CSEET · Fundamentals of Accounting

Depreciation and Amortization: formula sheet

Full chapter guide

Key formulas

Definition (AS 10): Depreciation = systematic allocation of the depreciable amount of an asset over its useful life; Quote this wording in written answers. It is the standard's own definition.
Depreciable amount: Depreciable amount = Cost of asset − Residual value; Residual value is the expected amount on disposal at the end of useful life.
Carrying amount: Carrying amount = Cost − Accumulated depreciation; Also called book value or written down value in the books.
Journal entry for depreciation: Depreciation A/c Dr. ; To Asset A/c (or Provision for Depreciation A/c); At year-end, Depreciation A/c is closed to Profit and Loss Account.
Depreciable amount: Depreciable amount = Cost − Residual value; Residual value is net of estimated disposal costs. Land is not depreciated.
Straight-line depreciation per year: Annual depreciation = (Cost − Residual value) ÷ Useful life in years; Gives a constant charge as long as the residual value does not change.
Review rule (para 53): Review residual value and useful life at least at each financial year-end; If expectations differ from earlier estimates, the change is a change in accounting estimate under AS 5.
Method rule (paras 63 and 64): Choose the method that reflects the pattern of consumption of benefits; apply it consistently; Review the method at each year-end. If the expected pattern of consumption has significantly changed, change the method; this is a change in accounting estimate under AS 5 (para 63). Para 64 also allows the method to be changed in accordance with the statute. The text does not call that statutory change an estimate change.
Residual value at or above carrying amount (para 56): If residual value ≥ carrying amount, depreciation = 0; Depreciation resumes only if the residual value later falls below the carrying amount.
Annual depreciation: Depreciation per year = (Cost − Scrap value) ÷ Useful life in years; Cost includes purchase price plus installation and other costs needed to bring the asset into use.
Rate of depreciation: Rate % = (Annual depreciation ÷ Original cost) × 100; Use this when the question gives the rate and you need the amount, or the reverse.
Depreciation with rate given: Depreciation = Original cost × Rate % × Period in years; Rate is applied on original cost every year. For part of a year, multiply by months ÷ 12.
Book value: Book value = Cost − Accumulated depreciation; Also called written down value at that date.
Depreciation entry: Depreciation A/c Dr. ; To Asset A/c (or To Provision for Depreciation A/c); Then: Profit and Loss A/c Dr. ; To Depreciation A/c.
Depreciation for a full year: Depreciation = Opening book value × Rate % ÷ 100; Opening book value, not original cost, is the base from the second year onwards.
Book value at year-end: Closing book value = Opening book value − Depreciation; This closing figure becomes next year's opening figure.
Part-year depreciation: Depreciation = Book value × Rate % ÷ 100 × Months used ÷ 12; Used in the year of purchase (or sale) when the asset is held for only some months.
Book value after n years (full years): Book value = Cost × (1 − Rate)ⁿ; Rate is written as a decimal, e.g. 20% = 0.20. Handy for checking your answer.
Cost of the asset: Cost = Purchase price + Freight + Installation and other costs needed to bring it to use; Inauguration, advertising, staff training and general overheads are not part of the cost (AS 10, para 20).
Machine hour rate: Rate per hour = (Cost − Residual value) ÷ Estimated total working hours Yearly depreciation = Rate per hour × Hours worked in the year; Use the hours actually worked in each year. Depreciation can be zero if the machine did not run.
Depletion: Depletion per unit = (Cost − Residual value) ÷ Estimated total quantity Yearly depletion = Rate per unit × Units extracted; Used for mines, quarries and oil wells. Cost includes the amount paid for the right to extract.
Sum of years digits: Sum of digits = n(n + 1) ÷ 2, where n is the life in years Depreciation for a year = (Years of life remaining at start of that year ÷ Sum of digits) × (Cost − Residual value); Year 1 uses n, year 2 uses n − 1, and so on. The fractions add up to 1.
Annuity method: Interest for the year = Rate × Opening book value of the asset Depreciation for the year = Annual annuity − Interest; The annual annuity is read from an annuity table or given in the question. Interest falls each year, so depreciation rises.
Sinking fund method: Yearly instalment = Amount needed for replacement ÷ Accumulation factor Fund balance = Instalments + Interest earned on fund investments; The accumulation factor comes from a table and is given in the question. The asset stays at cost.
Insurance policy method: Yearly charge = Annual premium paid Gain or loss on closing = Policy surrender or maturity value − Policy account balance; The premium is charged to the Profit and Loss Account each year. Any difference at the end is transferred to the asset replacement or profit side as the question directs.
Book value: Book value = Cost − Accumulated depreciation; Include depreciation up to the date of sale, not just up to the last year-end.
Profit or loss on sale: Profit/(Loss) = Sale price − Book value on date of sale; Positive means profit. Negative means loss.
Part-year depreciation (SLM): Depreciation = (Cost − Residual value) ÷ Life × (Months used ÷ 12); Use months held in the year, unless the question gives a different basis.
Part-year depreciation (WDV): Depreciation = Book value at start × Rate % × (Months used ÷ 12); For a new asset, the opening book value is its cost.
Asset Disposal Account balancing: Debit: Asset at cost + Profit on sale. Credit: Accumulated depreciation + Sale proceeds + Loss on sale; Only one of profit or loss appears. It is the balancing figure.
Change in estimate (AS 10, paragraphs 53 and 63): Review residual value, useful life and method at least at each year-end; A change is an accounting estimate change under AS 5.
Annual amortization (straight line): Annual amortization = (Cost − Residual value) ÷ Useful life in years; Residual value of intangibles is usually nil, so it becomes Cost ÷ Useful life.
Amortization for part of a year: Amortization = Annual amortization × Months used ÷ 12; Use this when the asset is bought or sold during the year.
Book value (carrying amount): Book value = Cost − Accumulated amortization; Shown in the Balance Sheet at the year-end.
Journal entry: Amortization A/c Dr. To Patents A/c (or To Accumulated Amortization A/c); Then transfer Amortization to the Profit and Loss Account.
Core rule on allocation: Depreciable amount is allocated systematically over the useful life (AS 10, para 52); Review useful life and residual value at least at each year-end (para 53).

