Double entry records for
Double entry records for
depreciation
Learning objectives
After you have studied this chapter, you should be able to: l incorporate depreciation calculations into the accounting records l record the entries relating to disposal of fixed assets l make depreciation entries using either a one-stage or a two-stage method of
recording depreciation
Introduction
Now that you know what depreciation is and how it may be calculated, in this chapter you’ll learn how to make the appropriate entries for depreciation in the accounting books. You’ll also learn how to make the appropriate period-end entries in the financial statements.
27.1 Recording depreciation
Previously, the charge for depreciation on a fixed asset was recorded in the account for that fixed asset. This method has now fallen into disuse.
Activity
27.1 Why do you think this is no longer done?
The method now used 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 the ‘accumulated provision for depreciation account’, often shortened to the accumulated depreciation account (or sometimes, confusingly, known as the ‘provision for depreciation account’).
Activity
27.2 Why do you think it would be confusing to call the accumulated provision for depreciation account 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 how it is used in the example shown in Exhibit 27.1.
Chapter 27 l Double entry records for depreciation The depreciation is posted directly into the cumulative provision for depreciation account.
The double entry is: Debit the profit and loss account
Credit the accumulated provision for depreciation account
Exhibit 27.1
A business has a financial year end of 31 December. A computer is bought for £2,000 on 1 January 20X5. 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:
Computer
20X5
Jan 1 Cash
Accumulated Provision for Depreciation – Computer
20X5
£ Dec 31 Balance c/d
20X5
Dec 31 Profit and loss 400 20X6
20X6
Dec 31 Balance c/d
Jan
1 Balance b/d 400 Dec 31 Profit and loss
Dec 31 Balance c/d
Jan
1 Balance b/d 720 Dec 31 Profit and loss
20X8 Jan
1 Balance b/d 976
Profit and Loss Account (extracts) for the year ended 31 December
£ 20X5 Depreciation
400 20X6 Depreciation
320 20X7 Depreciation
Note: In this case, the depreciation for the period being posted to the profit and loss account is being described as ‘depreciation’ and not by the name of the account it is being posted from. This clearly is not the convention usually adopted when posting entries between ledger accounts and is very much ‘the exception that proves the rule’.
Activity
27.3 What advantages are there in making this exception to the rule by using ’depreciation’ rather than ‘accumulated provision for depreciation’ in the profit
and loss account entry?
Now the balance on the Computer Account is shown on the balance sheet at the end of each year less the balance on the Cumulative Provision for Depreciation Account.
Part 4 l Adjustments for financial statements
Balance Sheets (extracts)
£ £ As at 31 December 20X5 Computer at cost
2,000 Less Accumulated depreciation
( 400) 1,600 As at 31 December 20X6 Computer at cost
2,000 Less Accumulated depreciation
( 720) 1,280 As at 31 December 20X7 Computer at cost
2,000 Less Accumulated depreciation
27.2 The disposal of a fixed asset Reason for accounting entries
Upon the sale of a fixed asset, we will want to remove it from our ledger accounts. This means that the cost of that asset needs to be taken out of the asset account. In addition, the accumu- lated depreciation on the asset which has been sold will have to be taken out of the accumulated provision. Finally, the profit and loss on sale, if any, will have to be calculated and posted to the profit and loss account.
When we charge depreciation on a fixed asset we are having to make an informed guess. We will not often guess correctly. This means that, when we dispose of an asset, the amount received for it is usually different from our estimate.
Activity
27.4 List as many things as you can think of in one minute that could cause the amount charged for depreciation to have been incorrect.
