Theory question 102
Depreciation(a) Define and list two classification of each of the following: (i) assets; (ii) liabilities.
(b) State and explain the factors to be considered in determining the annual depreciation charge for a fixed asset.
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(a)(i) Assets: resources owned or controlled by the business from which future benefits are expected.
Classification: fixed (non-current) assets, e.g. land, machinery; current assets, e.g. stock, debtors, cash. (Tangible/intangible also accepted.)
(ii) Liabilities: amounts the business owes to outsiders, to be settled in future.
Classification: long-term (non-current) liabilities, e.g. debentures, long-term loans; current liabilities, e.g. creditors, accrued expenses, bank overdraft.
(b) Factors:
- Cost of the asset: purchase price plus costs of getting it ready for use (carriage, installation, legal fees).
- Estimated useful life: number of years the business expects to use the asset.
- Estimated residual (scrap) value: what the asset is expected to fetch at the end of its life.
- Method of depreciation chosen (straight line, reducing balance etc.).
Annual straight-line charge = (cost − residual value) ÷ useful life ties the three main factors together.