DEPRECIATION

DEFINITION
Depreciation can be defined as the process of allocating the cost of a fixed asset (non-current

asset) over its useful life in a rational and systematic manner.

CAUSES OF DEPRECIATION
Wear and tear : Physical deterioration of a non-current

asset 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 Obsolescence : When an asset has become out of date.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 goes by. Depletion : Fall in value of an asset (land) due to extraction of raw material from it. Inadequacy : When an asset can no longer cater for the growing demand perhaps due to its size etc.

METHODS OF CALCULATING DEPRECIATION

Theoretically, asset is depreciated until the value of the asset is zero. In practice, a value of RM 1 is left in the balance sheet to indicates that even though the asset has been fully depreciated, it is still being used in the company. There are two main methods of calculating depreciation: Straight Line Method Reducing Balance Method

STRAIGHT LINE METHOD

Under this method depreciation expense is the same

every 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

REDUCING BALANCE METHOD

Under this method the annual depreciation is

declining until the cost of the asset becomes zero. Depreciation is calculated based on the net book value. Depr. = Depr. Ratio (%) x Net Book Value (NBV) of fixed asset/Non-Current Asset NBV = Cost Accumulated Depreciation

JOURNAL ENTRIES
Journal entries to record depreciation:
Debit Credit Depreciation Account Accumulated Depreciation/Provision for Depreciation Account

(Being depreciation provided for a non-current asset)

LEDGER ENTRIES
Ledger 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

CAPITAL VS REVENUE EXPENDITURE

Expenditure : 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

Capital Expenditure
Payments for the purchase of

Revenue Expenditure
Expenditures that provide

an asset, which provides benefits to the business for several 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.

benefits only during the current accounting period. Examples: Repairs and maintainance Petrol Road tax Depreciation Insurance expenses

DIFFERENCE BETWEEN
CAPITAL EXPENDITURE
Expenditure to buy or to add

REVENUE EXPENDITURE
Expenditure for running

value on fixed assets, which last for a long term usually more 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.

on a day-to-day basis. Normally used up in less than one accounting period. Appears in the Income Statement as an expenses

Illustration: Classify the following between capital or revenue expenditure.

Expenditure
1.
2. 3. 4.

Types of expenditure
1. 2. 3. 4. 5. 6. 7.

5.
6. 7. 8. 9.

Buying motor van Petrol costs for motor van Repairs to motor van Putting extra headlights on motor van Buying machinery Electricity costs of using machinery Spent RM2,000 on machinery, RM 1,200 for an item added to the machine and RM 800 for repairs. Painting outside of a new building Three years later repainting outside of the same building.

8.
9.

CE RE RE CE CE RE CE: RM1,200 RE:RM 800 CE RE