Provision for

Depreciation

Definition of

TERMS

DepreciationDepreciation is systematic allocation the cost of a fixed asset over its useful life. It is a way of matching the cost of a fixed asset with the revenue (or other economic benefits) it generates over its useful life.

Without depreciation accounting, the entire cost of a fixed asset will be recognized in the year of purchase. This will give a misleading view of the profitability of the entity. The observation may be explained by way of an example.

Fixed assetsFixed assets, also known as Property, Plant and Equipment, are tangible assets held by an entity for the production or supply of goods and services, for rentals to others, or for administrative purposes.

INTRODUCTION

Assets which are relatively permanent in nature are fixed assets. They are used by the business in its operation and are not intended for sale.

The value of these assets, except land decreases as time passes by due to the following reasons:

1.Wear & tear from operations

2. Inadequacy and obsolescence

An asset is said to be inadequate for the business if there is business expansion and the asset can no longer fulfill the needs of the business.

It is said to be obsolete in the introduction of new models or inventions and the business desires to replace the old asset with a new one.The cost of the fixed asset is allocated to the number of its useful life. Depreciation is the portion of the cost of the asset which is already used or consumed.

There are several methods of depreciating assets. However, we will only deal with the simplest method, the straight-line method of depreciation. The following formula is used to compute for depreciation:

D is the depreciation

C is the original cost which includes the invoice price less discount plus other costs incurred before the use of the asset such as freight and installation

S is the salvage value or scrap value; This is the amount wherein the asset can be sold after its useful life.

n is the number of estimated useful years

A delivery truck was purchased for P250,000. It is estimated to last 0 years after which it shall have a value of P5,000. Compute for the depreciation.

Example:

P250,000 – P50,000

10 years

Answer:

P20,000 / yr.

Adjusting entry

Depreciation, delivery truck P20,000

Accumulated depreciation, delivery truck P20,000

Depreciation is an expense account. Accumulated depreciation is a contra asset account. A contra asset account is an account the balance of which is deducted from a related asset to show the proper amount of such asset. The asset account is not credited to preserve the historical cost of the asset. Instead, a contra asset account is credited because depreciation is merely an estimate and to preserve the original cost of the asset.

EVALUATION

TRUE OR FALSE

1. Fixed assets are used by the business in its operation and are intended for sale.

2. The value of fixed assets, except land increases as time passes by.

3. An asset is said to be adequate for the business if there is business expansion and the asset can no longer fulfill the needs of the business.

4. The cost of the fixed asset is allocated to the number of its useful life.

5. Depreciation is the portion of the cost of the asset which is already used or consumed.

6. The simplest method of depreciating assets is called ________________.

7. - 8. What is the formula used to compute for depreciation?

9. – 10. A delivery van was purchased for P500,000. It is estimated to last 20 years after which it shall have a value of P10,000. Compute for the depreciation.

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REFERENCE(S):Book: Accounting Principles pg. 136-137

Sites:http://accounting-simplified.com/financial/fixed-assets/depreciation-methods/http://accounting-simplified.com/financial/fixed-assets/http://accounting-simplified.com/financial/fixed-assets/capital-and-revenue-expenditure.htmlhttp://trans-par-en-cy.tk/http://aplaceforart.tumblr.com/

TEH END.