreciation 400 Statement of Profit or loss 400 X4 Balance c/d 400 X4 Depreciation Charge £400 X5 Machinery accumulated depreciation 400 X5 Balance b/d 400 Depreciation charge 400 800 Statement of Profit or loss 400 X5 Balance c/d 800 800 Each year the charge is debited to the Statement of Profit or Loss, the new financial year starts with the depreciation charge account being set to nil, the accumulated depreciation charge will go to the balance sheet to offset the asset. The difference between the two accounts will show the carrying amount of the asset (ie 1200 – 400 = 800). This also falls into the accruals concept and prudence by not over stating the statement of financial position. X6 Machinery accumulated depreciation 400 Statement of Profit or loss 400 X6 Balance b/d 800 Depreciation charge 400 1200 X6 Balance c/d 1200 1200

Depreciation on the ETB The accumulated depreciation to Statement of Financial Position. Depreciation charge sent to Statement of Profit or Loss.

Disposal of Assets Brings together the initial cost, accumulated depreciation and disposal proceeds. Uses the Asset at Cost, Accumulated Deprecation, Disposal and Profit or Loss Accounts. The disposals account allows the bookkeeper/accountant to see whether or not the asset has made a loss or profit on disposal, this will be due to either over or under depreciation. Everything is ‘emptied’ into the Disposals account. Any money or part exchange is also entered into the Disposals Account.

Disposal of Assets Empty the Asset at Cost account into the Disposals Account. Disposals Asset at Cost Dr Cr Dr Cr Asset at Cost £2000 Bal b/d £2000 Disposal £2000 First empty the Asset at Cost account into the Disposals account, so the asset has been removed from the books.

Accumulated Depreciation Disposal of Assets Next empty the Accumulated Depreciation Account into the Disposals Account Disposals Accumulated Depreciation Dr Cr Dr Cr Asset at Cost £2000 Bal b/d £300 Accum. Dep £300 Disposal £300 Next empty the Accumulated Depreciation into the Disposals account, removing this from the books.

Disposal of Assets Any sale proceeds need to be debited to the Bank and credited to the Disposals Account Disposals Bank Dr Cr Dr Cr Asset at Cost £2000 Disposal £100 Accum. Dep £300 Bank £100 Take into account any sale proceeds, in the usual fashion ie debit bank, credit the disposals account, or if any PE has happened...

Disposal of Assets Any part exchange proceeds need to be debited to the Asset at Cost account and credited to the Disposals Account Disposals Asset at Cost Dr Cr Dr Cr Asset at Cost £2000 Part Ex £100 Accum. Dep £300 Asset at Cost £100 Part exchange is similar to bank receipts, but the asset at cost account is credited rather than the bank account.

Disposal of Assets Finally balance the Disposals account and send it to the P or L account. Disposals Profit or Loss Dr Cr Dr Cr Disposals £1600 (loss on disposal) Asset at Cost £2000 £2000 Accum. Dep £300 Bank £100 PL Account £1600 £2000 Finally transfer the amount (bal c/d) to the PL account, here we can see there has been a loss on disposal of £1600, a profit entry would be a credit entry as it would be entered as Income. The Accumulated Depreciation and the Assets at Cost accounts will probably have residual balances on them as they will hold the details of all assets and all the depreciation, opposed to just one asset, although I’ve not shown that here. It’s important to only transfer the amount relating to the asset that has been disposed of.

Questions

Lesson Recap Depreciation is a non-cash transaction. Spreads the cost of the asset over its useful life. Two common methods are straight line and diminishing balance. The charge is shown on the statement of Profit or Loss. The accumulated depreciation offsets the asset on the Statement of Financial Position. When a non-current asset is disposed of an adjustment needs to be made in the Disposals Account. All depreciation transactions are recorded in the journal. IAS 16.

Exercises