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Lecture Notes 9
Financial Statements &
Depreciation
Depreciation
Definition
Depreciation is the measure of the:
– wearing out,
– consumption
– or other reductions in the useful economic life of a
fixed asset,
whether arising from:
– use,
– passage of time or
– obsolescence.
Depreciation
Definition
• Depreciation is the term most often employed to
indicate that tangible plant assets have declined in
service potential.
Depreciation in the Financial Statements
• Unless assets are depreciated their value may
sometimes be overstated on the Balance Sheet.
• Assets must be depreciated so as to give a true and fair
value of the assets in the Balance Sheet.
Depreciation
Depreciation in Accounting
• Depreciation is defined as:
– the accounting process of allocating the cost of tangible
assets to expense
– in a systematic and rational manner
– to those periods expected to benefit from the use of the
asset.
• To accountants, depreciation is not a matter of
valuation but a means of cost allocation.
• Assets are not depreciated on the basis of a decline in
their fair market value, but on the basis of systemic
charges to expense.
[Keiso & Weygandt 1990:543]
Depreciation
Where to find it?
• Depreciation is found in:
– Trial Balance – Accumulated Depreciation
– Notes to the trial balance – Years Depreciation
Charge
Accumulated Depreciation
• Accumulated Depreciation – Total depreciation
provided on asset from date of purchase to date on
current balance sheet
Depreciation
How to treat it? – Trial Balance
• Accumulated Depreciation in the trial balance is
deducted from the Asset at cost in the Balance Sheet.
NOTES to Trial Balance
• Calculate - Depreciation Charge should be calculated
using the Method prescribed by notes.
• Record – Depreciation charge is recorded in the Profit
and Loss A/c as an expense.
Depreciation
NOTES to Trial Balance
• Add – Depreciation Charge is added to the
accumulated Depreciation found in the Trial Balance
before deducting it from Asset at cost in Balance Sheet.
• If there is no Accumulated Depreciation in the Trial
Balance then the Depreciation Charge Calculated is the
only thing deduction from the Asset in Balance sheet
Depreciation
Example
Trial Balance (Extract)
• Machinery
• Depreciation
Debit
50,000
Credit
18,000
Notes
Provide for depreciation on machinery which has a useful
life of 5 years and will be worth $5,000 at the end of that
time
Depreciation
Example
Calculation
Straight Line Method = Cost – Scrap Value
Useful Life
= 50,000 – 5,000
5
= $9,000
Depreciation
Example
Profit and Loss (extract)
Depreciation
9,000
Balance Sheet (Extract) Cost
• Machinery
50,000
Dep.
27,000
NBV
23,000
Depreciation
Example – NO Accumulated Depreciation
Trial Balance (Extract)
Debit
• Machinery
50,000
Credit
Notes
Provide for depreciation on machinery which has a useful
life of 5 years and will be worth $5,000 at the end of that
time
Depreciation
Example
Calculation
Straight Line Method = Cost – Scrap Value
Useful Life
= 50,000 – 5,000
5
= $9,000
Depreciation
Example
Profit and Loss (extract)
Depreciation
9,000
Balance Sheet (Extract) Cost
• Machinery
50,000
Dep.
9,000
NBV
41,000