Question 4.5: Tartantrips Ltd, a company in Scotland, operates several fer...
Tartantrips Ltd, a company in Scotland, operates several ferries and has a policy of holding several in reserve, due to the weather patterns and conditions of various contracts with local authorities. A ferry costs £5 million and has an estimated useful life of 10 years, at which time its realisable value is expected to be £1 million.
Calculate and discuss three methods of depreciation that the company may use:
(i) sum of the digits
(ii) straight line
(iii) reducing balance.
(i) Sum of the digits depreciation
The company needs to decide on the economic life of the asset (say 10 years in this example) and its estimated residual value at the end of its life (£1m in this example).
| Cost | £5,000,000 |
| Residual value | £\underline{1,000,000} |
| Amount to be written-off over 10 years | £\underline{4,000,000} |
| Over 10 years the digits 10 + 9 + 8 . . . 2 + 1 add up to 55 | |
| Depreciation in year 1 is 10/55 × £4,000,000 | = £727,272 |
| Depreciation in year 2 is 9/55 × £4,000,000 | = £654,545 |
| Depreciation in year 3 is 8/55 × £4,000,000
and so on until |
= £581,818 |
| Depreciation in year 9 is 2/55 × £4,000,000 | = £145,546 |
| Depreciation in year 10 is 1/55 × £4,000,000 | = £\underline{72,727} |
| Total depreciation for 10 years | £\underline{4,000,000} |
(ii) Straight line depreciation
This method is very simple to operate. The company needs to decide on the economic life of the asset and its residual value at the end of its life (as above). The annual depreciation will be:
Depreciation per year is £4,000,000 divided by 10 years = £400,000 per year
It can be seen that there is a constant charge to the annual profit and loss account for the systematic allocation of the depreciable amount of the non-current asset.
(iii) Reducing balance depreciation
This method is quite different to the straight line method because the depreciation charge is much higher in the earlier years of the life of the asset. The same sort of estimates are required: economic life, residual value, which are used in a reducing balance formula to calculate each year’s depreciation.
The reducing balance formula where d is the percentage depreciation to charge on the written down value of the asset at the end of each year is:
d=1-\sqrt[10]{1,000,000/5,000,000} =14.9% (which may also be calculated using the Excel DB function)
| Depreciation in year 1 is 14.9% of £5,000,000 | = £745,000 |
| Depreciation in year 2 is 14.9% of £4,255,000 | = £633,995 |
| Depreciation in year 3 is 14.9% of £3,621,005
and so on until year 10 |
= £539,530 ___ |
| The total depreciation for 10 years is | £\underline{4,000,000} |