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What is Depreciation?

Depreciation is defined as an accounting methodology which allows an organization to spread the cost of a fixed asset over the expected useful life of that asset. The cost of the fixed asset immediately comes out of the cash account of the organization and is entered as an asset for the organization. At the end of each period of the useful life of the asset a part of the cost is expensed. This amount is added to the accumulated depreciation for the asset. The net value of the asset on the books of the organization is the asset account less the accumulated depreciation account.

A fixed asset is considered depreciable if it will wear out or become obsolete over a period of years. The period of years is called the life or the useful life of the item. The life that is assigned to an item will depend on industry standards, management standards, and governmental regulations. Generally, depreciable items include buildings, manufacturing equipment, office equipment, and vehicles. Land is not considered a depreciable item as it does not wear out or become obsolete.

Some fixed assets may be expected to have a market value at the end of their useful life. This expected value is called the salvage value. Some organizations set this value on a per asset basis, some use a percentage of the purchase price, some assume that all assets will have zero salvage value, and some use a combination of these methods.

Organizations usually set a price at which a fixed asset is considered depreciable. Any asset purchased at less than the set price is immediately expensed. This eliminates the need to track every waste basket, stapler, hammer, wrench, desk lamp, etc. Some organizations set this as low as $100.00. Other organizations set it at $10,000.00 or more. Once this limit has been set it should be adhered to and should not be reset every year

How to Calculate Depreciation

Depreciation expense is calculated utilizing either a straight line depreciation method or an accelerated depreciation method. The straight line method calculates depreciation by spreading the cost evenly over the life of the fixed asset. Accelerated depreciation methods such as declining balance and sum of years digits calculate depreciation by expensing a large part of the cost at the beginning of the life of the fixed asset.

The required variables for calculating depreciation are the cost and the expected life of the fixed asset. Salvage value may also be considered. Examples of depreciation calculations for both straight line and accelerated methods are provided below.

Straight Line Depreciation Method

The straight line depreciation method divides the cost by the life.

SL = Cost / Life

Example: A desk is purchased for $487.65. The expected life is 5 years. Calculate the annual depreciation as follows: 
487.65 / 5 = 97.53 
Each year for 5 years $97.53 would be expensed.

What if there is a salvage value?

Declining Balance Depreciation Method

The declining balance depreciation method uses the depreciable basis of an asset multiplied by a factor based on the life of the asset. The depreciable basis of the asset is the book value of the fixed asset -- cost less accumulated depreciation.

The factor is the percentage of the asset that would be depreciated each year under straight line depreciation times the accelerator. For example, an asset with a four year life would have 25% of the cost depreciated each year. Using double declining balance or 200%, which is the most common, would mean that depreciation expense in the first year would be twice that or 50%. So to calculate the depreciation expense each year the depreciable basis would be multiplied by 50%.

Example: A copy machine is purchased for $3,217.89. The expected life is 4 years. Using double declining balance the depreciation would be calculated as follows: 
factor = 2 * (1/4) = 0.50

Year Depreciable 
Basis Depreciation
Calculation Depreciation 
Expense Accumulated
Depreciation
1 3,217.89 3,217.89 * 0.5 1,608.95 1,608.94
2 1,608.94 1,608.94 * 0.5 804.47 2,413.41
3 804.48 804.48 * 0.5 402.24 2,815.65
4 402.24 402.24 * 0.5 201.12 3,016.77


What if there is a salvage value?
Sum of the Years Digits

The first step is to sum the digits or numbers starting with the life and going back to one. For example, an asset with a life of 5 would have a sum of digits as follows: 5+ 4+ 3 +2 + 1 = 15
To find the percentage for each year divide the year's digit by the sum. In the example above the percentage would be calculated as follows:

Year 1 5 / 15 = 33.34%
Year 2 4 / 15 = 26.67%
Year 3 3 / 15 = 20 %
Year 4 2 / 15 = 13.33 %
Year 5 1/ 15 = 6.67%
Example: A conference table is purchase for 1,467.89. The expected life is 5 years. Since this is a 5 year asset the yearly factors have been calculated above.

Year Depreciation
Calculation Depreciation
Expense
1 1,467.89 * 33.34 % 489.40
2 1,467.89 * 26.67 % 391.49
3 1,467.89 * 20 % 293.58
4 1,467.89 * 13.33 % 195.67
5 1,467.89 * 6.67 % 97.91

Revaluation of Fixed Assets

Revaluation of fixed assets is the process of increasing or decreasing their carrying value in case of major changes in fair market value of the fixed asset. Internation Financial Reporting Standards (IFRS) require fixed assets to be initially recorded at cost but they allow two models for subsequent accounting for fixed assets, namely the cost model and the revaluation model.

