Classwork Exercise and Series (Financial Accounting- SS2): Depreciation of Fixed Asset

 Meaning of Asset

An asset can be defined as an object which has a longer life span that is used in business .it is in inform of equipment, vehicles, machinery or plant and building.

An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. Asst can be fixed or current

Meaning of depreciation

Depreciation is a fall or decrease in the value of an asset as a result of wear and tear in its uses. For accounting purposes, depreciation indicates how much of an asset’s value has been used up.

1. Physical Factors: This Comes As Result Of Change Is Outlook, Rust, Depreciation Or change in colour Of The Asset
2.  Wear And Tear: When Asset Are Used Over Time, They Get Worn out And May Not Perform As When It Was New
3. Obsolescence: is the state  which occurs when an object, service, or practice is no longer wanted even though it may still be in good working order.When It becomes outdated i.e No Longer In use or due  to change in technology.
4. Inadequacy: When the asset cannot perform much task as required,i.e it is said to be ineffective
5. Passage Of Time :When it is no longer working due to its life span

Element of depreciation

1. Original Cost-The Cost At Which The Asset Is Bought
2. Estimated Value Or Residual Value Or Scrap Value-The cost of the asset at the time of disposal
3. Estimated Useful Life-Number Of Years The Asset Is Expected To Use

 Methods of calculating Depreciation Of Asset

The Methods Of calculating Depreciation of Asset are:

1. Straight Line Method
2. Annuity Method
3. Sinking Fund Method
4. Sum Of The Year Digit Method
5. Reflection Unit Method
6. Insurance Policy Method
7. Revaluation Method

The method to be used depends on the policy the management of the  business agreed on, however,consistency need to be applied. This means that all similar assets should be depreciated by the same method and the same method method every year.

But for the purpose of this study only one method will be dealt with. whatever method adopted the elements of depreciation must be take into consideration.

Straight line method : This method make provision for equal amount to be charged as depreciation for each year of useful life. It is calculated by thus; cost of asset less residual value divided by the number estimated as the useful life span

The formula to be adopted is

Cost-estimated value

Years of useful life

Illustration

The cost of a machine is 10,000 and the residual value is 4000 it is expected to last for 4years use a straight line method to prepare the depreciation on the asset

10,000-40000/4=1500

Depreciation schedule

Years	Cost of asset	Depreciation	rate	accumulated
1	10,000	1,500	1,500	8,500
2	10,000	1,500	3,000	7,000
3	10,000	1,500	4,500	5,500
4	10,000	1,500	6,000	4,000

From the above schedule, equal amount was charge as depreciation every year

Note that column

• 1 represent the estimate useful life span
• cost of asset
• depreciation rate that is, using the formula
• accumulated depreciation that is, addition of annual depreciation
• Net book value-this is arrived at by deducting accumulated depreciation from the cost of the asset.

Diminishing or reducing balance method:  By this method a fixed percentage is written off the diminishing balance of the asset yearly.The total depreciation is spread over the anticipated useful life of the asset by annual installment of diminishing amount. Depreciation is more artificially provided here for larger amount of depreciation

Sum of the digit method

Under the sum of the digit method,a decreasing depreciation is computed by a simple mathematical procedure relating to arithmetical progression each year of an asset life should be represented by a digit add these digits and charge from actions of the asset cost to the year in reverse order.

Illustration

A machine was bought in 1990 for 5500 it was estimated to 500 after 4years of usage using sum of the year digit method calculate the depreciation.

Solution

Years         digit

1                 4

2                 3

3               2

4               1

Depreciation =cost –scrap value

5500-500=5000

Depreciation charge for each year will be

Year 1=4/10 x 5000=2000

Year2=3/10 x 5000=1500

Year3=2/10 x 5000=1000

Year4=1/10 x 5000=500

Revaluation method: This method of depreciation is good for asset like loose tools like hammer, chisels, spanner, livestock.e.t.c. By this method the asset is revalue each tear and difference will be charged as depreciation to the profit and loss account the value of the asset at the  beginning and at the end of the asset must be known.

Exercise

Illustration

On 1^st Jan 1998 the value of loose tools was 16,000 on the 30^th June new tools were bought for 3,000 on the 31^st of Dec 1998 they were revalued at 17,600.show the loose tools account using revaluation method

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