METHODS OF PROVIDING FOR DEPRECIATION

1.0 INTRODUCTION

There are capital expenditures that are incurred for the purpose of generating revenue in the future and, since the benefit will accrue to more than one accounting period, it is usual to spread the cost over the expected years when such expenditures are expected to bring benefit. The process of spreading the cost is referred to as depreciation, which shall be the focus of our discussion in this Unit. A number of methods of providing for depreciation would be discussed, giving illustrative examples.

2.0 OBJECTIVES

1. At the end of this unit, you should be able to: 
2. define Depreciation 
3. appreciate various methods of providing for depreciation 
4. understand how to compute depreciation on an asset acquired during the year 
5. maintain accounting records for depreciation. 

3.0 MAIN CONTENT

3.1 Depreciation Methods

3.2 Definition of Depreciation

Depreciation may be defined as the permanent and continuing diminution in the quality, quantity or value of a fixed asset. Depreciation is therefore the proportion of the cost of an asset that is deducted from revenue for assets services used in the operation of a business. Depreciation is simply about decrease in the value of a fixed asset, as a result of wear and tear, passage of time, heat of sun, etc. However, there are other terms used in defining depreciation. These terms are “depletion” and “amortization’. Depletion refers to the depreciation of an available but irreplaceable resource such as extraction of coal from coal mine or oil out of an oil well. Amortization, on the other hand, refers to the writing off of an obligation like loan.

The basic differences between depreciation and these other concepts is that depreciation is used to refer to the process of charging the cost of man- made fixed assets to operations whereas depletion refers to the cost allocations of natural resources such as oil and mineral deposits while amortization relates to cost allocation for intangible assets such as patents and copyrights.

SELF ASSESSMENT EXERCISE 1

1.  What do you understand by the concept of depreciation? 
2. Discuss any two other concepts related to depreciation. 

3.3 Methods of Computing Depreciation

There are numerous methods of computing depreciation, broadly grouped into the following:

1.  Uniform charge methods: 
2.  Fixed installments method; 
3. Depletion method; 
4.  Machine hour rate method. 

2. Declining charge methods:

1.  Diminishing balance method; 
2.  Sum of the years’ digit method; 
3. Double declining method. 

3. Other Methods:

1. Group depreciation method; 
2.  Inventory or revaluation method; 
3.  Annuity method; 
4. Sinking fund method; and 
5. Insurance policy method. 

For the purpose of this course, we shall restrict our discussion to the fixed installment, diminishing balance method, sum of the years’ digit and inventory methods.

4.0 CONCLUSION

This Unit is basically about the popular methods of computing depreciation that were emphasized on in the Statement of Accounting Standard (SAS) 9 issued by the Nigerian Accounting Standard Board (NASB). Illustrative examples were provided to make students
understand how the methods are used in computing depreciation to be charged to the profit and loss account.

5.0 SUMMARY

In this Unit, we have defined depreciation and discussed methods of providing for depreciation. Alternative ways of charging depreciation on newly acquired assets were highlighted. All the major SAS 9 methods of providing for depreciation were discussed and exemplified for the clear understanding of the students.