1.  Understand WHAT is depreciation & REASONS for depreciation:

Depreciation is the permanent and continuing diminution in the quality, quantity or value of an asset.

Simply, depreciation is the loss of value due to fixed assets being consumed in order to earn a profit.

Therefore depreciation figure is merely the DIFFERENCE BETWEEN COST & BOOK VALUE of assets during the financial year.

For example, when we buy fixed asset like factory machinery, this is merely an advance payment of which we expect that this fixed asset is able to enhance or earn certain earnings for the business.

Over a period of time, the fixed asset we buy will become valueless or unable to generate the necessary earnings. To reflect this continuing diminution in the value of the factory machinery, we need to apply depreciation accounting.

REASONS for depreciation

Wear and tear, obsolescence, fall in market price, effluxion of time, physical factors, inadequacy or superfluous

2.  Learn The Three(3) Major Method Of Depreciation:

Straight line method

Reducing/Diminishing Balance method

Units of Production/Expected units

3. Remember double entry for depreciation of fixed assets:

Debit : Profit or Loss Account

Credit Provision for Depreciation Account

Notes:

Depreciation of assets is treated as expenses, therefore it should be disclosed in the debit side of the Profit & loss account.

In the Balance sheet, remember to present the Cost of Fixed Assets ( in categories like motor vehicles, plant and machinery, furniture & fitting, etc ) less Provision for depreciation ( accumulated depreciation ) which is equal the book value of the fixed assets.

4. Learn to deal with Disposal Of Fixed Asset

Main objective when an asset is disposed off or sold is to determine the GAIN/(LOSS) from the sale. Following steps:

(a) when an asset is disposed off, transfer it to a Disposal account namely Debit Disposal account and credit assets account (based on the original purchase price.

(b) next, transfer the total ACCUMULATED depreciation of the asset from purchase date to disposal date to Disposal account by

Debit: Provision for Depreciation on Fixed Asset a/c and Credit: Disposal account.

© when cash/cheque is received,

Debit bank/cash account and Credit: Disposal account ( based on disposal price or selling price)

(d) finally balance the disposal account to find the gain/loss from the sale of the asset.

For gains/profit Debit: Disposal Account and Credit Profit & Loss Account.

For Loss: Debit Profit & Loss Account and Credit Disposal Account

Notes on Gain or Loss in the Disposal of Fixed Assets:

When there is a profit on disposal of assets, it is treated as an income of the business. Therefore, it will appear on the CREDIT side of the Profit & Loss account.

When there is a loss on disposal of assets, it is treated as an expense of the business. Therefore it will appear on the DEBIT side of the Profit & Loss account.

[ Pl read my detailed articles in the Depreciation & Provision Category)