Depreciation to Fixed Assets

An increasing Depreciation to Fixed Assets ratio may indicate the company has purchased new fixed assets, showing the company is making improvements to its operations. A decreasing Depreciation to Fixed Assets ratio may indicate the company's purchase plans for new fixed assets has stalled, possibly indicating increasingly constrained budgets or a lack of priority of gaining new assets.

The Depreciation to Fixed Assets ratio will vary widely among different industries, and measurement of this ratio needs to be done in the context of the industry the company operates within. Companies in industries whose operations require large purchases of assets that also depreciate rapidly will often record higher amounts of depreciation than companies who either do not purchase many fixed assets, or purchase assets that can be used far beyond the depreciation time span.

In question A, You need to understand first what type of business are going in the above company. Second depreciation would not apply on land because of its life not fixed. U may calculate last depreciation done in inventory (only in this case) by applying previous and new rates....variances would be listed to know the exact inventory value at the of Dec-2012.

In second question: there are two methods being used in revaluation of assets, cost methods and revaluation method surplus methods....In case of surplus you would increase assets value (Assets Dr and Rev.Surplus Cr.) and in case of loss you need to reverse it: Rev. Surplus Dr. Assets Cr. just add your understanding in shape of logical facts.

Keep one thing in mind there is never dep'n charged on land its always amortization

 

Just mention that no depreciation would be charged on inventory and land, reason: there is no fixed life of land as well as inventory returns its value after sales of goods.

Depreciation is decrease in the value of assets due to getting old, wear and tear, accidents and other reasons. Generally it is debited in Profit and loss account at a fixed percentage of the value of assets.

The students are advised to take great care as regards the rate of depreciation. If the rate is without the words 'per annum or p.a.', then the rate will be applied without any regard to the period of time. This is very important specially in those cases where the period of accounts is less than one year. On the other hand, if the rate of depreciation is 'p.a. or per annum', the depreciation should be calculated on the assets with due consideration to the period for which the asset has been used in business during the year.

In case of additions to assets during the year, it is advisable to ignore depreciation additions, if the date of additions is not given. Same rule shall hold  good for the sale of assets during the year.




Revaluation of fixed assets is the process of increasing or decreasing their carrying value in case of major changes in fair market value of the fixed asset.

Question A:-
Non-depreciable assets
Assets that have characteristics of a fixed asset, but cannot be depreciated. Generally, these assets include:
Property placed in service and disposed of in the same taxable year
Tangible property including land, inventory, rented property, and term interest in property
Intangible property including goodwill, trademarks, and trade names
Question B:-
Reversal of Revaluation

A revaluation loss is charged to profit and loss account in the period in which the revaluation is carried out, however a revaluation decrease should be charged directly against any related revaluation surplus to the extent that the decrease does not exceed the amount held in surplus in respect of the same asset.


In question A, You need to understand first what type of business are going in the above company. Second depreciation would not apply on land because of its life not fixed. U may calculate last depreciation done in inventory (only in this case) by applying previous and new rates....variances would be listed to know the exact inventory value at the of Dec-2012.
====================================
a reduction in value in inventory is not possible in term of depreciation until or unless U fully understand "nature of business" clearly defined. Most of the business have inventory with its expiry date/bar codes system which indicates that items expired or to be expired....In automobile company either inventory which is available have limited life or items which are finally produced in shape of CAR are not going to sale because of less market growth.....So in the second case, you would charge depreciation according to company policy which has been mentioned. Otherwise it would lead to cost of goods sold and closing balance which require in the financial statement.....So in my opinion there would be no depreciation charged on both inventory and land in this case...
================================
In second question: there are two methods being used in revaluation of assets, cost methods and revaluation method surplus methods....In case of surplus you would increase assets value (Assets Dr and Rev.Surplus Cr.) and in case of loss you need to reverse it: Rev. Surplus Dr. Assets Cr. just add your understanding in shape of logicl facts
================================
Just mention that no depreciation would be charged on inventory and land, reason: there is no fixed life of land as well as inventory returns its value after sales of goods. simple


