Cambrige Notes: Principles of Accounting: Calculating/Estimating depreciation

• Before it is entered in the books depreciation has to be calculated
• Where an accurate figure cannot be estimated an estimate has to be used
• It is entirely up to the business in question to choose an appropriate way of calculating depreciation for each class of assets
• Whatever the method certain terminology is used when calculating and recording depreciation:
  • Cost– this is the actual amount/cost of the asset
  • Depreciation for the year– the amount of actual/estimated depreciation for the period in question for the asset
  • Accumulated depreciation– the total/aggregate amount of depreciation for the asset so far
  • Useful life- the estimated amount of time the asset is going to remain in use within the business
  • Residual value– the estimated value of the asset at the end of its useful life it has to be $0 or greater
  • Net book value– the cost of the asset less its accumulated depreciation
  • Disposal- this is when an asset is sold i.e. disposed of
• Estimates such as the useful life of an asset and its residual value are based on the nature of the asset and the business’s own past experiences among other things
• Also a decision has to be made whether depreciation on how exactly depreciation is to be charged
• A business has three options especially when an asset is bought and sold on a day other than the beginning or end of a trading period:
  1. Charging full depreciation in the year in which an asset is bought and none in the year of disposal
  2. Charging no depreciation in the year in which the asset is bought and full depreciation when the asset is disposed
  3. Charging depreciation on a pro rata basis
• The third method is to be preferred but it is entirely up to examiners and the question you encounter how you will charge and calculate deprecation
• There are a lot of methods for calculating the actual depreciation including the following:
  1. Straight Line method
  2. Reducing Balance/Diminishing Balance method
  3. Revaluation method
  4. Sum of year’s digits
  5. Units of production
  6. Machine hour method
• To learn more about each method just click on it, if you cannot click on a method then either the method is not acceptable or it is beyond the scope of the syllabus
• The sum of year’s digits is probably one of the most irrational methods of calculating depreciation and is to be deemed totally unacceptable

To access more topics go to the Principles of Accounting Notes.