Depreciation Flashcards
Depreciation
The decline in value of an asset over time, mainly bc of wear and tear
Net book value
The cost of the machine - the depreciation
- the value after depreciation taken off
Accumulated depreciation
Depreciation added up over the years
Residual value
Value at the end of its life once the depreciation has been deducted
Lifetime of the machine
How long it’s predicted to last
What are the two methods of depreciation?
- straight line method
- reducing balance method
Straight line method
The value of the asset is reduced equally per year over its lifetime.
Eg machine costs £120,000 with expected lifetime 10 years and residual value of £20,000. Work out depreciation per year.
£120,000-£20,000= £100,000/ 10= £10,000
What are the advantages of the straight line method?
- amount of depreciation is lower in the first few years compared to reduced balance method so makes fixed assets appear higher on balance sheet
- lower level of depreciation = higher levels of profit in early years
- easy to calculate
Disadvantages of straight line method
- need to estimate residual value
- assumes asset life is known
- lower amount of depreciation can be misleading (looses most value in early years but doesn’t show this)
Reducing balance method
Applies a constant rate of depreciation each year to machine
Example of reduced balance method
Machine costs £100,000 and expected to depreciate by 10% a year. Life time is 4 years. Calculate rate of depreciation and its residual value after 4 years.
Year 1= £100,000 x 0.9 = £90,000
Year 2= £90,000 x 0.9= £81,000
Year 3= £81,000 x 0.9 = £72,900
Year 4= £72,900 x 0.9 = £65,610
Advantages of reducing balance method
- more realistic as reflects the value of the assets, especially as they loose value more in first years
- no estimate of residual value needed
Disadvantages of reducing balance method
- higher intital depreciation = lower level on balance sheet
- more complex to calculate
