Accounting Business Reporting for Decision Making

CHAPTER 6 Statement of profit or loss and statement of changes in equity 225

The diminishing balance depreciation method assumes that the economic benefits of using the asset

will decrease over its useful life. Consequently, depreciation expense is higher in the asset’s earlier

years relative to later years. Diminishing balance is calculated by applying a constant percentage to

the asset’s carrying amount at the start of each reporting period. Assume the asset is depreciated using

a 50 per cent diminishing balance depreciation method. The depreciation expense for each of the next

three years would be $15 000 in year 1 (50 per cent of $30 000), $7500 in year 2 (50 per cent of ($30 000

− $15 000)), and $3750 in year 3 (50 per cent of ($30 000 − ($15 000 + $7500)). Employing dimin-

ishing balance depreciation, the annual depreciation is higher in earlier years relative to later years.

The asset’s carrying value at the end of the third year is $3750, being its cost price of $30 000 less the

accumulated depreciation of $26 250.

The units of production depreciation method charges depreciation expense based on the activity or

output in the reporting period relative to the asset’s total expected activity or output. Units of production

depreciation is calculated using the equation below.

Depreciation expense (for the period)=

(Cost of asset − Expected residual value)

×Units in the period

Total estimated units

Suppose that the asset used in this illustration is a machine with a useful life of 100 000 units of pro-

duction. The depreciation charge each year would be a function of the yearly units produced. Assume

the machine produces 50 000, 30 000 and 20 000 units in years one to three respectively. Using the units

of production method, the depreciation expense in the statements of profit or loss for the next three

reporting periods would be $13 500 in year 1 calculated as ([$30 000 − $3000]/100 000) × 50 000 units;

$8100 in year 2 calculated as ([$30 000 − $3000]/100 000) × 30 000 units; and $5400 in year three cal-

culated as ([$30 000 − $3000]/100 000) × 20 000 units. The asset’s carrying value at the end of the third

year is $3000, being its cost price of $30 000 less the accumulated depreciation of $27 000 in years 1,

2 and 3.

Table 6.2 presents a comparison of annual and total depreciation expense of the three methods. Given

that the depreciation expense differs according to the depreciation method employed, the estimated

useful life and estimated residual value, the reported profit or loss in a particular reporting period will

vary according to these selections and estimations as will the carrying value of the assets subject to

depreciation.

TABLE  6.2 Comparison of depreciation methods

Year

1 2 3

Straight-line

Asset carrying value at start of year

Annual depreciation expense

30 000

9 000

21 000

9 000

12 000

9 000 27 000

Asset carrying value at end of year 21 000 12 000 3 000

Diminishing balance

Asset carrying value at start of year

Annual depreciation expense

30 000

15 000

15 000

7 500

7 500

3 750 26 250

Asset carrying value at end of year 15 000 7 500 3 750

Units of production

Asset carrying value at start of year

Annual depreciation expense

30 000

13 500

16 500

8 100

8 400

5 400 27 000

Asset carrying value at end of year 16 500 8 400 3 000