Straight line depreciation is a simple and straightforward calculation. It gives a higher level of profit to the business in the first years of the life of the machine and is particularly useful when the business is expecting constant returns over the life of the asset. This is shown in Figure l.
2. The declining balance method of depreciation reduces the book value of the asset by a fixed percentage calculated to apportion the value of the machine after residual value has been subtracted from initial cost over the expected life of the machine. This means that depreciation is highest in the early years of the life of the machine. The use of the declining balance method takes into account that as the machine grows older its running and maintenance costs are likely to increase and its earning power will decrease. As a machine gets older it is more susceptible to obsolescence and may be more difficult to sell. Figure 2 shows declining balance depreciation using the data from Figure 1.
2.Comprehension check.
Read the text again more carefully. Choose the correct answer from a, b, c.
1. To become aware of an assets value means:
b) to see it
c) to buy it
d) to change it
2. Fixed assets are:
a) petrol and oil
b) machinery and vehicles
c) stock and debtors
3. During a life span an asset’s value:
a) does not change
b) decreases
c) increases
4. Some of value of fixed assets is necessary:
a) to charge each year
b) to write off in a year
c) to write off each year
5. Writing off some of value is:
a) a charge on the profit and loss account after tax is paid
b) a charge on the profit and loss account before tax is paid
c) a charge on the profit and loss account
6. Deprecation of fixed assets means:
a) to economize on tax and increase profit
b) to economize on tax and decrease profit
c) to understate taxes and increase profit
7. To depreciate the book value of an asset is:
a) to reduce the book value of an asset
b) to increase the book value of an asset
c) to control the book value of an asset
8. The book value does not reflect:
a) historical value of an asset
b) cost value of an asset
c) market value of an asset
9. How many methods of depreciation exist?
a) one
b) four
c) two
10. What method of depreciation does not exist?
a) the straight line method
b) the declining balance depreciation
c) the progressive balance depreciation
11. The straight line method of depreciating assets:
a) reduces the book value by the fixed amount for each year of its life
b) reduces the book value by the same amount for each year of its life
c) reduces the book value by the amount increasing each year
12. The declining balance method indicates that:
a) deprecation is lowest in the early years of the life of an asset
b) deprecation is highest in the early years of the life of an asset
c) deprecation is the same each year of the life of an asset
13. The use of the declining balance method takes into account that as an asset grows older:
a) its running and maintenance costs increase
b) its production and distribution costs increase
c) its running and maintenance costs increase
3.Read the text once again. Find words in the text that mean the opposite of the following.
a) to be of little value
b) to reject
c) purchase
d) to raise
e) stability
f) taken into account
g) hidden, concealed
h) saved, economized
i) increase in a book cost of fixed assets
j) loss
k) installation, setting up
l) historical, purchase value
m) partial
n) value, price
o) curve line
p) variable
q) added
r) final cost
s) grow younger
t) desolation, neglect
u) unprofitability
4.Solve the problem. An assets cost £20000. Its residual value is expected to be £2000 and its life span is six years. The business concerned uses the straight line method of depreciation. By how much will it reduce the book value of machine each year?
*Review[2]
1.A machine costs £30 000 and has a useful life of five years. At the end of that time it will have a residual value of £5000. The business decides to use the declining balance method of depreciation. The figures are as follows:
Year Depreciation provision Net book value
1. 9035 20965
2. 6314 14651
3. 4412 10239
4. 3084 7155
5. 2155 5000
a. What is meant by the terms:
І residual value?
ІІ depreciation?
ІІІ net book value?
b. From the data given and using the same axes draw graphs to show the effect on the book value of using:
i the straight line method of depreciation,
ii the declining balance method.
c. Give one reason why the business might have decided to use the declining balance method of depreciation.
d. State and explain three factors which influence the life of an asset.
2.The information given below is a summary of the transactions of a small business during its first year of trading.
£
€
Cash received
Cash paid
Proprietor's funds
For stock
Loan from bank
For rent of premises
Sales revenue
For fixtures & fittings
For rates
For administration
Owner's drawings
Heating & lighting
The following information is also available at the end of the accounting period:
· the business is owed £2000 by its customers.
· there is a stock of goods worth £5000.
· cash and bank balances total £1000.
· the business owes suppliers £4000.
· cost of lease £10 000.
a. Draw up the profit and loss account for the firm at the end of the first year of trading.
b. Draw up the balance sheet of the business at the end of the first year of trading,
c. What other information would you need in order to estimate the business’s chances of survival?
12 12
2 2
0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10