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:
- Asset account ( e.g. Machinery Account)
- Provision for Depreciation Account
- Profit and Loss Account
- 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
- 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
- The amount set aside out of profit for a specific purpose is _______
(a) depletion (b) reserve (c) provision (d) depreciation
- 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
- 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.
- 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
- 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:
- Prepare the Provision for Depreciation of Machinery account for years 1 to 5
- Prepare a Balance Sheet extract to show the fixed asset of machinery at the end of each of the five years.
