IAS 4, also known as International Accounting Standard 4, provides guidance on accounting for depreciation. Depreciation is the systematic allocation of the cost of a non-current asset over its useful life. Depreciation is important because it helps to reflect the decrease in value of an asset over time in a company’s financial statements. Here are some examples of how depreciation accounting works:
Straight-line method:
Suppose a company purchases a machine for $100,000, and it has an estimated useful life of 10 years. Using the straight-line method of depreciation, the annual depreciation expense would be calculated as follows:
Annual depreciation expense = (Cost of asset – Salvage value) / Useful life
Assuming a salvage value of $10,000, the annual depreciation expense would be:
($100,000 – $10,000) / 10 = $9,000
The annual depreciation expense would be recorded in the company’s income statement, and the accumulated depreciation would be recorded in the company’s balance sheet.
Accelerated method (Reducing balance method) (Net book value method):
Suppose a company purchases a car for $20,000, and it has an estimated useful life of 5 years. Using the accelerated method of depreciation, the depreciation expense would be higher in the early years and lower in the later years. One common accelerated method is the double-declining balance method, which calculates the annual depreciation expense as follows:
Annual depreciation expense = (Cost of asset – Accumulated depreciation) x 2 / Useful life
Assuming a useful life of 5 years, the annual depreciation expense in the first year would be:
($20,000 – $0) x 2 / 5 = $8,000
In the second year, the remaining book value would be $12,000 ($20,000 cost – $8,000 first-year depreciation), and the annual depreciation expense would be:
($12,000 – $8,000) x 2 / 5 = $1,600
The annual depreciation expense would be recorded in the company’s income statement, and the accumulated depreciation would be recorded in the company’s balance sheet.
In conclusion, depreciation accounting is an important aspect of financial reporting, and it requires companies to allocate the cost of non-current assets over their useful life in a systematic and consistent manner. The choice of depreciation method depends on various factors, such as the asset’s useful life, residual value, and tax considerations. Companies need to disclose their depreciation policies in their financial statements to provide transparency and consistency to users of financial statements.