Quick revision

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.
Depreciable amount = Cost − Residual value.
SLM: annual charge = (Cost − Residual value) ÷ Useful life; it stays constant if the residual value does not change.
WDV: charge = rate × opening book value; the charge falls each year.
Units of production: the charge is based on expected use or output.
A method based on revenue generated by using the asset is not appropriate under AS 10.
Choose the method that best reflects the expected pattern of consumption of benefits, and apply it consistently.
Review residual value, useful life and method at least at each financial year-end; changes are changes in accounting estimates under AS 5.
Depreciation starts when the asset is available for use; it does not stop just because the asset is idle.
Profit or loss on sale = Sale price − Book value at the date of sale.
Amortization is the same allocation idea, applied to intangible assets.
Show formula, substitution and answer in every sum to protect marks.

Common mistakes

Saying depreciation is the fall in market value of an asset. Fix: Write that depreciation is allocation of cost over useful life, as AS 10 defines it, not market valuation.
Treating depreciation as cash set aside to replace the asset. Fix: Remember depreciation is a non-cash expense. No cash leaves the business when you charge it.
Depreciating the full cost and ignoring residual value Fix: Always write depreciable amount = cost − residual value first.
Leaving out installation and freight from cost Fix: Add all costs needed to bring the asset to working condition. Keep repairs out.
Ignoring scrap value in the formula. Fix: Always write (Cost − Scrap value) first. If no scrap value is given, treat it as nil.
Charging depreciation on the reducing book value each year. Fix: In straight line, the base is always original cost, so the charge never changes.
Applying the rate to the original cost every year. Fix: From year two, always use the previous closing book value as the base. Depreciation should fall each year.
Forgetting the months fraction in the year of purchase. Fix: Check the purchase date first. If the asset was held for 9 months, multiply by 9 ÷ 12.
Using cost instead of cost less residual value as the base. Fix: Always write 'Depreciable amount = Cost − Residual value' as your first line.
In SYD, using the same fraction every year. Fix: Start with the full life as the numerator in year 1, then reduce it by one each year. Make sure the numerators run n, n − 1, ... 1.

Exam tips

Begin every theory answer with the AS 10 definition. It earns the first marks quickly.
In 'causes' questions, give each cause a one-line example. Examiners look for these.
In differentiation questions, make the asset type the first point of comparison.
Do not call depreciation a fund or a valuation. Both are common wrong ideas.
In numericals, compute depreciable amount before anything else and check for residual value.
Write the three factors (cost, residual value, useful life) by name in every theory answer. Examiners look for them.
In numerical questions, show the depreciable amount as a separate line. It earns method marks even if later arithmetic slips.
If the question says land and building were bought together, split them first.