Depreciation
- Straight-line
- (cost − salvage)/life
- Double-declining balance
- 2/life × book value at the start of the year
- Sum of the years’ digits
- (cost − salvage) × remaining life/SYD
- SYD
- n(n + 1)/2
- Book value
- cost − accumulated depreciation
Financial Accounting: cram pack
Formula sheets, the key method steps for every topic and 4 practice problems, with full solutions at the back.
1Formulas and methods
2Practice problems
1.Financial accountingMedium
Which depreciation method charges the same amount every year?
- AUnits of production
- BStraight-line
- CReducing balance
- DSum-of-the-years'-digits
2.Financial accountingHard
A company's debt-to-equity ratio rises sharply. What does this usually indicate?
- AHigher financial risk because the company relies more on borrowed money
- BThat shareholders invested more money
- CHigher profitability
- DBetter liquidity in the short term
3.DepreciationMedium
A machine costs €30 000, has a useful life of 5 years and a salvage value of €0. Using the double-declining-balance method (without switching to straight-line), find the depreciation charge D in year 2.
cost = €30 000life = 5salvage = €0year = 2
D = €
4.DepreciationHard
A computer system costs €30 000, has a useful life of 6 years and a salvage value of €6 000. Using the sum-of-the-years’-digits method, find the depreciation charge D in year 4.
cost = €30 000life = 6salvage = €6 000year = 4
D = €
3Solutions
1.Financial accounting
Answer: B · Straight-line
Why this is the answer
Straight-line spreads the depreciable amount evenly. Reducing balance charges more in early years; units of production follows actual use.
Answer
B · Straight-line
2.Financial accounting
Answer: A · Higher financial risk because the company relies more on borrowed money
Why this is the answer
A higher ratio means more leverage: interest and repayments must be met whatever the results, so financial risk rises, although returns to shareholders may also rise.
Answer
A · Higher financial risk because the company relies more on borrowed money
3.Depreciation
Answer: D = 7200 €
Depreciation spreads the cost of an asset over its useful life. Straight-line: (cost − salvage value)/life every year. Double-declining balance: 2/life times the book value at the start of each year, so the charge falls each year (salvage is not subtracted, but the book value never goes below it). Sum-of-the-years’-digits: (cost − salvage) × remaining life/(1 + 2 + … + n).
Rate
2/5 = 0.4
Year by year
year 1: 0.4·30 000.00 = €12 000.00
year 2: 0.4·18 000.00 = €7 200.00
Answer
D = €7 200.00
4.Depreciation
Answer: D = 3429 €
Depreciation spreads the cost of an asset over its useful life. Straight-line: (cost − salvage value)/life every year. Double-declining balance: 2/life times the book value at the start of each year, so the charge falls each year (salvage is not subtracted, but the book value never goes below it). Sum-of-the-years’-digits: (cost − salvage) × remaining life/(1 + 2 + … + n).
Fraction for year 4
(6 − 4 + 1)/21 = 3/21
Depreciation
D = 24 000·3/21 = €3 428.57
Answer
D = €3 428.57
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