Depreciation
Introduction to Depreciation
This is an example of a long-term adjustment. Depreciation is wear and tear allowances or where a fixed asset's value is decreased over a number of years as assets are usually not made to last indefinitely. Depreciation is normally calculated on the fixed assets used by the business to generate income over the life span of such fixed assets. Depreciation is normally recorded as an expense in the depreciation account and the depreciation is usually credited to the accumulated depreciation account.
The accumulated depreciation account is an asset contra account, because the credit balance is reported in the balance sheet under fixed assets. Fixed assets are normally reported in the balance sheet at cost price, less the accumulated depreciation, which is the net value of the asset. On the other hand, depreciation is reported in the income statement (or the profit and loss account) as an expense, which will decrease the net profits of a business.
The following extraction of the fixed assets in the balance sheet illustrate how accumulated depreciation is usually reported:
600-000 Furniture and Fittings Net Value 600-010 Furniture and Fittings @ Cost 1807.00 600-020 Furniture and Fittings Accum Deprec <350.00> 610-000 Motor Vehicles Net Value 610-010 Motor Vehicles @ Cost 5000.00 610-020 Motor Vehicles Accumulated Deprec <600.00> Total for Fixed Assets 5857.00
The following extraction of the fixed assets in the trial balance sheet illustrate how accumulated depreciation is usually reported:
600-000 Furniture and Fittings Net Value 600-010 Furniture and Fittings @ Cost 1807.00 600-020 Furniture and Fittings Accum Deprec 350.00 610-000 Motor Vehicles Net Value 610-010 Motor Vehicles @ Cost 5000.00 610-020 Motor Vehicles Accumulated Depreci. 600.00
The accumulated depreciation is a fixed asset contra account, which will reflect the book value of each fixed asset in the balance sheet or trial balance. Should you generate the balance sheet or trial balance and you do not select the sub accounts option on the report options screen, only the net value (book value) will be reflected.
600-000 Furniture and Fittings Net Value 1457.00 610-000 Motor Vehicles Net Value 4400.00 Total for Fixed Assets 5857.00 G600 Furniture and Fittings Net Value 1457.00 G610 Motor Vehicles Net Value 4400.00
To manage fixed assets and depreciation in a Set of Books, you need for each of your groups or categories of Fixed Assets to:
- Create a General Ledger Account - this is the main account or totaling account which will summarize the net book value or amounts of transactions of your sub accounts for the cost price less the accumulated depreciation.
- Create General Ledger Sub-accounts for the Fixed Asset at Cost Price and the Accumulated Depreciation.
When you purchase a fixed asset, you will need process the purchase transaction in the payments journal (if it is cash) or in the purchase journal (if it is on credit). If you are registered as a VAT vendor, the net purchase price (excluding VAT) will be recorded in the Fixed Asset at Cost sub-account.
When you write-off depreciation, you need to credit the Accumulated Depreciation sub-account and debit the Depreciation expense account. There are various methods according to which depreciation can be calculated. The most commonly used methods are the fixed instalment and the diminishing amount methods. The principles and processes for journalising depreciation is basically the same irrespective of the method you use to calculate depreciation.
There are two basic steps to write off depreciation:
- Identify the Fixed Assets and the method to calculate the depreciation. You may also need to consult with your accountant or the Tax Authorities. The Tax Legislation may be amended from time to time and you may find some valuable information such as practice notes, etc. on your Tax Authorities' Web Site. To access and browse on the Web Site for your Tax Authority, click on the speed button or icon of the Help File and select the Web Site address of your Tax Authority.
- Record the Depreciation in the General Journal or a Depreciation Journal (if you have created such a Journal).
The following methods are commonly used to calculate depreciation:
- Fixed Installment Method
- Reducing or Diminishing Balance Method
- Production Method
- Assets purchased for Less Than a Prescribed Amount
In the final year in which depreciation is written off, a nominal value of R(£) 1 should be retained in the books, unless the asset has a book value or scrap value. The value of an asset should never be reflected as 0 (zero) in the financial statements of a business. The final value of an asset is shown at a nominal value of R(£) 1 in the balance sheet. Only when the asset is disposed of, the value of R(£) 1 will be cleared when the profit or loss with the sale of the fixed asset is calculated.
Write-off Depreciation
Calculate Depreciation
Fixed Installment
Cost Price Method
Calculate Depreciation Reducing (Diminishing) Balance Method
According to the diminishing method, most of the fixed asset's value will diminish or be written off in the first year and a lesser amount in the second year and even lesser amounts in the successive years. If compared to the fixed installment or cost price method, the amount of depreciation will differ from year to year and will decrease from year to year. The book value reduces or diminishes rapidly up to 50% in the first year and a lesser percentage in the second and successive years. This is also why some people refer to it as the accelerated method. The book value is the difference between the cost price and the accumulated depreciation.
There are two basic formulas that may be used to calculate depreciation when the diminishing balance method is used. These methods are:
- Fixed percentage on the diminishing or reducing balance method
- The Sum-of-the-digits method
