chapter 8 - depreciation
TRANSCRIPT
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DEPRECIATION
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DEFINITION
Depreciation can be defined as the process of
allocating the cost of a fixed asset (non-currentasset) over its useful life in a rational andsystematic manner.
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CAUSES OF DEPRECIATION
Wear and tear: Physical deterioration of a non-currentasset caused by its used, rust, rot and decay.
Obsolescence : When an asset has become out of date.
Passage of time : When asset falls in value as time goesby.
Depletion : Fall in value of an asset (land) due toextraction of raw material from it.
Inadequacy : When an asset can no longer cater for thegrowing demand perhaps due to its size etc.
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METHODS OF CALCULATING
DEPRECIATIONTheoretically, asset is depreciated until the value of the
asset is zero. In practice, a value of RM 1 is left in thebalance sheet to indicates that even though the assethas been fully depreciated, it is still being used in thecompany.
There are two main methods of calculating
depreciation:Straight Line Method
Reducing Balance Method
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STRAIGHT LINE METHOD
Under this method depreciation expense is the sameevery year.
Annual depreciation can be calculated using the
following formula:Depreciation = Original cost Salvage /scrap value
No. of expected useful life
OR
Depreciation = Depr. ratio (%) x Original cost of
fixed asset
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REDUCING BALANCE METHOD
Under this method the annual depreciation isdeclining until the cost of the asset becomes zero.
Depreciation is calculated based on the net bookvalue.
Depr. = Depr. Ratio (%) x Net Book Value (NBV) of
fixed asset/Non-Current Asset
NBV = Cost
Accumulated Depreciation
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JOURNAL ENTRIESJournal entries to record depreciation:
Debit Depreciation AccountCredit Accumulated Depreciation/Provision
for Depreciation Account
(Being depreciation provided for a non-current asset)
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LEDGER ENTRIESLedger Entry:
Depreciation Account
xx/xx/xx Prov. for depr. xxx xx/xx/xx To IS xxx
xxx xxx
Prov. For Depreciation a/c
xx/xx/xx Bal. c/d xxx xx/xx/xx Depr. xxx
xxx xxx
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CAPITAL VS REVENUE
EXPENDITUREExpenditure :
Refer to a payment or the acceptance of an
obligation to make a future payment.Can be divided into 2 categories:
1. Capital Expenditure
2. Revenue Expenditure
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Capital Expenditure Revenue Expenditure
Payments for the purchase ofan asset, which providesbenefits to the business forseveral accounting periods.
Examples: Purchase price of fixed asset
Installation cost
Renovations or addition to
fixed assets Taxes on purchase of fixed
assets
Insurance during transit.
Expenditures that providebenefits only during thecurrent accounting period.
Examples:
Repairs and maintainance
Petrol
Road tax
Depreciation
Insurance expenses
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DIFFERENCE BETWEEN
CAPITAL EXPENDITURE REVENUE EXPENDITURE
Expenditure to buy or to add
value on fixed assets, which
last for a long term usuallymore than one accounting
period and permanently
increase the profit making
capacity of the business.
Appears in the Balance
Sheet as part of the value or
cost of an asset.
Expenditure for runningon a day-to-day basis.
Normally used up in lessthan one accountingperiod.
Appears in the Income
Statement as an expenses
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Illustration:
Classify the following between capital or revenue expenditure.
Expenditure
1. Buying motor van
2. Petrol costs for motor van
3. Repairs to motor van
4. Putting extra headlights on motor van
5. Buying machinery
6. Electricity costs of using machinery
7. Spent RM2,000 on machinery, RM 1,200 for an
item added to the machine and RM 800 for repairs.
8. Painting outside of a new building
9. Three years later repainting outside of the same
building.
Types of expenditure
1. CE
2. RE
3. RE
4. CE5. CE
6. RE
7. CE:
RM1,200
RE:RM 800
8. CE
9. RE