Accounting entries needed
On the sale of a fixed asset, in this example a computer, the following entries are needed:
(A) Transfer the cost price of the asset sold to an assets disposal account (in this case a computer disposals account):
Debit computer disposals account Credit computer account
(B) Transfer the depreciation already charged to the assets disposal account: Debit accumulated provision for depreciation: computer
Credit computer disposals account (C) For the amount received on disposal: Debit cash book
Credit computer disposals account
Chapter 27 l Double entry records for depreciation (D) Transfer the difference (i.e. the amount needed to balance the computer disposals account)
to the profit and loss account. (i) If the computer disposals account shows a credit balance (i.e. if more has been credited
to the account than has been debited to it), there is a profit on the sale: Debit computer disposals account
Credit profit and loss account (ii) If the computer disposals account shows a debit balance, there is a loss on sale: Debit profit and loss account
Credit computer disposals account These entries can be illustrated by looking at those needed if the computer already shown in
Exhibit 27.1 was sold on 2 January 20X8. At 31 December 20X7, the cost was £2,000 and
a total of £976 had been written off as depreciation leaving a net book value of £2,000 − £976 = £1,024. If the computer is sold in 20X8 for more than £1,024 a profit on sale will be made. If, on the other hand, the computer is sold for less than £1,024 then a loss will be incurred.
Exhibit 27.2 shows the entries needed when the computer has been sold for £1,070 and
a profit of £46 on sale has, therefore, been made. Exhibit 27.3 shows the entries where the com- puter has been sold for £950, thus incurring a loss on sale of £74. In both cases, the sale is on
2 January 20X8 and no depreciation is to be charged for the two days’ ownership in 20X8. (The letters in brackets refer to the accounting double entries, A–D, above.)
Exhibit 27.2 Fixed asset sold at a profit
Jan 2 Machinery disposals (A) 2,000
Accumulated Provision for Depreciation: Computer
2 Machinery disposals (B)
Jan 1 Balance b/d
Computer Disposals
Jan 2 Accumulated provision Dec 31 Profit and loss
46 for depreciation (B) 976
Jan 2 Cash
Profit and Loss Account for the year ended 31 December 20X8
£ Gross profit
xxx Add Profit on sale of computer
(D) 46
Part 4 l Adjustments for financial statements
Exhibit 27.3 Fixed asset sold at a loss
Computer
20X5
£ Jan 1 Cash
2 Computer disposals (A) 2,000
Accumulated Provision for Depreciation: Computer
20X8
£ Jan 2 Computer disposals (B)
1 Balance b/d 976
Computer Disposals
20X8
£ Jan 2 Computer
2 Accumulated provision for depreciation
(B) 976
Jan
(C) 950 Dec 31 Profit and loss
Profit and Loss Account for the year ended 31 December 20X8
£ Gross profit
xxx Less Loss on sale of computer
(D) (74)
In many cases, the disposal of an asset will mean that we have sold it. This will not always be the case. For example, a car may be given up in part exchange against the purchase of a new car. Here the disposal value is the exchange value. If a new car costing £10,000 was to be paid for by £6,000 in cash and an allowance of £4,000 for the old car, then the disposal value of the old car is £4,000.
Similarly a car may have been in an accident and now be worthless. If it was insured, the dis- posal value will be the amount received from the insurance company. If an asset is scrapped, the
disposal value is that received from the sale of the scrap, which may be nil.
27.3 Change of depreciation method
It is possible to make a change in the method of calculating depreciation. This should not be done frequently, and it should only be undertaken after a thorough review. Where a change is made, if material ( see Chapter 10 on materiality), the effect of doing so upon the figures reported should be shown as a note to the financial statements in the year of change.
Further examples
So far, the examples have deliberately been kept simple. Only one fixed asset has been shown in each case. Exhibits 27.4 and 27.5 give examples of more complicated cases.
Chapter 27 l Double entry records for depreciation
Exhibit 27.4
A machine is bought on 1 January 20X5 for £1,000 and another one on 1 October 20X6 for £1,200. The first machine is sold on 30 June 20X7 for £720. The business’s financial year ends on 31 December. The machinery is to be depreciated at 10 per cent, using the straight line method. Machinery in existence at the end of each year is to be depreciated for a full year. No depreciation is to be charged on any machinery disposed of during the year.
