Toronto Manufacturing commenced business on 1 January 2011. On that date it
bought machinery costing £200,000. The machinery is to be depreciated on the straight line method over 10 years with an estimated residual value of £24,400.
Operating profits after depreciation for its first three years were as follows:

Question

Year ended 31 December 2011 £160,000
Year ended 31 December 2012 £190,000
Year ended 31 December 2013 £230,000

(a) Explain what is meant by depreciation.

(b) Calculate the annual depreciation charged on the machinery in each of the three
years.

(c) If, instead of using the straight line method, they had used the diminishing balance
method (using a 19% per annum depreciation rate) to depreciate the
machinery over the same time period and to the same residual value, what operating
profit after depreciation would have been recorded for each of the three years?
Explain the results shown in your calculations.

Accepted Answer

(a) Depreciation is defined by International Accounting Standard 16: Property, Plant and
Equipment as ‘the systematic allocation of the depreciable amount of an asset over its
useful life’. The depreciable amount refers to the loss of value that the asset suffers due
to factors such as wear and tear, passage of time and obsolescence due to changes in
technology.

(b) Depreciation is charged under the straight line method:

Annual depreciation [latex]= \frac{Cost - Estimated residual value}{Estimated useful life} [/latex]

= (£200,000 - £24,400)/10 = £17,560 pa

(c) The depreciation charge for the first three years under the diminishing balance method
at 19% per annum will be:

Year ended 31 December 2011 £200,000 ×19% = £38,000
Year ended 31 December 2012 (£200,000 - £38,000) × 19% = £30,780
Year ended 31 December 2013 (£200,000 - [£38,000 + £30,780]) × 19% = £24,932

The effect on the operating profit is shown in the table below:

Year ended 31 December	Original profit after depreciation (straight line method)	Straight line depreciation (see (b) above)	Original profit before depreciation	Diminishing balance depreciation (see above)	Revised profit after depreciation if diminishing balance method had been used
2011	£160,000	£17,560	£177,560	£38,000	£139,560
2012	£190,000	£17,560	£207,560	£30,780	£176,780
2013	£230,000	£17,560	£247,560	£24,932	£222,628

If the diminishing balance method is used, high depreciation is charged in the early
years but this progressively reduces over the life of the asset. This has the effect of
a greater reduction in profit in the early years when compared to the straight line
method, but a lower charge in the later years. For example, depreciation under the
diminishing balance method in the eighth year of ownership of the machinery is only
£8,693 compared to the £17,560 under the straight line method.

Question 3.st.2: Toronto Manufacturing commenced business on 1 January 2011. ...

This Question has been Answered.

Already have an account?

Login

Related Answered Questions