Depreciation

Most non current (fixed) assets lose value with time which is called depreciation.
Example of non current assets which depreciates are buildings, machinery, motor vehicle, furnitures and fittings, fixtures and fittings, office equipment, etc.

NOTE: 1. Land does not depreciate. Instead it appreciates. (It is an appreciating non current asset)
             2. Goodwill does not depreciate. The term used is amortisation (it has the same concept as                                depreciation but the technical term is different).

Definition of Depreciation
Depreciation is the fall in the value of non current assets.

Purpose of Depreciation
Depreciation is charged to spread the cost of a non current asset over its useful life.
It is also charged to comply with the accruals (matching) concept which states that all costs should be matched with the revenue earned.

Causes of Depreciation
1. Wear and tear (physical deterioration)
2. Passage of time
3. Depletion
4. Obsolescence (change in technology; outdated)

Methods of Depreciation
There are three methods of depreciation namely: Straight-line method, reducing (diminishing) balance method and revaluation method.

Straight-line Method
When using the straight-line method, the non current asset depreciates evenly, that is by the same amount over its life.
To find depreciation using the straight line methods, the formula below can be used or a percentage can be given.

Example:
1. Universe Ltd bought a machine for $80 000. It has decided a residual (scrap) value of $8 000. The               machine is planned to be used for 10 years in the business. Calculate the depreciation that should be             charged each year.

2. Black purchases a motor vehicle for $ 100 000. He decides to charge 10% depreciation using the   straight-line method. Find the amount of depreciation at the end of the financial year.

Reducing (diminishing) Balance Method
When using this method of depreciation, the percentage depreciation should be charged on the net book value (that is, cost - accumulated depreciation) of the asset.

Example:
White owned furniture and fittings at cost $ 50 000. The provision for depreciation of furniture and fittings account (accumulated depreciation) had a balance of $35 000. He charges a 50% depreciation using the diminishing balance method. What is the depreciation charged for that particular financial year?

Revaluation Method
This method is used on tools which have low value where exact information is not required as per the materiality concept. Their value keeps fluctuating during the year. The formula to calculate the depreciation is as follows:

                     Opening inventory  +  Purchases  -  Closing inventory

Example:
Peter had an opening balance for loose tools valued $1 500 at the start of the year. During the year, he bought tools of $2 000. At the end of the year, the closing balance was $3 200. What is the depreciation for the loose tools?