Page 250 - DMGT104_FINANCIAL_ACCOUNTING

Financial Accounting

Notes 5. Assessment of depreciation and the amount to be charged in respect thereof in an accounting
period are usually based on the following three factors:
(i) Historical cost or other amount substituted for the historical cost of the depreciable
asset when the asset has been revalued;
(ii) Expected useful life of the depreciable asset; and
(iii) Estimated residual value of the depreciable asset.

6. Historical cost of a depreciable asset represents its money outlay or its equivalent in
connection with its acquisition, installation and commissioning as well as for additions to
or improvement thereof. The historical cost of a depreciable asset may undergo subsequent
changes arising as a result of increase or decrease in long-term liability on account of
exchange fluctuations, price adjustments, changes in duties or similar factors.
7. The useful life of a depreciable asset is shorter than its physical life and is:
(i) Predetermined by legal or contractual limits, such as the expiry dates of related
leases;
(ii) Directly governed by extraction or consumption;
(iii) Dependent on the extent of use and physical deterioration on account of wear and
tear which again depends on operational factors, such as, the number of shifts for
which the asset is to be used, repair and maintenance policy of the enterprise etc.;
and
(iv) Reduced by obsolescence arising from such factors as:
(a) Technological changes;
(b) Improvement in production methods;

(c) Change in market demand for the product or service output of the asset; or
(d) Legal or other restrictions.
8. Determination of the useful life of a depreciable asset is a matter of estimation and is
normally based on various factors including experience with similar types of assets. Such
estimation is more difficult for an asset using new technology or used in the production of
a new product or in the provision of a new service but is nevertheless required on some
reasonable basis.
9. Any addition or extension to an existing asset which is of a capital nature and which
becomes an integral part of the existing asset is depreciated over the remaining useful life
of that asset. As a practical measure, however, depreciation is sometimes provided on
such addition or extension at the rate which is applied to an existing asset. Any addition or
extension which retains a separate identity and is capable of being used after the existing
asset is disposed of, is depreciated independently on the basis of an estimate of its own
useful life.

10. Determination of residual value of an asset is normally a difficult matter. If such value is
considered as insignificant, it is normally regarded as nil. On the contrary, if the residual
value is likely to be significant, it is estimated at the time of acquisition/installation, or at
the time of subsequent revaluation of the asset. One of the bases for determining the
residual value would be the realisable value of similar assets which have reached the end
of their useful lives and have operated under conditions similar to those in which the asset
will be used.

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