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Home Depreciation, Provisions and Reserves Methods of Recording Depreciation
 
 

Methods of Recording Depreciation:

Two methods are normally used to record the depreciation in the books. These are:
  1. Depreciation account - no provision for depreciation account is maintained
  2. Accumulated depreciation account - provision for depreciation account is maintained

These methods have been explained below:

Depreciation Account - No Provision for Depreciation Account is Maintained:

Under this method, depreciation account is debited and asset account is credited with the amount of annual depreciation.

Example:

Suppose, the cost of a machine is $1,000 and its depreciation is 10% p.a. The entries to record the depreciation will be:

Journal Entries

Depreciation a/c Dr. 100  
     Machinery a/c     100
(Being depreciation charged on machinery @10% p.a.)      

     
Profit and loss a/c Dr. 100  
     Depreciation a/c     100
(Being transfer of depreciation)      

The depreciation will be shown in the profit and loss account as follows:

Profit and Loss A/C
For the year ended .......

Other Expenses

XXX Gross profit XXX
Depreciation XXX    
       
       
       
       
       

The asset will be shown in the balance sheet as follows:

Balance Sheet
as at........

Assets   $ Liabilities $
Machinery 1,000      
Less Depreciation 100 900    
 
     
         
         
         

This method of recording depreciation has now fallen into disuse. It has the effect of reducing the balance shown in the ledger for the fixed asset so that over time, it may be very much less than the original cost. This makes it difficult to identify the original cost of fixed assets and means that, the only information that can be given is the value to which each fixed asset has been written down. Anyone looking at this information will have no way of assessing whether a fixed asset was originally very expensive (which may be relevant, for example, if it is a building) and so cannot arrive at a realistic view of what the fixed assets really comprise. Nor, especially in the case of smaller business, is it immediately obvious how long a fixed asset is likely to continue to be used or, in fact, whether there is actually an asset in current use - if the value has been written down to zero, it wouldn't have a balance, may have been written out of the ledger, and certainly wouldn't be included in the balance sheet.

Accumulated Depreciation Account - Provision for Depreciation Account is Maintained:

This method involves maintaining each fixed asset at its cost in the ledger account while operating another ledger account where the depreciation to date is recorded. This account is known as accumulated provision for depreciation account, often shortened to the accumulated depreciation account (or sometimes, confusingly, known as the provision for depreciation account).

Let's look at how this method of recording depreciation is applied by first looking at the double entry required and then looking at it being used in the example.

The depreciation is posted directly into the cumulative provision for depreciation account. The double entry to record the depreciation is as follows:

Debit the profit and loss a/c
     Credit the accumulated depreciation a/c

Example:

In a business with financial years ended 31 December a machine is bought for $2,000 on 1 January 2005. It is to be depreciated at the rate of 20 per cent. using the reducing balance method. The records for the first three years are:

Machinery

2005   $     $
Jan. 1 Cash 2,000      
           
           
           
           
           

Accumulated Provision for Depreciation - Machinery

2005   $ 2005   $
Dec. 31 Balance c/d 400 Dec. 31 Profit and loss a/c 400
   
   
2006     2006    
Dec. 31 Balance c/d 720 Jan. 1 Balance b/d 400
      Dec. 31 Profit and loss a/c 320
   
   
    720     720
   
   
2007     2007    
Dec. 31 Balance c/d 976 Jan. 1 Balance b/d 720
      Dec. 31 Profit and loss a/c 320
   
   
    976     976
   
   
      2008    
      Jan. 1 Balance b/d 976
           
           

 

Profit and Loss Account (extracts) for the year ended 31 December
2005 Depreciation 400
2006 Depreciation 320
2007 Depreciation 256

Now the balance on the machinery account is shown on the balance sheet at the end of each year less the balance on the cumulative provision for depreciation account.

Balance Sheet (extracts)
  $ $

As at 31 December 2005

   
Machinery at cost 2,000  
Less accumulated depreciation (400) 1,600
 
 

As at 31 December 2005

   
Machinery at cost 2,000  
Less accumulated depreciation (720) 1,280
 
 

As at 31 December 2005

   
Machinery at cost 2,000  
Less accumulated depreciation (976) 1,024
 
 
 

More study material from this topic:

Definition, explanation and causes of depreciation
Depreciation is not a matter of valuation but a means of cost allocation
Activity method of depreciation
Straight line method of depreciation
Sum of the years' digits method of depreciation
Reducing balance method
Annuity method
Depreciation fund method or sinking fund method
Insurance policy method
Revaluation method
Depletion method
Machine hour rate, mileage, and global method
Methods of recording depreciation
Reserves
Difference between general reserve and specific reserve
Difference between capital reserve and general reserve
Difference between reserve and reserve fund
Difference between provision and reserve

 

A D V E R T I S E M E N T

 

Financial Accounting Topics


  Introduction to Accounting
 ----------------------------------------------------------------------------
  Transactions and Accounting Equation
----------------------------------------------------------------------------
  Analysis of Business Transactions
----------------------------------------------------------------------------
  Journal, Ledger and Trial Balance
----------------------------------------------------------------------------
  Accounting for Bills of Exchange
----------------------------------------------------------------------------
  Special Journals
----------------------------------------------------------------------------
  Cash Book
----------------------------------------------------------------------------
Bank Reconciliation Statement
----------------------------------------------------------------------------
  Final Accounts
----------------------------------------------------------------------------
  Work Sheet
----------------------------------------------------------------------------
  Capital and Revenue Items
----------------------------------------------------------------------------
  Valuation of Inventories
----------------------------------------------------------------------------
  Accounts of Non-profit Making Organizations
----------------------------------------------------------------------------
  Statement of Cash Flows
----------------------------------------------------------------------------
  Accounting Ratios Analysis
----------------------------------------------------------------------------
  Depreciation, Provisions and Reserves
----------------------------------------------------------------------------
  Accounting Dictionary
----------------------------------------------------------------------------
  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
----------------------------------------------------------------------------
  Cost Volume Profit Relationship
----------------------------------------------------------------------------
  Variable Costing System
----------------------------------------------------------------------------
  Materials and Inventory Cost Control
----------------------------------------------------------------------------
  Activity Based Costing System
----------------------------------------------------------------------------
  Standard Costing and Variance Analysis
----------------------------------------------------------------------------
  Balanced Scorecard
----------------------------------------------------------------------------
  Capital Investment Analysis/Capital Budgeting
 

 

 

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