TOPIC 4 DEPRECIATION AND DISPOSAL OF FIXED ASSETS NON CURRENT ASSETS – ACCOUNTANCY
Depreciation
Is that part of the original cost of a non–current asset that is consumed during its period of use by the business, OR Is the fall in the value of an asset.
Causes of Depreciation:
1. Physical deterioration:-
1. Wear and tear.
2. Erosion , rust and decay.
2. Economic factors:-
1. Obsolescence.
2. Inadequacy.
3. Time.
4. Depletion.
METHODS OF CALCULATING DEPRECIATION CHARGES:-
(i) Straight line method:
In this method, the number of years of use is estimated. The cost is then divided by the number of years.
Example
If a van was bought for 22,000 and we thought we could keep it for four years and then sell it for 2,000. What depreciation to be charged each year would be?.
(disposal value)/(Estimated number of year).
Depreciation = (22,000-2,000)/4 = 20,000/4 = 5,000/=
Therefore, Depreciation to be per year is 5,000/=
(ii) Reducing balance method:-
In this method, a fixed percentage for depreciation is deducted from the cost in the first year. In the second and the third years the same percentage is taken of the reduced balance.
This method is also known as “Diminishing balance method” A machine is bought for 10,000/= and depreciation is to be charged at 20%. The calculations of the first three years would be as follows:-
| cost | 10,000 | |
| 1st year | Depreciation (20%) | -2,000 |
| Remaining value 1st year | 8,000 | |
| 2nd year | Depreciation (20%) of 8,000 | -1,600 |
| Remaining value 2nd year | 6,400 | |
| 3rd year | Depreciation (20%) of 6,400 | -1,280 |
| Remaining value 3rd year | 5,120 |
(iii) Units of output method:-
This method establishes the total expected units of output expected from the assets. Depreciation, based on cost less salvage value, is then calculated for the period by taking that period units of output as a proportion of the total expected output over the life of the asset.
A machine which is expected to be able to produce 10,000 widgets over its useful life. It has cost 6,000/= and has an expected salvage value of 1,000/=. In year 1 a total of 1500/= widgets are produced and in year 2 the production is 2500 widgets.
(Cost – salvage value) x { Period’s production Total expected production}
Year 1: (6000 – 1000 ) x (31500)
10,000
= 5000 x 3/20 = 1500 = 750
Year 2: 5000 x 2,500
= 10000
= 1,250
= Year 1: = 750/= Depreciation
= Year 2: = 1,250/= Depreciation
(iv) Sum of years digit method:-
Given an asset costing 3,000/= which will be in use for five years, the calculation will be:-
Sum of years digit = n/2 (n + 1)
= 5/2 (5 +1)
= 5/2 x 6 = 15
1styear : 5/15 x 3000 = 1,000
2nd year: 4/15 x 3,000 = 800
3nd year: 3/15 x 3,000 = 600
4th year: 2/15 x 3,000 = 400
5th year: 1/15 x 3,000 = 200
3,000
(v) Depletion unit method:-
A quarry was bought for 5000/= and it was expected to contain 1,000 tonnes of salable materials, then for each tonne taken out we would depreciate it by 5/=,(Since 5000 ÷ 1,000) = 5. This can be shown as;
(cost of asset)/(Expected total contents in units) x Number of units taken
(vi) Machine hour method:-
With a machine the depreciation provision may be based on the number of hours that the machine was operated during the period compared with the total expected running hours during the machines life with the business.
ASSIGNMENT:
A Company, which makes up its financial statements annually to 31st DEC, provides for depreciation of its machinery at the rate of 15% per annum using the reducing balance method.
On 31/12/2008, the machinery consisted of three items purchased as shown:-
| On 1st January 2006 (Machine A) | 2,000 |
| On 1st September 2001 (Machine B) | 4,000 |
| On 1st May 2008 (Machine C) | 3,000 |
Required:
Your calculations showing the depreciation provision for the year 2008.
