Chapter 21 depreciation

• What are non-current assets?

  Long-life assets used in business for several years, not for resale
• What are the two types of non-current assets?

  Tangible and intangible non-current assets
• Give an example of a tangible non-current asset.

  Machinery
• Give an example of an intangible non-current asset.

  Patent
• Why is accounting for intangibles different from tangibles?

  Intangibles do not have a physical substance
• What is the main international accounting standard for tangible non-current assets?

  IAS 16 Property, Plant and Equipment
• What does the accrual basis of accounting require?

  Income earned must match expenses incurred in the same year
• How would you account for a machine bought for £1,200 expected to be used for three years?

  Recognize £400 as an expense each year for three years
• Why must businesses estimate the useful life of non-current assets?

  To allocate the cost of the asset over its useful life
• What is depreciation?

  A method of spreading the cost of a non-current asset over its useful life
• What is the difference between useful life and actual life of a non-current asset?

  Useful life is the period the asset is expected to generate income, while actual life is how long it physically lasts
• What is the estimated residual value of a non-current asset?

  The estimated amount the asset can be sold for at the end of its useful life
• How is the depreciable amount calculated?

  Original cost minus estimated residual value
• If a machine costs £1,200 and has a residual value of £200, what is the depreciable amount?

  £1,000
• What is the carrying amount of an asset?

  The amount at which it is shown in the balance sheet
• What are the two effects of depreciation on financial statements?

  It affects the income statement and the balance sheet
• If a machine costs £10,000 and has a depreciation expense of £2,000 in year 1, what is its carrying amount at the end of year 1?

  £8,000
• What is accumulated depreciation?

  The total amount of the asset’s original cost that has been used up so far
• Why might businesses assume a residual value of zero?

  Because the estimated residual value is often insignificant
• What is the straight-line method of depreciation?

  The cost of the asset is divided by its estimated useful life
• If a van costs £22,000 and has a residual value of £2,000 over four years, what is the annual depreciation expense using the straight-line method?

  £5,000
• How does the carrying amount change over the years using the straight-line method?

  It decreases by the same amount each year
• What will be the carrying amount of a car costing £20,000 after three years if it has a residual value of £5,000 and is depreciated using the straight-line method?

  £15,000
• What is the reducing balance method of depreciation?

  Depreciation is calculated as a percentage of the carrying amount each year
• If a machine costs £10,000 and is depreciated at 20% using the reducing balance method, what is the depreciation expense in the first year?

  £2,000
• What is the depreciation expense in the second year for a machine that has a carrying amount of £8,000 and is depreciated at 20%?

  £1,600
• Why might the reducing balance method be more appropriate for certain assets?

  It reflects that benefits from the asset are greater in the early years
• What should you do if a question does not refer to a residual value?

  Assume that the residual value is zero
• What is the purpose of depreciation in accounting?

  To allocate the asset’s original cost over its useful life systematically
• How do the straight-line and reducing balance methods differ in terms of expense recognition?

  Straight-line recognizes equal expenses each year, while reducing balance decreases over time
• What is the significance of the term "carrying amount" in accounting?

  It represents the value of the asset as recorded in the balance sheet
• What is the formula for calculating annual depreciation using the straight-line method?

  Annual Depreciation = (Cost - Residual Value) / Useful Life
• What is the formula for calculating depreciation using the reducing balance method?

  Depreciation Expense = Carrying Amount × Depreciation Rate
• Why is it important to understand the difference between carrying amount and market value?

  Carrying amount reflects accounting value, while market value reflects potential selling price
• How does the choice of depreciation method affect financial statements?

  It impacts reported expenses and asset values on the balance sheet
• How does the annual depreciation expense change over the years in the reducing balance method?

  It is higher in the early years than in the later years
• What does the reducing balance method assume about the benefits obtained from using an asset?

  Benefits are greatest in the early years and decline over time
• When would the reducing balance method be more appropriate according to the accrual basis of accounting?

  When an asset is likely to generate greater revenues in its early years
• What will textbook and exam questions involving the reducing balance method always specify?

  The percentage to be applied
• What should businesses consider when choosing between straight-line and reducing balance methods?

  Which method best reflects the expected pattern of benefits from the assets