The depreciation formula can be expressed as follows:
Depreciation expense = (Cost - Estimated residual value)
Estimated useful life
The top left-hand corner of the formula is known as the
"depreciable amount". According to paragraph 50 of AASB 116, the
depreciable amount of an asset is the amount which must be
allocated on a systematic basis over the asset's estimated
useful life. The amount of depreciation expense is to be
recognised in the profit and loss statement.
The amount of depreciation expense is dependant upon three
factors:
a. Estimating the asset's residual value;
b. Estimating the asset's useful life; and
c. The choice of depreciation method.
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First, an estimate must be made of the asset's residual (or
disposal) value. Paragraph 6 of AASB 116 defines the residual
value as:
"The estimated amount that an entity would currently obtain from
the disposal of the
asset, after deducting the estimated costs of disposal at the
end of its useful life".
The estimate is based on the net amount that the entity could
recover for similar assets which have already reached the end of
their useful lives and have operated under similar conditions to
those under which the asset will be used.
The disposal value may be based on the asset's scrap value or on
its expected trade-in value. If this value cannot be
ascertained, then a value of $Nil should be assigned. The
residual value is also known as the salvage value or trade-in
value. The residual value of every asset should be reviewed at
least as the end of each financial year and revised if
necessary.
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Secondly, the asset's estimated useful life must be determined.
Accordingly to paragraph 6 of AASB 116, an asset's useful life
is defined as:
- The period over which an asset is expected to be available for
use by the entity; or
- The number of production or similar units expected to be
obtained from the asset by an entity.
The useful life of an asset is expressed on a time basis
(usually in years). Paragraph 56 of AASB 116 states that in
determining the useful life of a depreciable asset, considerable
should be given to the following:
- Expected usage of the asset;
- Expected physical wear and tear;
- Technical or commercial obsolescence; and
- Legal or similar limits on the use of the asset.
Note that the definition of useful life refers to the estimated
useful life to the entity. This means that if a motor vehicle
has a physical useful life of eight years, but the owner of the
vehicle intends to dispose of the vehicle in five years' time,
the useful life is five years, not eight years. The useful life
of every asset should be reviewed at least at the end of each
financial year and revised if necessary.
Practically, it is very difficult for bookkeepers, accountants
or the owners of the business to determine the useful lives of
assets.
For taxation purposes, the Commissioner of Taxation has
published its own determination of the useful lives of most
depreciable assets. These effective lives can be found in
Taxation Ruling TR2000/18 which can be downloaded from the
Australian Taxation Office's website.
Most small businesses use these taxation rates for accounting
purposes.
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Introduction
AASB 116 prescribes three acceptable depreciation methods that
all result in the systematic allocation of the cost of the asset
over its useful life. These three methods are used:
a. The straight-line method;
b. The reducing balance method; and
c. The units of production method.
AASB 116 does not specify a particular depreciation method to be
adopted by the entity. An entity has a choice of any of the
three abovementioned depreciation methods.
However, paragraph 60 of the standard states that the
depreciation method chosen must result in the best reflection of
the pattern in which the asset's future economic benefits are
expected to be consumed by the entity.
The depreciation method should be reviewed at least at the end
of each financial year and changed if necessary. However,
generally, once an entity chooses a particular depreciation
method for an asset, it should apply this method consistently
over the useful life of the asset. All entities are required to
disclose the depreciation method used in the financial report.
Each of the depreciation methods are discussed in the following
paragraphs.
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The straight-line depreciation method results in an equal amount
of depreciation for each year in the asset's useful life. Under
the straight-line method, depreciation expense is calculated by
applying the following formula:
(Cost - Estimated residual value)
Estimated useful life
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The reducing balance method is an example of an accelerated
depreciation method. It assumes that the asset will yield more
service potential in the earlier years than in the later years.
Hence it allocates greater amounts of depreciation in the
earlier years of the asset's life than in the later years.
Hence, it allocates greater amounts of depreciation in the
earlier years of the asset's life than in the later years. It
does this by "weighting" or increasing the straight-line
depreciation by a percentage of 200%.
The formula for calculating the depreciation rate for the
reducing balance method is as follows:
RB rate = 100% x 200%
Useful life (in years)
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The units of production (or units of usage) depreciation method
allocates depreciation based on the physical use of the asset.
This method can only be used where the asset's output can be
measured (either in tie or in number of units). For example, a
machine may produce a certain number of units of output per year
or operate for a certain number of machine hours per year.
The formula for calculation the depreciation under the units of
production method is as follows:
(Cost - Estimated residual value) = Depreciation per unit
Total estimated number of units
Depreciation expense = Depreciation per unit x No. of units per
year
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Facts: A photocopier is purchased in March 2006 for $10,000.
The following table compares the depreciation expense of the
photocopier using each of the three depreciation methods.
|
Year
Straight-line Reducing
balance Units of
Production
2006
$1,000
$1,800 $1,500
2007
$2,000
$3,060
$2,500
2008
$2,000
$2,142
$1,800
2009
$2,000
$1,499
$2,000
2010
$2,000
$1,050
$1,600
2011
$1,000
$499 $600
Total
$10,000
$10,000
$10,000 |
|
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