Accounting Q26-30

Exhibit 15.

Straight Line Method

Depreciation expense in a year:

        (Acquisition cost – Salvage value) ÷ Useful life in years

Example:        Acquisition cost                $2,200

                        Useful life                        4 years

                        Salvage value                $200

     Depreciation percentage:

                100 ÷ № of useful life in years

                100 ÷ 4 years = 25%

      Depreciation expense:

                ($2,200 - $200) ÷ 4 years = $500 per year

    Advantages of the method:

• Easy to calculate
• Applicable to the majority of non-current assets
• Easy to use in planning

    Disadvantages of the method:

• Every year the depreciation expense is the same in the

Income statement, although the contribution to the business is lower as the asset is older  

• As time goes by, the repair and maintenance costs are higher and higher which causes a higher total expense for this asset in late years

8/8

Decreasing Charge Methods

1. Declining balance method

This method applies a depreciation rate to the book value of the asset at the beginning of each year. As the book value decreases, so does the depreciation charge.

The rate is calculated by a mathematical formula, but for the sake of simplicity, we will use a predetermined rate given for each case.  Following the previous example, the rate according to the calculation is 45% (rounded).

Then:

                                        Acquisition cost                 $2,200

Depreciation in Year 1 is: $2,200 × 45%                      990

Balance at the start of Year 2:                                 $1,210

Depreciation in Year 2: $1,210 × 45%                     545  (rounded)

Balance at the start of Year 3:                                $   665

Depreciation in Year 3: $665 × 45%                             299  (rounded)

Balance at the start of Year 4:                                 $   366

Depreciation in Year 4:                                              166*

Balance at the end of the lifetime                           $   200

*The ending amount must be equal to the salvage value, therefore no need to calculate in the last year the exact amount, which will be different from the required sum thanks to rounding error.

Two short-cut ways to calculate the required rate:

• Double declining balance (DDB)

The straight line % is multiplied by 2. This is: SL 25% × 2 = 50%

• X % declining balance

E.g. 180% estimation × SL 25% = 45%

                                        8/9

2 Sum-of-the-years’ digit method

        Sum of the years: 1 + 2 + 3 + 4  = 10

        Year                Depreciation expense

           1                         4/10 × 2,000 =   800

           2                         3/10 × 2,000 =   600

           3                         2/10 × 2,000 =   400

           4                         1/10 × 2,000 =   200

                                                           2,000

Advantages of the two decreasing charge methods:

*   Both the declining balance and the sum-of-the-years

digit method reflect the intensive use of the asset in early  years.

        *   The calculation is easier in case of sum-of-the-year digit

method than the exact calculation of the declining balance percentage.

        Disadvantage of the two methods:

        *   Their use is limited to specific kind of assets.

                                        8/10

Units of Service Method

        Using the original data, additional information is the following:

                Year 1                3,000 units of output

                        2                2,500           “

                        3                1,500          “

                        4                1,000          “

                Total                        8,000 units of output           

        Solution:

                Cost of one unit:

                        ($2,200 - $200) ÷ 8,000 units = $0.25

                Depreciation expense:

                Year 1        3,000 units × $0.25 = $    750

                        2        2,500    “         × $0.25 =       625

                        3        1,500    “    × $0.25 =       375

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