Theory question 103
Depreciation(a)(i) What is depreciation? (ii) State three characteristics of a depreciable asset.
(b) Explain the following methods of calculating depreciation: (i) straight line; (ii) reducing balance; (iii) sum of the years digit.
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(a)(i) Depreciation is the permanent fall in the value of a fixed asset through use, wear and tear, passage of time or obsolescence; in accounts, the cost (less residual value) is spread over the asset's useful life.
(ii) Any three: expected to be used for more than one accounting period; has a limited useful life; held for use in producing goods/services, not for resale; has a cost (or valuation) that can be measured; may have a residual (scrap) value.
(b)(i) Straight line: the same amount is charged every year = (cost − residual value) ÷ useful life.
(ii) Reducing balance: a fixed percentage is applied each year to the net book value (cost less accumulated depreciation), so the charge falls each year.
(iii) Sum of the years' digits: the years of life are added (e.g. 5 years: 1+2+3+4+5 = 15); each year's charge = (cost − residual value) × remaining years ÷ sum (5/15, 4/15, …), so charges fall each year.
Give a short formula or example for each method.