Depreciation.

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Presentation transcript:

Depreciation

Depreciation is the decrease in value of physical properties with the passage of time. It is an accounting concept, a non-cash cost, that establishes an annual deduction against before-tax income. It is intended to approximate the yearly fraction of an asset’s value used in the production of income. Applied only to Fixed Asset

FIXED ASSET What are fixed asset: Used in business to produce income for more than 12 months

Fixed Asset Vs Inventory Car dealers (Vimal) Vs Celcom car INVENTORY FIXED ASSET

Property is depreciable if it is used in business or held to produce income. it has a determinable useful life, longer than one year. it is something that wears out, decays, gets used up, becomes obsolete, or loses value from natural causes. it is not inventory, stock in trade, or investment property. One exception to depreciation is land

Definition 2011 2012 2013 2014 Revenue (mill) 1 Cost of good sold Variable (thousand) -100 Factory Retooling (Fixed Cost) (thousand) -500 Gross Profit 400 900 SG & A (Selling General & Administration Operating Profit

Not a good way of accounting Lumpiness of the statement Create impression of vulnerable business on very stabile business Spreading throughout the years - depreciation

Definition 2011 2012 2013 2014 Revenue (mill) 1 Cost of good sold Variable (thousand) -100 Factory Retooling (Fixed Cost) (thousand) -250 Gross Profit 650 SG & A (Selling General & Administration -500 Operating Profit 150

Definition Depreciation 2011 2012 2013 2014 Revenue (mill) 1 Cost of good sold Variable (thousand) -100 Factory Retooling (Fixed Cost) (thousand) -250 Gross Profit 650 SG & A (Selling General & Administration -500 Operating Profit 150 Depreciation

DEPRECIATION METHODS Straight line depreciation methods Declining balance depreciation methods Double declining method Sum-of-the-year depreciation method Unit-of-production depreciation method

DEPRECIATION METHODS Straight line depreciation methods Declining balance depreciation methods Double declining method (DDB) Sum-of-the-year depreciation method Unit-of-production depreciation method

IMPORTANT TERMS Book Value – It is the original cost of property, including any adjustments with depreciation deductions. Represent the amount of capital that remains invested in the property Market Value - The amount that will be paid by a willing buyer to a willing seller for a property.

DEPRECIATION METHODS Example that we will be used throughout the class: Purchase cost : $304,000 Service life : 8 years Est. Salvage Value : $16,000

Straight Line Methods Purchase cost : $304,000 Service life : 8 years Est. Salvage Value : $16,000 Formula : (Cost-Selvage value)/est. service life =Depreciation charge : (304,000 – 16,000)/8 = 36,000/yr

Straight Line Methods Depreciation schedule Yr Depreciation Charge Cumulative depreciation BV end year 304,000 1 36,000 268,000 2 72,000 232,000 3 108,000 196,000 4 144,000 160,000 5 180,000 124,000 6 216,000 88,000 7 252,000 52,000 8 288,000 16,000

Declining Balance Methods (DB) Depreciation schedule Yr BV Beg. Years Rate, DB Deprec. Charge Cum. Deprec. BV end year 1 304,000 25% 76,000 228,000 2 57,000 133,000 171,000 3 42,750 175,750 128,250 4 32,063 207,813 96,188 5 24,047 231,859 72,141 6 18,035 249,895 54,105 7 13,526 263,412 40,579 8 10,145 273,566 30,434

Declining Balance Methods (DB) How to determine the rate? DB methods also known as double declining rate; declining rate (%) is the rate from straight line method, and in our example is 1/8 1/8 = 12.5 Double declining rate is 2 times of declining rate: = 2 x 12.5% = 25%

Double Declining Methods (DDB) Formula: Depreciation charge for yr 1 = BV at the start of year 1 X double declining rate (DD) BV at the start of yr 1 = Original cost – AD at the start of year 1 Double declining rate = 100%/useful life x2 Depr charge for yr 1 = BV year 1 x DD Depr charge for yr 2 = BV year 2 x DD