Depreciation: An Overview

Depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life. This systematic allocation
helps in matching the cost of the asset with the revenue it generates, ensuring accurate financial reporting.
The International Accounting Standards (IAS) provide comprehensive guidelines on how depreciation should be handled in
financial statements.

Key Concepts of Depreciation

1. Depreciable Amount: The depreciable amount is the cost of an asset, or other amount substituted for cost, less
   its residual value. This amount is allocated over the asset's useful life.

2. Useful Life: The period over which an asset is expected to be available for use by an entity. It can also be the number
   of production or similar units expected to be obtained from the asset by the entity.

3. Residual Value: The estimated amount that an entity would currently obtain from the disposal of the asset, after deducting
   the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.

Methods of Depreciation

IAS 16 outlines several methods for calculating depreciation, each reflecting the pattern in which the asset's future economic
benefits are expected to be consumed by the entity:

• Straight-Line Method: This method allocates an equal amount of depreciation each year over the asset's useful life.
  It is calculated as:

• Diminishing Balance Method: This method applies a constant rate of depreciation to the reducing book value of
  the asset each year. It results in higher depreciation expenses in the earlier years of the asset's life and lower expenses
  as the asset ages.
• Units of Production Method: This method allocates depreciation based on the asset's usage, activity, or parts
  produced. It is suitable for assets whose wear and tear is more closely related to usage rather than the passage of time.

Depreciation in IAS 16

IAS 16, "Property, Plant and Equipment," provides the primary guidance on accounting for depreciation. According to IAS 16,
 depreciation should be charged to profit or loss unless it is included in the carrying amount of another asset.
Depreciation begins when the asset is available for use and continues until the asset is derecognised, even if it is idle

Key Points from IAS 16

1. Initial Recognition: Property, plant, and equipment should be initially measured at cost. This includes the purchase price,
   any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating
   in the manner intended by management, and the initial estimate of the costs of dismantling and removing the item and
   restoring the site on which it is located.

2. Subsequent Measurement: After initial recognition, an entity can choose either the cost model or the revaluation model
   for each class of property, plant, and equipment.

3. Depreciation Method: The depreciation method used should reflect the pattern in which the asset's future economic
    benefits are expected to be consumed by the entity. The method should be reviewed at least at each financial year-end,
   and if there has been a significant change in the expected pattern of consumption of the future economic benefits, the
   method should be changed to reflect the new pattern.

4. Impairment: If the carrying amount of an asset is greater than its recoverable amount, the asset is considered impaired,
   and its carrying amount should be reduced to its recoverable amount. This reduction is recognized as an impairment loss.

5. Derecognition: An asset should be derecognised on disposal or when no future economic benefits are expected from
   its use or disposal. The gain or loss arising from derecognition should be included in profit or loss when the item
   is derecognised.

For more detailed information, you can refer to the full text of IAS 16.

 Task 1. Calculate depreciation using the straight-line and Diminishing Balance methods

Given Data:

• Cost of production equipment: USD 579,800

• Liquidation value: 11% of the cost

• Useful life: 12 years

Straight-Line Method

The straight-line method of depreciation allocates an equal amount of depreciation each year over the useful life of the asset.

• Calculate the liquidation value:

• Calculate the depreciable amount:

• Calculate the annual depreciation expense:

Diminishing Balance Method

The diminishing balance method applies a constant rate of depreciation to the reducing book value of the asset each year.
This method results in higher depreciation expenses in the earlier years of the asset's life and lower expenses as the asset
ages.

• Calculate the depreciation rate: The depreciation rate for the diminishing balance method can be calculated using
  the formula:

• Calculate the annual depreciation expense for each year: The depreciation expense for each year is calculated
  by applying the depreciation rate to the book value at the beginning of the year.

This process continues for each year until the end of the useful life.

Summary

• Annual Depreciation (Straight-Line Method): USD 43,001.83

• Annual Depreciation (Diminishing Balance Method): Varies each year, starting with approximately USD 97.406.4
  in the first year and decreasing each subsequent year.

Task 2. Production method of depreciation

Given Data:

• Initial cost of the fixed asset: 30,000 USD

• Total volume of products expected to be produced: 90,000 units

• Volume of products manufactured in the reporting period: 2,500 units

• Liquidation value: 3,000 USD

Production Method of Depreciation

The production method of depreciation calculates depreciation based on the actual usage or production of the asset.
The formula for calculating depreciation using this method is:

Summary

• Depreciation Expense for the Reporting Period: 750 USD

This method ensures that the depreciation expense is directly related to the usage or production level of the asset,
providing a more accurate reflection of the asset's wear and tear.