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Sunday, 21 September 2014

Story About Depreciation



Let say in the beginning of Year 1, Moonitez want to sell burger. Besides learning the way to produce a delicious burger and buying the material to produce a burger, the most important thing is he needs a burger stall.



The selling price of a burger stall is RM10 000, and a burger stall can be used for 10 years. In the 1st year, Moonitez pays RM10 000 for cash to buy the burger stall. But he thinks that, if he records RM10 000 as expense this year, then most probably the year's profit will be negative.(not beautiful  to apply loan).



Moonitez is a smart guy.  Since the burger can be used for 10 years, so he decides to divide this RM10 000 expenses into 10 years, and each year records a RM1000 expense in Income Statement.



So how should Moonitez record the value of burger stall in balance sheet? Since burger stall can be used for 10 years, therefore the value of burger stall depreciates RM1 000 each year.



In the beginning of Year 1, Moonitez records burger stall as  PPE, In non-current asset part as RM10 000 (Historical Value).



In the beginning of Year 2, Moonitez records RM9 000 which equals to RM10 000 (Historical Value)- RM1 000 (Total Depreciation )



In the beginning of Year 3, Moonitez records RM8 000 which equals to RM10 000 (Historical Value)- RM2 000 (Total Depreciation)

*Rm2000 (Total Depreciation) = RM1000 (Accumulate Depreciation) + RM1000 (Depreciation Current Year)



In the beginning of Year 4, Moonitez records RM7 000 which equals to RM10 000 (Historical Value)- RM3 000 (Total Depreciation)

*Rm3000 (Total Depreciation) = RM2000 (Accumulate Depreciation) + RM1000 ( Depreciation Current Year)



If the depreciation expense is the same for each year, it is called straight line depreciation method. However, there are some assets are difference which using different types of appreciation method. For example, car.

The value of car depreciates faster in the early years and then slows down in the latter years, so accelerated depreciation method is more appropriate.   



As a result, depreciation value not only depends on how many years an asset can be used, but also concerns about how much the asset can be sold in the market (market value) for each year. If there is a difference between the value recorded in financial report (carrying amount) and the value that the asset can be sold (market value), written off will be occurred.



For example, let says in the beginning of Year 4, he want to sell off the burger stall. According to the record of the financial report above, the value of burger stall is RM7000. Moonitez go to meet a professional price evaluator.  The price evaluator says the burger stall only worth RM5000.



Now the burger stall record as RM5000 in balance sheet, which equals to RM10 000 (Historical Value)- RM3 000 (Total Depreciation)- Rm2000  (Write-off)



Expenses in income statement also increase by RM2000 for written off. 

 

1 comment:

  1. Very useful information for beginners.. thanks. =)

    ReplyDelete