Financial Accounting and Reporting/Cost Allocation
Depreciation
[edit | edit source]Definition
[edit | edit source]Depreciation is the systematic allocation of the cost of an asset over its useful life. Depreciation is treated as an expense for the period incurred, and is accumulated for the whole useful life of an asset as a contra-account to a specific PPE account. The proforma entry is:
| Date | Description | Post Ref. |
Dr | Cr | |
|---|---|---|---|---|---|
| 20xx xxx |
xx | Depreciation Expense | xxx | ||
| Accumulated Depreciation | xxx | ||||
Depreciation Methods
[edit | edit source]Basic Formula
[edit | edit source]Depreciation expense is calculated based on the depreciable amount (D) and not on the actual cost of the asset, i.e.,, where D is the difference between the Original Cost (C) and the Scrap Value (S) or .
Straight-line method
[edit | edit source]The straight-line method is based on the following assumptions;
- The asset wastage is a function of time and independent of usage, i.e.,
- The wastage is constant or linear.
Consider the following illustration: ABC Co. has a $30,000 threshold for capitalization of assets. As a policy, any asset acquired for less than $30,000 are expensed immediately. The company reported the following purchases related to PPE for the year:
| Item | Purchase date | List Price | Trade discount | Cash discount | Taken? | Fair value at yeat end of current period |
|---|---|---|---|---|---|---|
| 65E | January 31 | 54,000 | none | 3% | no | 75,000 |
| 65F | March 15 | 15,700 | 10% | 2% | no | 13,200 |
| 65G | April 1 | 46,470 | none | none | none | 49,000 |
| 65H | June 15 | 4,599 | none | 1% | yes | 3,000 |
| 65I | September 1 | 100,000 | none | 3% | yes | 104,000 |
| 65J | November 30 | 48,000 | 2% | 2% | yes | 43,000 |
| Land acquired for capital appreciation | November 30 | 540,000 | n/a | n/a | none | 562,000 |
Prior to this, the company reported the following amounts in their previous year's financial statements;
| Account | Cost | Fair Value at year-end of current period | Accumulated Depreciation | Scrap value | Useful life remaining |
|---|---|---|---|---|---|
| Land on operating lease | 549,000 | 760,000 | n/a | n/a | n/a |
| Building on operating lease | 2,590,000 | 1,543,000 | 325,000 | 20% of cost | 15 yrs |
| Building on finance lease | 2,490,000 | 3,209,000 | 126,000 | 15% of cost | 10 yrs |
| Building used as headquarters | 23,500,000 | 12,040,000 | 5,450,000 | 12% of cost | 16 yrs |