Dec 31 Balance c/d 1,000 20X6
Jan 1 Balance b/d
Dec 31 Balance c/d 2,200 Oct
Jan 1 Balance b/d
Jun 30 Machinery disposals 1,000 Dec 31 Balance c/d
Jan 1 Balance b/d
Accumulated Provision for Depreciation: Machinery
20X5
£ Dec 31 Balance c/d
20X5
Dec 31 Profit and loss 100 20X6
20X6
Dec 31 Balance c/d
Jan
1 Balance b/d 100 Dec 31 Profit and loss
Jun 30 Disposals of machinery
1 Balance b/d 320 (2 years × 10 per cent
Jan
Dec 31 Profit and loss 120 × £1,000)
Dec 31 Balance c /d
Jan 1 Balance b/d
Machinery Disposals
£ 20X7
20X7
£ Jun 30 Machinery
Jun 30 Cash
720 Jun 30 Accumulated provision for depreciation
200 Dec 31 Profit and loss
Profit and Loss Account (extracts) for the year ended 31 December
£ Gross profit
xxx Less Expenses: 20X5 Provision for depreciation: Machinery
(100) 20X6 Provision for depreciation: Machinery
(220) 20X7 Provision for depreciation: Machinery
(120) Loss on machinery sold
Part 4 l Adjustments for financial statements
Balance Sheet (extracts) as at 31 December
£ £ 20X5 Machinery at cost
1,000 Less Accumulated depreciation
( 100) 900 20X6 Machinery at cost
2,200 Less Accumulated depreciation
( 320) 1,880 20X7 Machinery at cost
1,200 Less Accumulated depreciation
Another example can now be given. This is somewhat more complicated. Firstly, it involves a greater number of items. Secondly, the depreciation provisions are calculated on a proportionate basis, i.e. one month’s depreciation for one month’s ownership.
Exhibit 27.5
A business with its financial year end being 31 December buys two vans on 1 January 20X1, No 1 for £8,000 and No 2 for £5,000. It also buys another van, No 3, on 1 July 20X3 for £9,000 and another, No 4, on 1 October 20X3 for £7,200. The first two vans are sold, No 1 for £2,290 on
30 September 20X4, and No 2 for scrap for £50 on 30 June 20X5. Depreciation is on the straight line basis, 20 per cent per annum, ignoring scrap value in this particular case when calculating depreciation per annum. Show the extracts from the assets account, provision for depreciation account, disposal account and profit and loss account for the years ended 31 December 20X1, 20X2, 20X3, 20X4, and 20X5, and the balance sheets as at those dates.
31 Balance c/d 13,000 20X2
20X3
Jan 1 Balance b/d
31 Balance c/d 13,000 20X3
Dec
Jan 1 Balance b/d
July 1 Cash
Oct 1 Cash
Dec
31 Balance c/d 29,200
Jan 1 Balance b/d
Sept 30 Disposals
Dec
31 Balance c/d 21,200
Jan 1 Balance b/d
June 30 Disposals
Dec
31 Balance c/d 16,200
21,200 20X6 Jan
1 Balance b/d
Chapter 27 l Double entry records for depreciation
Accumulated Provision for Depreciation: Vans
20X1
£ Dec 31 Balance c/d
20X1
Dec 31 Profit and loss 2,600 20X2
20X2 Jan
1 Balance b/d 2,600 Dec 31 Balance c/d
Dec 31 Profit and loss 2,600
5,200 20X3
20X3 Jan
1 Balance b/d 5,200 Dec 31 Balance c/d
Dec 31 Profit and loss 3,860
Sept 30 Disposals
1 Balance b/d 9,060 Dec 31 Balance c/d
Dec 31 Profit and loss 5,440
June 30 Disposals
1 Balance b/d 8,500 Dec 31 Balance c/d
Dec 31 Profit and loss 3,740
20X6 Jan
1 Balance b/d 7,740 Workings – depreciation provisions
£ £ 20X1 20% of £13,000
2,600 20X2 20% of £13,000
2,600 20X3 20% of £13,000 × 12 months
2,600 20% of £9,000 × 6 months
900 20% of £7,200 × 3 months
360 3,860 20X4 20% of £21,200 × 12 months
4,240 20% of £8,000 × 9 months
1,200 5,440 20X5 20% of £16,200 × 12 months
3,240 20% of £5,000 × 6 months
Workings – transfers of depreciation provisions to disposal accounts