Calculations:
| Machine A | Machine B | Machine C | |||
| Bought on 1.1.2006 | 2,000 | ||||
| 15% × 2,000 | -300 | ||||
| 1,700 | |||||
| Bought on 1.9.2006 | 4,000 | ||||
| 15% × 1,700 | -255 | ||||
| 15% × 4,000 × 4/12 | -200 | ||||
| 1,445 | 3,800 | ||||
| Bought on 1.5.2007 | 3,000 | ||||
| 15% × 1,445 |
|
||||
| 15% × 3,800 |
|
||||
| 15% × 3,000 × 8/12 | -300 | ||||
| 1,228 | 3,230 | 2,700 |
ASSIGNMENT
A machine which cost Tshs. 200,000 is to be depreciating at the rate of 20% p.a. On the straight line method. Assuming this machine was purchased on 1st January 19-7. Show the entries to record this as at 31st Dec 19-7, 19-8 and 19 – 9, by applying two alternative methods.
Workings:-
Straight line method:-
19 – 7: 200,000 x 20,000 = 40,000
19 – 8: 200,000 x 20/100 = 40,000
19 – 9: 200,000 x 20/100 = 40’000
METHOD 1:
ENTRIES IN THE ASSET A/C
DR. MACHINERY A/C CR
| 1.1.1997 | cash | 200,000 | 31.12.1997 | P&L | 40,000 |
| 31.12.1997 | Balance c/d | 160,000 | |||
| 200,000 | 200,000 | ||||
| 1.1.1998 | Balance b/d | 160,000 | 31.12.1998 | P&L | 40,000 |
| 31.12.1998 | Balance c/d | 120,000 | |||
| 160,000 | 160,000 | ||||
| 1.1.1999 | Balance b/d | 120,000 | 31.12.1999 | P&L | 40,000 |
| 31.12.1999 | Balance c/d | 80,000 | |||
| 120,000 | 120,000 | ||||
| 1.1.2000 | Balance b/d | 80,000 |
DR PROFIT AND LOSS A/C (EXTRACT) CR
| 31.12.1997 | Depreciation | 40,000 | |
| 31.12.1998 | Depreciation | 40,000 | |
| 31.12.1999 | Depreciation | 40,000 |
| 31.12.1997 Machinery 160,00031.12.1998 Machinery 120,000
31. 12. 1999 Machinery 80,000 |
METHOD 2:
DR MACHINERY A/C CR
| 1.1.1997 Cash | 200,000 | 31.12.1997 Balance c/d | 200,000 |
| 1.1.1998 Balance b/d | 200,000 | 31.12.1998 Balance c/d | 200,000 |
| 1.1.1999 Balance b/d | 200,000 | 31.12.1999 Balance c/d | 200,000 |
PROVISIONS FOR DEPRECIATION
DR PROVISION FOR DEPRECIATION A/C CR
| 31.12.1997 Balance c/d | 40,000 | 31.12.1997 P&L | 40,000 |
| 1.1.1998 Balance b/d | 40,000 | ||
| 31.12.1998 Balance c/d | 80,000 | 31.12.1998 P&L | 40,000 |
| 80,000 | 80,000 | ||
| 31.12.1999 Balance c/d | 120,000 | 1.1.1999 Balance b/d | 80,000 |
| 31.12.1999 P&L | 40,000 | ||
| 120,000 | 120,000 |
PROFIT AND LOSS A/C (EXTRACT)
| 31.12. 1997 Provision for depreciation | 40,000 |
| 31.12.1998 Prov. for depreciation | 40,000 |
| 31.12.1999 Provision for depreciation | 40,000 |
BALANCE SHEET (EXTRACT)
| ASSETS | ||||
| NON-CURRENT ASSETS | ||||
| 31.12.1997 | Machinery | 200,000 | ||
| Less: Provision for depreciation | 40,000 | 160,000 | ||
| 31.12.1998 | Machinery | 200,000 | ||
| Less: Provision for depreciation | 80,000 | 120,000 | ||
| 31.12. 1999 | Machinery | 200,000 | ||
| Less: Provision for depreciation | 120,000 | 80,000 |
DISPOSAL OF A NON-CURRENT ASSET:-
Accounting treatment:-
1. When we buy assets:-
DR: Asset a/c.
