Diploma in Islamic Banking and Finance Financial Accounting 1

Ahmad Hafiz Zainal Abidin

M Acc (UiTM), B Acc (Hons) UiTM, Dip. Ed (MPPP) Department of Accounting and Quantitative Kolej Profesional MARA Bandar Melaka

Nature of Depreciation
Capital Expenditures v/s Revenue Expenditures Definition and Causes of Depreciation

Methods of Depreciation
Straight Line Method Reducing Balance Method

Double Entries for Depreciation Adjustments to Financial Statements

Capital Expenditures
Acquiring non-current assets Expenditures that increase the value of the non-

current assets Costs are to be capitalized and depreciated annually

Revenue Expenditures
Expenses to run the business Costs are to be written-off in Income Statement

Definition
The reduction of non-current assets value due to

normal usage in business.

Causes of Depreciation
Physical Deterioration Economic Factors

Time Factors
Depletion

Straight Line Method

Reducing Balance Method

The economic benefits of the non-current assets are expected to be utilized equally throughout its useful life. A fixed rate / cost of depreciation are to be charged to income statement annually. The formula:
Acquisition Costs Estimated Salvage Value Estimated Economic Useful Life (years) or Fixed % x Costs of the Non-current assets

Illustration 1 Lisa Trader bought a motor van on 1 January 2012 at the following costs: Acquisition price RM120,000 Road tax and insurance (1st year) RM 2,500 PUSPAKOM inspection fee RM 1,300 Carriage inwards costs RM 6,200
The van is expected to used for 5 years before it could be traded-in at an estimated value of RM10,000 Tabulate the annual depreciation costs for five years (2012 2017)

Year End

Cost (RM)

Depreciation (RM) 24,000 24,000 24,000 24,000 24,000

Accumulated Depreciation (RM) 24,000 48,000 72,000 96,000 120,000

Net Realisable Value (RM) 106,000 82,000 58,000 34,000 10,000

31/12/2012 31/12/2013 31/12/2014 31/12/2015 31/12/2017

130,000 130,000 130,000 130,000 130,000

Annual Depreciation = RM24,000: Acquisition Costs Estimated Salvage Value Estimated Useful Life (120,000 + 2,500 + 1,300 + 6,200) 10,000 5 years

Illustration 2 Boboi Trading bought a machinery on 1 January 2012 at the following costs: Purchase price RM48,000 Installation of machine RM12,000 Annual salary of machine operator RM24,000
It is the policy of Boboi Trading to depreciate all machineries at 10% per annum on cost. Tabulate the depreciation costs chargeable to income statement during the first 3 years (2012 2014)

Year End

Cost (RM)

Depreciation (RM) 6,000 6,000 6,000

Accumulated Depreciation (RM) 6,000 12,000 18,000

Net Realizable Value (RM) 54,000 48,000 42,000

31 Dec 2012 31 Dec 2013 31 Dec 2014

60,000 60,000 60,000

Annual Depreciation = RM6,000 :

10% x Costs
= 10% x (RM48,000 + RM12,000)

Illustration 3 Zaharo Enterprise purchased a new bus on 1 January 2010 at RM500,000. It is the policy of the business to depreciate all buses at 20% annually on reducing balancing method.
Determine the net realizable value of the bus at the year end 31 December 2014.

Year End013

Cost (RM)

Depreciation (RM) 100,000

(20% x 500,000)

Accumulated Depreciation (RM) 100,000 180,000 244,000 295,200 336,160

Net Realizable Value (RM) 400,000 320,000 256,000 204,800 163,840

31 Dec 2010 31 Dec 2011 31 Dec 2012 31 Dec 2013 31 Dec 2014

500,000 500,000 500,000 500,000 500,000

80,000
(20% x 400,000)

64,000
(20% x 320,000)

51,200
(20% x 256,000)

40,960
(20% x 204,800)

Each time depreciation expenditures incur, there two effects in the accounting books:
The value (net realisable value) of an asset decreases
The cost / operating expense increases

Instead of crediting an asset account to show the decreases in value, a provision for depreciation account is created to undertake the effect:
Premises
2011

2011

Jan 1

Balance b/d

100,000

Dec 31 Depreciation
Dec 31 Balance c/d

10,000
90,000 100,000

100,000

Ct Provision for Premises Depreciation

2011
Jan 1 Balance b/d 100,000 Dt Depreciation 100,000

2011 Dec 31 Balance c/d

100,000 100,000

Provision for Depreciation - Premises 2011 Dec 31 Depreciation Depreciation - Premises 2011

10,000

Dec 31 Depreciation

10,000

Provision for depreciation is a kind of liability in accounting, thus it will be carried forward to next year, and be shown in the Premises Statement of Financial Position

2011
Jan 1 Balance b/d 100,000 100,000

2011 Dec 31 Balance c/d

100,000 100,000

Depreciation is an expense in nature, hence it will be included in Provision for Depreciation - Premises expenses part of an Income 2011 2011 Statement.

Dec 31 Balance c/d

10,000

Dec 31 Depreciation

10,000

10,000
Depreciation - Premises 2011 2011 Dec 31 Income Dec 31 Depreciation 10,000 Statement 10,000

10,000

10,000 10,000

The double entries for depreciation is:

Debit Depreciation / Income statement Credit Provision for Depreciation

Provision for depreciation account will be retained / carried forward to next year (as long as the asset is still in use in the business). All non-current assets are capitalized and retained in the accounting books at cost (Historical cost concept).

Since depreciation involves two effects in accounting (i.e. liabilities and expenses), the present of depreciation in preparing financial statements will affect both Income Statement and Statement of Financial Position:
Depreciation

As an additional expense in Income Statement

As an additional liabilities (to deducted from respective noncurrent asset