16.5 Comparing depreciation methods
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Transcript of 16.5 Comparing depreciation methods
© Michael Allison, Trinity Grammar School.Author’s permission required for external use
A business purchased a vehicle with the following details:
Cost = $32,000
Estimated useful life = 4 years
Estimated residual value = $12,800
The fi rm is debating which depreciation
16.5 COMPARING DEPRECIATION METHODS
Reducing Balance
Depreciation @ 20%
Straight-Line Depreciation or
© Michael Allison, Trinity Grammar School.Author’s permission required for external use
A business purchased a vehicle with the following details: Cost = $32,000 Estimated useful life = 4 years Estimated residual value = $12,800
Straight-Line Depreciation
Expense=
Residual
Cost -
Useful Life
= $4,800
=12,80032,000 -
4
YearDepreciati
on
Accumulated
Depreciation
Carrying Value
YearDepreciati
on
Accumulated
Depreciation
Carrying Value
1 4,800 4,800 27,200
YearDepreciati
on
Accumulated
Depreciation
Carrying Value
1 4,800 4,800 27,200
2 4,800 9,600 22,400
YearDepreciati
on
Accumulated
Depreciation
Carrying Value
1 4,800 4,800 27,200
2 4,800 9,600 22,400
3 4,800 14,400 17,600
YearDepreciati
on
Accumulated
Depreciation
Carrying Value
1 4,800 4,800 27,200
2 4,800 9,600 22,400
3 4,800 14,400 17,600
4 4,800 19,200 12,800
Straight-Line Depreciation
16.5 COMPARING DEPRECIATION METHODS
© Michael Allison, Trinity Grammar School.Author’s permission required for external use
A business purchased a vehicle with the following details: Cost = $32,000 Estimated useful life = 4 years Estimated residual value = $12,800
Reducing Balance @ 20%=
Carrying Value at end
of period
Reducing Balance Depreciation
Expensex
Reducing Balance Depreciation @ 20%
16.5 COMPARING DEPRECIATION METHODS
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
Depreciation Expense Accumulated Depreciation Carrying Value
1 20% x$32,00
0= $6,400 = $6,400
$32,000
- $6,400 =$25,60
0
2 20% x$25,60
0= $5,120 $6,400 + $5,120 =
$11,520
$32,000
-$11,52
0=
$20,480
3 20% x$20,48
0= $4,096
$11,520
+ $4,096 =$15,61
6$32,00
0-
$15,616
=$16,38
4
4 20% x$16,38
4= $3,277
$15,616
+ $3,277 =$18,89
2$32,00
0-
$18,892
=$13,10
7
© Michael Allison, Trinity Grammar School.Author’s permission required for external use
Cost$32,000
$4,800
Carrying Value
$27,200
Carrying Value
$22,400
Carrying Value
$17,600
Straight-line depreciation…
$4,800 $4,800
0 1 2 3 4
$4,800
Carrying Value
$12,800
Cost$32,000
32,000 x 20% =
$6,400
Carrying Value
$25,600
Carrying Value
$20,480
Carrying Value
$16,384
Reducing balance depreciation…
0 1 2 3 4
Carrying Value
$13,107
25,600 x 20% =
$5,120
20,480 x 20% =
$4,096
16,384 x 20% =
$3,277
16.5 COMPARING DEPRECIATION METHODS
© Michael Allison, Trinity Grammar School.Author’s permission required for external use
Comparison…
Reducing Balance
Depreciation @ 20%
Straight-Line Depreciation
16.5 COMPARING DEPRECIATION METHODS
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 4,800 4,800 27,200
2 4,800 9,600 22,400
3 4,800 14,400 17,600
4 4,800 19,200 12,800
Total
19,200
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 6,400 6,400 25,600
2 5,120 11,520 20,480
3 4,096 15,616 16,384
4 3,277 18,892 13,107
Total
18,893
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 4,800 4,800 27,200
2 4,800 9,600 22,400
3 4,800 14,400 17,600
4 4,800 19,200 12,800
Total
19,200
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 6,400 6,400 25,600
2 5,120 11,520 20,480
3 4,096 15,616 16,384
4 3,277 18,892 13,107
Total
18,893
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 4,800 4,800 27,200
2 4,800 9,600 22,400
3 4,800 14,400 17,600
4 4,800 19,200 12,800
Total
19,200
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 6,400 6,400 25,600
2 5,120 11,520 20,480
3 4,096 15,616 16,384
4 3,277 18,892 13,107
Total
18,893
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 4,800 4,800 27,200
2 4,800 9,600 22,400
3 4,800 14,400 17,600
4 4,800 19,200 12,800
Total
19,200