CR: Cash / Bank / Creditor.
2. Annual provision for depreciation:-
DR: P &L
CR: Provision for depreciation
3. When asset sold / disposal :-
1st step: DR: Disposal a/c at cost.
CR: Asset a/c
2nd step: Dr. Cash / Bank} Selling price of the asset
Cr. Disposal
3rd step: Dr. Provision for depreciation} with the amount of Prov.
Cr. Disposal for depreciation Of the asset sold.
4th step: Dr. P & L } In case of loss on disposal.
Cr. Disposal.
Or
Dr. Disposal } In case of gain on disposal.
Cr. P & L
A machine bought on 1.1.2008 for 1,000,000 and sold on 1.1.2010 for 500,000. Depreciation per annum is 10% on straight line method.
Draw up: – Disposal a/c
-Provision for depreciation a/c
-P & L a/c
DR MACHINERY A/C CR
| 1.1.1998 Cash | 1,000,000 | 31.12.2008 Balance c/d | 1,000,000 |
| 1.1. 2009 Balance b/d | 1,000,000 | 31.12.2009 Balance c/d | 1,000,000 |
| 1.1.2010 Balance b/d | 1,000,000 | 1.1.2010 Disposal | 1,000,000 |
DR. PROVISION FOR DEPRECIATION A/C CR
| 31.12.2008 Balance c/d | 100,000 | 31.12.2008 P & L | 100,000 |
| 31.12. 2009 Balance c/d | 200,000 | 1.1 .2009 Balance b/d | 100,000 |
| 31.12.2009 P & L | 100,000 | ||
| 200,000 | 200,000 | ||
| 1.1.2010 Disposal | 2,000,000 | 1.1.2010 Balance b/d | 200,000 |
DR DISPOSAL A/C CR
| 1.1.2010 | Machine | 1,000,000 | 1.1.2010 | Cash/Bank | 500,000 |
| Provision for depreciation | 200,000 | ||||
| P&L | 300,000 | ||||
| 1,000,000 | 1,000,000 | ||||
ASSIGNMENT
1. A motor vehicle was purchased for Tshs. 400,000 on 1st January 1996. Depreciation was to be provided at the rate of 25% per annum on diminishing balance method. Show the entries as 31.12.1996, 1997, and 1998 in the following a/c.
(a) Motor vehicle a/c.
(b) Provision for depreciation on motor vehicle a/c.
(c) P & L a/c (Extract).
(d) Balance sheet (Extract).
2. Best view hotel had crockery valued at sh. 65,000 on 1.1.1987. During 1987, they purchased some more crockery for sh. 50,000 and on 31.12.1987; it was valued at Sh. 100,000. Calculate the depreciation charge of crockery for the year ending 31.12.1987 and show the entries in the relevant a/c’ s.
3. Kilimanjaro Company Limited acquired the following fixed assets during 1986.
(a) Furniture and fitting for Tshs. 10,000. These are expected to be depreciation at 20% per annum. Date of purchase 1.1.1986.
(b) Premises on a 99 years lease for Tshs. 198,000. Date of acquisition 17:1986.
(c) Motor van for Tshs. 45,000. It is expected to have a useful life of 7 years and leave a scrap value of shs. 3,000. Date of purchase 1.09.1986.
The company has no other fixed assets. It maintains a provision for depreciation a/c for each fixed asset.
you are required to calculate the following:-
1. The balance on motor van a/c on 31.12.1987.
2. The balance of provisions for depreciation on furniture and fittings a/c on 31.12.1987.
3. The book value of premises on 31.12.1987.
4. The amount of depreciation charged to profit and loss a/c on all fixed assets at the end of 1987.
5. On 1st January 1986 Kahawa Transporters LTD, purchased three motor vehicle costing Tshs. 108,000 each. The useful life of these vehicles was estimated to be five years with a disposal value of shs. 8,000 for each vehicle.
The company’s normal practice is to use straight line method for depreciation.
One of the vehicles was damaged in an accident and was sold on 1.1.1986 for Tshs. 45,000.
