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
A company pays its insurance for next year in advance. How is the payment recorded at the year end?
- AAs revenue
- BAs a liability
- CAs an expense of the current year in full
- DAs a prepaid expense (asset)
2.Financial accountingHard
A company borrows at 5% interest to invest in assets that earn 12%. What is the likely effect on return on equity?
- AROE falls, because interest is an expense
- BROE rises, but financial risk also increases
- CROE stays the same, because debt is not equity
- DROE rises and financial risk falls
3.DepreciationMedium
A production line costs €12 000, has a useful life of 6 years and a salvage value of €2 500. Using the double-declining-balance method (without switching to straight-line), find the depreciation charge D in year 3.
cost = €12 000life = 6salvage = €2 500year = 3
D = €
4.DepreciationHard
A computer system costs €20 000, has a useful life of 8 years and a salvage value of €0. Using the sum-of-the-years’-digits method, find the depreciation charge D in year 4.
cost = €20 000life = 8salvage = €0year = 4
D = €
3Solutions
1.Financial accounting
Answer: D · As a prepaid expense (asset)
Why this is the answer
The unused part of the payment is an asset (prepayment) and becomes an expense in the period it covers.
Answer
D · As a prepaid expense (asset)
2.Financial accounting
Answer: B · ROE rises, but financial risk also increases
Why this is the answer
Positive financial leverage: assets earn more than the debt costs, so profit per euro of equity rises. If returns drop below 5%, leverage works against shareholders.
Answer
B · ROE rises, but financial risk also increases
3.Depreciation
Answer: D = 1778 €
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
2/6 = 0.3333
Year by year
year 1: 0.3333·12 000.00 = €4 000.00
year 2: 0.3333·8 000.00 = €2 666.67
year 3: 0.3333·5 333.33 = €1 777.78
Answer
D = €1 777.78
4.Depreciation
Answer: D = 2778 €
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
(8 − 4 + 1)/36 = 5/36
Depreciation
D = 20 000·5/36 = €2 777.78
Answer
D = €2 777.78
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