On 1st January 20X3, a company purchased a machinery having list price of Rs. 500,000
with the condition of making full payment within 15 days from the date of purchase to
avail discount equal to 2% of the list price.
The company incurred transportation expenses Rs. 20,000 and insurance-in-transit Rs.
5,000. The company availed the discount & installed the machinery at the cost of Rs.
35,000.
The estimated useful economic life of the asset is 10 years with the residual value of Rs.
50,000.
Calculate:
(1) The cost of the asset to be capitalized for balance sheet purpose;
(2) The annual depreciation expense for year 20X3under straight line depreciation; &
(3) The annual depreciation expense for year 20X4under declining balance method.
Solution:
(1) The cost of the asset to be capitalized for balance sheet purpose is 500,000
Calculation:
Paid cash for machinery purchase
List price of machinery 500,000
Less 2% discount (500,000*2/100) 1,000
Paid Cost for machinery 490,000
Purchase
Cost of asset capitalized for balance sheet
Calculation:
Paid cost for machinery purchase 490,000
Add Transportation expense 20,000
Add Insurance in transit 5,000
Add Installation expenses 35,000
Cost of asset capitalized for balance 550,000
sheet.
(2) The annual depreciation expense for year 20X3under straight line
depreciation
Calculation:
Depreciation expense under straight line method = Cost – Residual Value / N
= 550,000 – 50,000 / 10
= 500,000 / 10
= 50,000 Rs.
(3) The annual depreciation expense for year 20X4under declining balance method.
Calculation:
Year Details Depreciation Written Down Value
Depreciable Cost 550,000
20 * 3 550,000 * 22% 121,000 429,000
20 * 4 429,000 * 22% 94,380 3,34,620


Alloy Manufacturers Limited (AML) is a well-known company working in the automobiles Alloy industry. Mr. Naseer is working as accounts manager at AML and has more than 05 years of relevant experience. His major responsibilities include looking after accounting matters for accounting of fixed assets – incorporation, maintenance, depreciations, revaluation, and disposal etc. as per accounting rules, IASs and other related laws. a) ALM has been charging depreciation at the rate of 10%-15% from 2001 to 2012 on its all fixed assets. From 2012 onwards, the management has decided to change its depreciation rates from 15%-20%. Balance sheet of AML as at December 31, 2012 has carries the value of inventory and Land at Rs. 850,000 and Rs. 2,000,000 respectively. As a student of accounting, you are required to suggest that at which rate business should charge depreciation on inventory and land from year 2012 and onwards? Support your answer with logical reasons. b) From year 2005 onwards, AML has also been bringing forward “Revaluation surplus”. But in year 2012, business incurred a loss on revaluation of its Buildings. You are required to suggest that what will be the accounting treatments of this loss? Support your answer with logical reasons.


Revaluation of fixed assets is the process of increasing or decreasing their carrying value in case of major changes in fair market value of the fixed asset.

Question A:-
Non-depreciable assets
Assets that have characteristics of a fixed asset, but cannot be depreciated. Generally, these assets include:
Property placed in service and disposed of in the same taxable year
Tangible property including land, inventory, rented property, and term interest in property
Intangible property including goodwill, trademarks, and trade names
Question B:-
Reversal of Revaluation

A revaluation loss is charged to profit and loss account in the period in which the revaluation is carried out, however a revaluation decrease should be charged directly against any related revaluation surplus to the extent that the decrease does not exceed the amount held in surplus in respect of the same asset.

Part-A: Depreciation never charge on the land because the value of the land will always be decreased and the owner will get profit on the land instead of loss so depreciation can be calculate on that things which would be falls their price in the future and owner on that item want to check the current price of the item in current days. For example if the land value in 2001 was 850000 which was the purchasing value for the owner and now in 2013 the value would be 2000000 which is the profit for the owner and this is not a depreciable asset, moreover the depreciation would not be charge on the inventory as well. Depreciate assets are cars, computers, office furniture and machines.

Part-B: When we purchase a land and start work on it then the expense on it would be the loss for the owner for the particular time period because when the owner will start making a building then he will never get a profit for specific time period so how we will recover this loss? When we evaluate from the land purchasing date and we will considered the current value of the building which will show our profit rather then loss, therefore that loss which was at the time of building making would be converted in the profit because current value of the building will be higher than before.

Write the solution in your words.

Depreciation never charge on the land because the value of the land will always be decreased ?????? check your sentence ....mention increased instead of decreased...


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