Required:
Prepare the following a/c for the three years ended 31.12.1986, 1987, and 1988:-
1. Motor vehicle a/c.
2. Motor vehicle disposal a/c.
3. Provision for depreciation on Motor vehicle a/c.
The following transactions relate to AJS limited in respect of plant and machinery:-
1. On 1st March 1986 machine M. 5 purchased for Tshs. 120,000. The estimated useful life being 5 years and having a residual value of sh.20, 000.
2. On 1.1. 1987 machine M.6 purchased for Tshs. 180,000. The estimated useful life being 7 years and having a residual value of Tshs. 40,000.
3. On 1.9.1988 machine M.5 was given a part exchange for machine M.7, the allowance being sh. 40,000, machine M.7 costs Tshs 200,000 will an estimated useful life of 10 years and having a residual value of sh. 60,000.
Assume full depreciation expenses in the year of purchase, and ignore depreciation in the year of sale.
Required:-
Plant and machinery a/c and the related depreciation and disposal a/c in respect of the three years ending 31.12.1989.
WORKINGS/SOLUTIONS
FOR ASSIGNMENT. 1
DR MOTOR VEHICLE A/C CR
| 1.1.1996 Cash | 400,000 | 31.12.1996 Balance c/d | 400,000 |
| 1.1.1997 Balance b/d | 400,000 | 31.12.1997 Balance c/d | 400,000 |
| 1.1.1998 Balance b/d | 400,000 | 31.12.1998 Balance c/d | 400,000 |
| 1.1.1999 Balance b/d | 400,000 |
DR PROVISION FOR DEPRECIATION A/C CR
| 31.12.1996 Balance c/d | 100,000 | 31.12.1996 P&L | 100,000 |
| 1.1.1997 Balance b/d | 100,000 | ||
| 31.12.1997 Balance c/d | 175,000 | 31.12.1997 P&L | 75,000 |
| 175,000 | 175,000 | ||
| 31.12.1998 Balance c/d | 231,250 | 1.1.1998 Balance b/d | 175,000 |
| 31.12.1998 P&L | 56,250 | ||
| 231,250 | 231,250 | ||
| 1.1.1999 Balance b/d | 231,250 |
DR. PROFIT AND LOSS A/C (EXTRACT) CR
| 31.12.1996 Prov. for depreciation | 100,000 | |
| 31.12.1997 Prov. for depreciation | 75,000 | |
| 31.12.1998 Prov. for depreciation | 56,250 | |
BALANCE SHEET (EXTRACT)
| 31.12.1996 | Motor vehicle | 400,000 | |
| Less: Depreciation | 100,000 | 300,000 | |
| 31.12.1997 | Motor vehicle | 400,000 | |
| Less : Depreciation | 175,000 | 225,000 | |
| 31.12.1998 | Motor vehicle | 400,000 | |
| Less :Depreciation | 231,250 | 168,750 | |
Other method
SINKING FUND
According to this method, the amount charged by way of depreciation is invested in a certain securities carrying a particular rate of interest.
The amount received from an account of interest from this security is also invested from time to time together with annual amount charged by way of depreciation.
At the end of useful life of the asset, when replacement is required, the securities are sold away and money realized on account of the sale of securities is used for the purchase of a new asset.
ACCOUNTING ENTRIES
1. On setting aside the amount of depreciation;
DR: Depreciation a/c or P+L a/c
CR: Depreciation Fund a/c
Note: The amount to be charged by way of depreciation is determined on the basis of the sinking fund table.
For investing the money charged by way of depreciation;
DR: Depreciation Fund Investment a/c
CR: Bank a/c.
(b) At the end of each sub sequence accounting year:-
(i) For receipt of interest
DR: Bank a/c
CR: Depreciation Fund a/c
(ii) For setting aside the amount of depreciation:-
DR: P & L a/c
CR: Depreciation Fund a/c
(iii) For investing money:-
DR: Depreciation fund investment a/c
CR: Bank (annual installment + Interest received)
2. At the end of last year, for the receipt of interest;
DR: P & L
CR: Depreciation
3. For setting aside the amount of depreciation:-
DR: P & L
CR: Depreciation
4. For the sale of Investment:-
DR: Bank.