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 6,400 6,400 25,600
2 5,120 11,520 20,480
3 4,096 15,616 16,384
4 3,277 18,892 13,107
Total
18,893
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 4,800 4,800 27,200
2 4,800 9,600 22,400
3 4,800 14,400 17,600
4 4,800 19,200 12,800
Total
19,200
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 6,400 6,400 25,600
2 5,120 11,520 20,480
3 4,096 15,616 16,384
4 3,277 18,892 13,107
Total
18,893
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 4,800 4,800 27,200
2 4,800 9,600 22,400
3 4,800 14,400 17,600
4 4,800 19,200 12,800
Total
19,200
YearDepreciatio
n
Accumulated
Depreciation
Carrying Value
1 6,400 6,400 25,600
2 5,120 11,520 20,480
3 4,096 15,616 16,384
4 3,277 18,892 13,107
Total
18,893
© Michael Allison, Trinity Grammar School.Author’s permission required for external use
Comparison…
Straight-line charges the same amount of depreciation each period
Reducing-balance charges more depreciation in the earlier periods
Reducing-balance depreciation decreases as the asset gets older
Year 1 Year 2 Year 3 Year 4
4,800 4,800 4,800 4,800
6,400
5,120
4,096
3,277
Depreciation ExpenseStraight-Line Reducing-Balance
16.5 COMPARING DEPRECIATION METHODS
© Michael Allison, Trinity Grammar School.Author’s permission required for external useYear 1 Year 2 Year 3 Year 4
4,800
9,600
14,400
19,200
6,400
11,520
15,616
18,892
Accumulated DepreciationStraight-Line Reducing-Balance
Comparison…
Both methods end up charging the same (or similar) amount of depreciation at the end of the asset’s useful life
But: Reducing
balance charges more at the start of the asset’s life
Reducing balance charges less at the end of the asset’s useful life
16.5 COMPARING DEPRECIATION METHODS
© Michael Allison, Trinity Grammar School.Author’s permission required for external useYear 1 Year 2 Year 3 Year 4
27,200
22,400
17,600
12,800
25,600
20,480
16,384
13,107
Carrying ValueStraight-Line Reducing-Balance
Comparison…
Both methods end up with the same (or similar) carrying value at the end of the asset’s useful life
The asset is more valuable in the Balance Sheet in the early years under the straight-line method
16.5 COMPARING DEPRECIATION METHODS
© Michael Allison, Trinity Grammar School.Author’s permission required for external use
Which depreciation method should a business choose?
The method selected should be the one that best satisfi es…
Reporting Period Principle :
• Pick the method that best matches the amount of depreciation to the amount of revenue generated each period
Relevance:
• Pick the method that calculate the most accurate profi t so good decisions can be made
• This will be the method which best matches the revenue earned by the asset with the depreciation incurred
16.5 COMPARING DEPRECIATION METHODS
© Michael Allison, Trinity Grammar School.Author’s permission required for external use
To do this, the revenue generating pattern of each asset must be analysed
Reducing Balance
Depreciation
Straight-Line Depreciation used
when…
used when…
The asset has the same revenue earning capacity over its entire useful life
The asset earns more revenue in its earlier years than in its later years
16.5 COMPARING DEPRECIATION METHODS
© Michael Allison, Trinity Grammar School.Author’s permission required for external use
If the asset generates the same revenue throughout its life then straight-line depreciation will best match revenues and expenses
If the asset generates the more revenue in its early years then reducing-balance depreciation will best match revenues and expenses
2015 2016 2017
Revenue = $10,000 Revenue = $10,000 Revenue = $10,000Depreciation = $2,000- Depreciation =
$2,000- Depreciation = $2,000-
2015 2016 2017
Revenue = $25,000 Revenue = $17,500 Revenue = $10,000Depreciation = $10,000- Depreciation =
$7,000- Depreciation = $5,000-
16.5 COMPARING DEPRECIATION METHODS
© Michael Allison, Trinity Grammar School.Author’s permission required for external use
In the real world…
16.5 COMPARING DEPRECIATION METHODS