UNIT CODE: MAF5101 UNIT TITLE: FINANCIAL

ACCOUNTING

Briefly describe any five methods of proving for depreciation.

1. Straight Line Method

Under this method, a fixed percentage of original cost is written off the asset every year.

The amount to be written off every year is arrived at as under:

= (Cost – Estimated Scrap Value) / Estimated Life

2. Written Down Value Method

Under this method, the rate or percentage of depreciation is fixed, but it applies to the value at
which the asset stands in the books in the beginning of the year. In other words, under this
method, a fixed percentage is written off every year on the reduced balance of the asset. Thus,
the percentage of depreciation is not applied to the original cost but only to the balance, which
remains after charging depreciation in the beginning of a year. The percentage of depreciation
remains fixed for all the years of the working life of an asset but the actual amount of
depreciation written off every year goes on decreasing with the reduction in the value of the
asset.

3. Sum of the Digits Method

Under this method, amount of the depreciation to be written off each year is calculated by the
following formula:

= Remaining Life of the Asset (including the Current Year) / Sum of all the Digits of the Life of
the Asset in Years x Cost of the Asset

4. Revaluation Method

This method is used only in case of small items like cattle (Livestock), or loose tools where it
may be too much to maintain an account of each single item. The amount of depreciation to be
written off is determined by comparing the value at the end of the year (valuation being done by
someone having expert knowledge of the valuation of the asset) with the value in the beginning.

5. Machine Hour Rate Method

This is more or less like the depreciation method. Instead of the usual method of estimating the
life of a machine in years, it is estimated in hours. Then, an accurate record is kept recording the
number of hours each machine is run and depreciation is calculated accordingly.

Briefly explain why provide for deprecation.

 To ascertain the net earnings/profit for an accounting period, depreciation need to be

computed. Depreciation normally constitutes a major part of the expenses of the business.
As the business buys fixed assets, it expects the fixed assets over the useful lives are able
to generate the necessary revenues for its business. Whilst revenues being earned and if
there is no allocation of depreciation cost to match these revenue, income will then be
overstated. Depreciation therefore follows very closely to the matching concept;

 The fixed assets in the Balance Sheet will be overstated if depreciation is not provided
for. Only that part of the costs of fixed assets that have not expired should be reflected in
the Balance sheet otherwise the financial statement will not reflect a true and fair view;

 If depreciation is not provided for and assuming if the whole profits were withdrawn
during the life of the asset, additional capital would have to be raised when it is time to
replace the fixed assets. By charging depreciation against profits, the ultimate residual
profit available for distribution is lowered and that funds are retained in the
business for future replacement.