Depreciation
1. Depreciation is the decline in the value of the fixed assets of the business.
2. Depreciation is regarded as “running out” half of a fixed asset due to its use to obtain revenue.
3. The fixed asset is used to assist business parties to earn more than one accounting period, provided the asset’s life has not expired. Hence, the cost of the asset is to be distributed as an asset’s depreciation over the life of the asset.
4. This is in line with the concept of matching in the accounting where the annual depreciation is the expenditure that must be matched with the revenue earned during the year. Therefore, depreciation expense is charged to the accounts for losses
5. Depreciation of fixed assets is allocated to the end of the useful life of an asset, new assets can be purchased. This is due to the dismissed fund that is enough to replace it with new assets.
Depreciation/Accumulated Depreciation
1. The Depreciation Provision Account or Accumulated Depreciation Account is opened to record the depreciation of a fixed asset so that the balance of the assets account is always shown at cost.
2. The Depreciation Provision Account is a liability account and the amount is deducted from the cost of fixed assets in the Balance Sheet to recover the net book value of the asset.
3. The longer the duration of fixed assets is used, the greater the amount of accumulated depreciation of the asset. This causes the value of the fixed asset book in the Balance Sheet decreased.
Causes of Fixed Asset Depreciated
1. Physical deterioration and damage caused by exposure to natural elements such as sun, rain, wind and other factors such as humanity, wear, rust, decay, etc.
2. Old models experience value drops or obsolescence when new, more advanced, efficient, modern, and economic models are introduced in the market. Assets like computers, vehicles, machines, and equipment are usually depreciated due to these factors. Time circulation – For assets that have been set by law, the value of these assets decreases when the lease term is shorter. For example assets in leasing, copyright, and patent.
3. Time circulation – For assets that have been set by law, the value of these assets decreases when the lease term is shorter. For example assets in leasing, copyright, and patent.
4. Depletion – Natural assets or natural resources such as mines, quarries, forests, and oil wells have decreased production capacity when they are in operation.
Example
Methods To Calculate Depreciation
There are three main methods for calculating the depreciation:
a) Straight line method
b) Reduced Balance Method
c) Re-evaluation Method
Straight Line Method/Permanent Installment/Flat Rates/Percent To The Cost
1. According to this method, the depreciation of each year is the same over the life of the fixed assets.
2. If the asset’s life span can be determined, the cost of the asset is evenly distributed over the period of its life:
Annual depreciation = Original Cost – Value Of Scrap
Number of years of asset use (Note: The scrap value is the net value, which is the asset value that is sold after the expiration of its use)
Example
Awang’s Company bought a machine with a price of RM38, 600 and the machine was estimated to be used for 8 years. At the end of the eighth year, the machine was expected to be sold as scrap metal for RM600. (The scrap value is RM600)
Calculation
Annual Depreciation = (RM 38, 600 – RM600)/8 = RM4,750
3. If the life of an asset can not be determined, the depreciation of the year is calculated with the following formula:
Annual Depreciation = % Depreciation of fixed assets x original asset cost
Furniture purchase cost by Stephen Company is RM6,600. The furniture is depreciated at a rate of 10% per annum from its original cost.
Calculation
Annual Depreciation = 10% x RM6,600 = RM660
4. The disadvantages of the straight line method are unrealistic or not exactly accurate. This is because the value of an asset is not depreciated at the same rate every year. The depreciation of an asset also depends on the frequency of its use. The more often an asset is used, the higher the value is depreciated.
Reduced Balance Method
1. Depreciation is charged to value book of assets or residual value at the beginning of each accounting period.
2. The amount allocated for depreciation will decrease as the value book of assets at the beginning of each accounting period is diminishing.
Re-evaluation Method
1. Fixed assets are valued at the beginning of the accounting year and also at the end of the accounting period. Impairment in asset value is depreciation.
2. This method is suitable for small device depreciation such as screwdriver, spana, hammer, and other tools for workshop use.
Ways To Record Depreciation
Method 1
1. Depreciation Expense Account of assets and account provision for asset depreciation shall be opened for each type of asset depreciated.
2. The Depreciation Provision Account is a liability (credit standing) account. Therefore, the amount of accumulated depreciation is deducted from the original quantity of fixed assets in the Balance Sheet
Example
On January 1, 1197, Vui Keong Company purchased a machine at RM16, 000 with a check. The machine is depreciated at 10% per annum according to the reduced balance method. You are required to prepare the following for 1997, 1998 and 1999:
(a) Machine Account
(b) Machine Depreciation Expense Account
(c) Machine Depreciation Provisioning Account
(d) Profit and Loss Account for the year ended 31 December 1997, 1998 and 1999
(e) Balance Sheet as at 31 December 1997, 1998 and 1999
Method 2
1. Depreciation expense account assets no need to be opened.
2. Account provision for depreciation of assets has to be open to any type of fixed assets are depreciated.
3. Total accumulated depreciation (depreciation allowances) are deducted from the cost of fixed assets in the balance sheet.