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
Why can a profitable company run out of cash?
- ACash is not recorded in accounting
- BProfit always equals cash
- CProfitable companies never pay taxes
- DProfit includes credit sales and non-cash items, while cash may be tied up in receivables and inventory
2.Financial accountingHard
Closing inventory this year is overstated by €10,000 by mistake. What is the effect on profit, if not corrected?
- AProfit is unaffected; only the balance sheet changes
- BOnly this year's profit is understated
- CBoth years' profits are overstated
- DThis year's profit is overstated and next year's understated by €10,000
3.DepreciationMedium
A delivery van costs €20 000, has a useful life of 10 years and a salvage value of €3 000. Using the double-declining-balance method (without switching to straight-line), find the depreciation charge D in year 3.
cost = €20 000life = 10salvage = €3 000year = 3
D = €
4.DepreciationHard
A machine costs €45 000, has a useful life of 6 years and a salvage value of €0. Using the sum-of-the-years’-digits method, find the depreciation charge D in year 4.
cost = €45 000life = 6salvage = €0year = 4
D = €
3Solutions
1.Financial accounting
Answer: D · Profit includes credit sales and non-cash items, while cash may be tied up in receivables and inventory
Why this is the answer
Profit is measured on an accrual basis; growth can tie up cash in inventory and receivables, so cash flow can be negative despite profits.
Answer
D · Profit includes credit sales and non-cash items, while cash may be tied up in receivables and inventory
2.Financial accounting
Answer: D · This year's profit is overstated and next year's understated by €10,000
Why this is the answer
Higher closing inventory reduces cost of sales, raising this year's profit. Next year opening inventory is too high, increasing cost of sales and lowering profit by the same amount.
Answer
D · This year's profit is overstated and next year's understated by €10,000
3.Depreciation
Answer: D = 2560 €
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
2/10 = 0.2
Year by year
year 1: 0.2·20 000.00 = €4 000.00
year 2: 0.2·16 000.00 = €3 200.00
year 3: 0.2·12 800.00 = €2 560.00
Answer
D = €2 560.00
4.Depreciation
Answer: D = 6429 €
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 = 45 000·3/21 = €6 428.57
Answer
D = €6 428.57
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