ACCOUNTING TREATMENT OF DEPRECIATION

FIRST TERM E-LEARNING NOTE

 

SUBJECT: FINANCIAL ACCOUNTING 

 

CLASS: SS 2

 

 

 

WEEKNINE

TOPIC: DEPRECIATION OF FIXED ASSETS

 

ACCOUNTING TREATMENT OF DEPRECIATION

There are two ways of treating depreciation in the ledgers. These are the Old Method and the Modern Method. However, the Modern Method which is preferred by accountants will be considered.

 

MODERN METHOD

An asset account is opened and a separate provision for depreciation account is also opened. The depreciation for each year is debited to the Profit and Loss Account and credited to the Provision for Depreciation Account

Therefore the following accounts should be prepared:

  1. Asset account ( e.g. Machinery Account)
  2. Provision for Depreciation Account
  3. Profit and Loss Account
  4. Balance Sheet

Illustration

A machine cost N100,000. It is expected to have a useful life of five years at the end of which time it is expected to be sold for N20,000 (its residual value)

 

You are required to show the necessary ledger accounts assuming the machine is depreciated on the straight line basis.

 

SOLUTION

Annual Depreciation Charge     =       Cost   –   Scrap Value

Estimated useful life

=       100,000 –  20,000

5

=                   80,000

5

.                                                           =                   N16,000

Ledger Accounts:

 

                                                    Machinery

                                                        N                                                             N

Year 1        Cash                        100,000     Year 1     Balance c/d            100,000

Year 2        Balance b/d             100,000     Year 2     Balance c/d            100,000

Year 3        Balance b/d             100,000     Year 3     Balance c/d            100,000

Year 4        Balance b/d             100,000     Year 4     Balance c/d            100,000

Year 5        Balance b/d             100,000     Year 5     Balance c/d            100,000

 

 

Profit Loss Account (extracts)

                              N                                             N

Year 1    Provision for dep. of machinery     16,000

Year 2   Provision for dep. of machinery      16,000

Year 3  Provision for dep. of machinery      16,000

Year 4  Provision for dep. of machinery      16,000

Year 5  Provision for dep. of machinery      16,000

 

Provision for Depreciation of Machinery

                                                N                                                                     N

Year 1 Balance c/d                  16,000             Year 1 Profit and Loss A/c     16,000

Year 2 Balance c/d                  32,000             Year 2 Balance b/d                 16,000

Profit and Loss A/c                 16,000

32,000                                                             32,000

Year 3 Balance c/d                  48,000             Year 3 Balance b/d                 32,000

Profit and Loss A/c                 16,000

48,000                                                             48,000

Year 4 Balance c/d                  64,000             Year 4 Balance b/d                 48,000

Profit and Loss A/c                 16,000

64,000                                                             64,000

Year 5 Balance c/d                  80,000             Year 5 Balance b/d                 64,000

Profit and Loss A/c                 16,000

80,000                                                             80,000

 

Notes:

*          The fixed asset account continues to show the machine at cost each year of its life.  Fixed assets accounts sometimes include the words ‘at cost’ in their titles to emphasise this point.

*          The balance on the Provision for Depreciation of Machinery Account increases each year.

*          A provision in accounting is an amount set aside for a particular purpose.

*          A separate Provision for Depreciation account must be opened for each class of fixed assets.

*          The balance on the Provision for Depreciation account is deducted from the cost of the fixed asset in the Balance Sheet.

*          The balance remaining after depreciation has been deducted from cost is known as NET BOOK VALUE (NBV) or WRITTEN DOWN VALUE(WDV) of the asset.  It is the amount of the cost of the asset which has not yet been charged against profit in the Profit and Loss Account.

 

Balance Sheet (extract)

                        FIXED ASSETS                   Cost                Dep.                NBV

Year 1 Machinery                   100,000           16,000             84,000

Year 2 Machinery                   100,000           32,000             68,000

Year 3 Machinery                   100,000           48,000             52,000

Year 4 Machinery                   100,000           64,000             36,000

Year 5 Machinery                   100,000           80,000             20,000

 

EVALUATION QUESTION

  1. A lorry cost N160,000. It will be kept for 4 years and then sold at a scrap value of N256.  Show the necessary accounts using diminishing balance method.

 

GENERAL EVALUATION

  • What are books of prime entry?
  • List any seven books of prime entry
  • State six reasons for keeping accounting records
  • Explain six factors that are taken into consideration in determining annual depreciation charge
  • State six errors that would not affect the agreement of the trial balance

READING ASSIGNMENT

Simplified and Amplified Financial Accounting, Page 151-167

 

WEEKEND ASSIGNMENT

  1. The amount set aside out of profit for a specific purpose is _______

(a) depletion                (b) reserve                   (c) provision                (d) depreciation

  1. Which of the following terms describes the provision made for the loss in the value of an asset that has a legal life span?

(a) capitalization          (b) depreciation           (c) depletion    (d) amortization

  1. Which of the following is not a cause of depreciation?

(a) inflation         (b) obsolescence           (c) erosion and decay         (d) wear and tear

Use the information below to answer questions 4 and 5

A motor van costs N60,000,000 at 1st January, 2004.  It was depreciated at 8% using the fixedinstallment method.

  1. What was the accumulated depreciation as at December 31st, 2005?

(a) N9,600,000            (b) N9,216,000            (c) N4,800,000      (d) N4,416,000

  1. What was the net book value of the motor van as at December 31st, 2005?

(a) N55,584,000          (b) N55,200,000          (c) 50,784,000      (d)  N50,400,000

 

THEORY

A machine costing N40,000 and with an expected useful life of five years is to be depreciated by the reducing balance method.  The annual rate of depreciation is 30%.

 

Required:

  1. Prepare the Provision for Depreciation of Machinery account for years 1 to 5
  2. Prepare a Balance Sheet extract to show the fixed asset of machinery at the end of each of the five years.