 # Depreciation of Fixed Assets II

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In today’s class, we will be talking more about the depreciation of fixed assets. Enjoy the class!

### Depreciation of Fixed Assets II CONTENT

• Methods of providing for depreciation

#### REDUCING BALANCE METHOD (or DIMINISHING BALANCE METHOD)

Under this method, a fixed percentage is written off the reducing (or diminishing) balance of the asset yearly. This method charges higher depreciation in the early years of the asset and lowers in the later years

The depreciation rate (%) to be applied is computed using the formula below:

S

Depreciation rate (%)   =    1   –       C

where:

n =    No. of  years

s  =   Scrap value

c  =   Cost

Illustration:

A machine costing N10,000 will realize N256 in four years. Show the yearly depreciation to be charged for each of the four years using a diminishing balance method.

SOLUTION:

S

Depreciation Rate (%)    =   1   –       C

256

=   1 –     10,000

4

=   1  –    10

=        0.6

=        60%

The depreciation charge applicable to each of the four years will be:

N

Cost                                                           10,000

Year 1       Depreciation = (60% X 10,000)                  6,000

REDUCED BALANCE (i.e. NBV)          4,000

Year 2      Depreciation = (60% X  4,000)                   2,400

REDUCED BALANCE (i.e. NBV)           1,600

Year 3      Depreciation = (60% X 1,600)                       960

REDUCED BALANCE (i.e. NBV)                           640

Year 4     Depreciation = (60% X 640)                          348

SCRAP VALUE (i.e. NBV)                                        256

##### ADVANTAGES OF THE DIMINISHING BALANCE METHOD
1. It is widely used.
2. Depreciation is more scientifically provided for.
3. It recognizes the efficiency of an asset by charging higher amounts in the early years and lower amounts in the later years.
4. Higher depreciation amounts and low maintenance cost in the early years even out with low depreciation amounts and higher maintenance cost in the later years
##### DISADVANTAGES OF THE DIMINISHING BALANCE METHOD
1. Calculating the rate of depreciation may be difficult
2. It is not ideal for all fixed assets. For example, it cannot be used for loose tools.
##### SUM OF THE YEARS DIGIT

Under this method, the years in the life of the asset are represented with digits and are added. The fraction of the asset cost is then charged to the years in reverse order.

Illustration:

A machine cost N10,000 and has a life span of four years after which it can be sold for N256. Calculate the yearly depreciation charge for each of the four years using the sum of the years digit method.

Solution

Amount  =  Cost  –  Scrap Value

=  N10,000  –  N256

=   N9,744

No. of years  =  4

Add up the years thus:  1 + 2 + 3 + 4 = 10

i.e. Sum of the four years  =  10

Reverse the digit for each of the years

Year                         Digit

1                                4

2                                3

3                                2

4                                1

Calculation of depreciation charge:

Year 1   =   4    X   9,744           =   N3,898

10

Year 2   =   3     X   9,744          =    N2,923

10

Year 3   =   2     X   9,744          =    N1,949

10

Year 4   =  1    X    9,744          =    N974

10

N.B

The sum of the year’s digit is similar in some respect to the diminishing balance method as it charges higher depreciation in the early years of the asset.

Therefore the advantages and disadvantages of the sum of the years digit are the same as for the Diminishing Balance Method.

EVALUATION QUESTIONS

1. Explain the following methods of depreciation: (a)  reducing balance method  (b) sum of the year’s digit
2. Write short notes on the following: (a)  Depreciation      (b) Salvage value     (c) Obsolescence
##### REVALUATION METHOD

Under this method the asset is revalued each year, any difference being charged to the profit and loss account.

This method is good for assets which cannot be easily depreciated because of their nature e.g. loose tools (i.e. bolts, nuts, hammer, chisel, screws) livestock, farm crops/plantations etc. The value of the assets at the beginning and end of the year will be estimated and used in the calculation of the depreciation.

Illustration:

On 1st January 2005, the value of loose tools was N25,000. Purchases of loose tools during the year was N7,000. On 31st December 2005, the loose tools were revalued at N24,000

Required:  Calculate the depreciation on a loose tool for the year.

Solution

N

Balance of loose tools 1 Jan 2005                     25,000

Add: Purchases of loose tools in 2005               7,000

32,000

Less:  Balance of loose tools 31 Dec 2005        24,000

Depreciation on loose tools for 2005          8,000

###### ADVANTAGES OF THE REVALUATION METHOD
1. It is suitable (or ideal) for loose tools, livestock etc.
###### DISADVANTAGES OF THE REVALUATION METHOD
1. It cannot be used for all classes of assets.
2. Revaluation of assets on yearly basis may be cumbersome
##### DEPLETION UNIT METHOD (or PRODUCTION UNIT METHOD )

This method is used for wasting assets such as quarry, mine, timber, and other assets (like machines) whose useful life can be estimated in hours.

Illustration

A machine costing N100,000 can work for 800 hours. If it works for 120 hours in 2005 and 200hours in 2006. Calculate the depreciation charges for each year.

Solution

Calculation of Depreciation on Machine

2005               120   X  N100,000          =   N15,000

800

2006               200    X  N100,000         =   N25,000

800

###### GENERAL EVALUATION
1. What is depreciation
2. Explain the following methods of calculating depreciation (i) straight line  (ii) reducing balance     (iii) sum of the years digit
3. What is the difference between depreciation and amortization
4. State ten uses of the general journal
5. Explain the principle of the double-entry system

In our next class, we will be talking more about Depreciation of Fixed Assets.  We hope you enjoyed the class.

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