CR: Depreciation Fund investment a/c.
The profit or loss on the sale of depreciation Fund investment will be transferred to a depreciation Fund a/c
For the sale of old asset;
DR: Bank
CR: Assets
The balance on the depreciation Fund represents accumulated depreciation. It will be transferred to the old assets a/c.
The proceeds or the sales realized on the a/c of it sale and investment will be utilized in the purchase of the new assets.
DR New asset
CR: Bank
ILLUSTRATION (1)
Sunshine Company Ltd bought a plant on 1.1.2005 for a sum of Tshs 100,000/= having a useful life of 5 years. It is estimated that the plant has the scrap value of Tshs 16,000/= at the end of its useful life.
Sunshine Co. decided to charge depreciation according to depreciation fund method. The depreciation fund invest are expected to earn an interest of 5% p.a. The sink Fund table shows that Tshs 0.180975. If invested yearly at 5% p.a produce Tshs 1 at the end of 5 years.
The investments are sold at the end of 5th year. For sum Tshs 65,000 A new plant was purchased for Tshs 120,000 on 1.12010. The scrap of the old plant realizes Tshs 17,000. You are required to prepare:-
1. Plant a/c
2. New plant a/c
3. Depreciation plant a/c
4. Depreciation Fund investment a/c
DR PLANT A/C CR
| 1.1.2005 cash | 1,000,000 | 31.12.2005 balance c/d | 1,000,000 |
| 1.1.2006 balance b/d | 1,000,000 | 31.12.2006 balance c/d | 1,000,000 |
| 1.1.2007 balance b/d | 1,000,000 | 31.12.2007 balance c/d | 1,000,000 |
| 1.1.2008 balance b/d | 1,000,000 | 31.12.2008 balance c/d | 1,000,000 |
| 1.1.2009 balance b/d | 1,000,000 | 31.12.2009 balance c/d | 1,000,000 |
| 1.1.2010 balance b/d | 1,000,000 |
DR DEPRECIATION FUND A/C CR
DR. DEPRECIATION AND INVESTMENT A/C CR
| 2005 Bank | 15,202 | 31.12.2005 Balance c/d | 15,202 |
| 1.1.2006 Balance b/d | 15,202 | ||
| Bank (15202+760) | 15,962 | 31.12.2006 Balance c/d | 31,164 |
| 31,164 | 31,164 | ||
| 1.1.2007 Balance b/d | 31,164 | ||
| Bank (15,202+1558 ) | 32,722 | 31.12.2007 Balance c/d | 63,886 |
| 63,886 | 63,886 | ||
| 1.1.2008 Balance b/d | 63,886 | ||
| Bank (63886+2396) | 66,282 | 31.12.2008 Balance c/d | 130,168 |
| 130,168 | 130,168 | ||
| 1.1.2009 Balance b/d | 130,168 | ||
| Bank(130,168+3276) | 133,444 | 31.12.2009 Balance c/d | 263,612 |
| 263,612 | 263,612 | ||
| 1.1.2010 Balance b/d | 263,612 | ||
DR DEPRECIATION FUND INVESTMENT A/C CR
| 2005 Bank | 15,202 | 31.12.2005 Balance c/d | 15,202 |
| 01.01.2006 Balance b/d | 15,202 | 31.12.2006 Balance c/d | 31,164 |
| Bank (15202+760) | 15,962 | ||
| 31,164 | 31,164 | ||
| 1.1.2007 Balance b/d | 31,164 | ||
| Bank (15202+1558) | 16,760 | 31.12.2007 Balance c/d | 47,924 |
| 47,924 | 47,924 | ||
| 1.1.2008 Balance b/d | 47,924 | ||
| Bank (15202 + 2396) | 17,598 | 31.12.2008 Balance c/d | 65,522 |
| 65,522 | 65,522 | ||
| 1.1.2009 Balance b/d | 65,522 | 31.12.2009 Balance c/d | 83,100 |
| Bank | 17,578 | ||
| 83,100 | 83,100 | ||
| 1.1.2010 Balance b/d | 83,100 |
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