Accounting Adjustments

Accounting Accounting AdjustmentsAdjustments

The effect on net profit of changing method of depreciation

© Hodder Education 2008

Changing method of depreciationA business may wish to change the method used to calculate depreciation.

This is acceptable provided that they have a good reason for changing the method.


Changing method of depreciationFor example the method used may no longer be appropriate for the type of asset.

If they wish to do this they have to show how this change in method has affected the net profit of the business.


Changing method of depreciationQuestions will often provide the net profit using the original method of depreciation.

You will then be required to calculate the revised net profit using the new method.


ExampleGary Kent commenced business on 1 January 2005. The following net profits were reported for the first two years of business:

£2005 65,0002006 72,000

Fixed asset transactions during this period were:

Machinery£44,000 bought on 1 January 2005£60,000 bought on 1 July 2006There were no disposals

Depreciation policy in 2005 and 2006 was:15% on cost straight line method, with rates being applied for eachproportion of the year the asset is owned.

Early in 2007 consideration was given to changing to the reducingbalance method of depreciation on machinery. A rate of 20% would beapplied, with the rate being charged for each proportion of the yearthe machinery is owned.


Requireda) Calculate the depreciation for machinery in 2005

and 2006, using the original method and rate selected by Gary Kent.

b) Calculate the depreciation for machinery in 2005 and 2006, using the alternative method of depreciation.

c) Prepare a statement to show the net profit which would have been reported in 2005 and 2006 if the reducing balance method had been used.


First calculate the depreciation using the original method:2005Machinery cost £44,000 on 1 January 2005

Depreciation 15% straight line method

Depreciation = £44,000 x 15% = £6,600


2006Machine 1 £44,000 x 15% = £6,600

Machine 2 £60,000 x 15% x 6/12 = £4,500

Total depreciation = £6,600 + £4,500 = £11,100


Next calculate the depreciation using the new method:2005Machinery cost £44,000 on 1 January 2005

Depreciation 20% reducing balance method

Depreciation = £44,000 x 20%

= £8,800


2006Machine 1 Net book value of machinery £44,000 – £8,800 = £35,200 Depreciation = £35,200 x 20%

= £7,040Machine 2 £60,000 x 20% x 6/12 = £6,000

Total depreciation = £7,040 + £6,000 = £13,040


Add back the depreciation using the original method.

Deduct the depreciation using the new method.

We have now calculated the net profit using the new method of depreciation.

Method


2005 £

Original net profit 65,000Add back old method 6,600

71,600Deduct new method 8,800Revised net profit 62,800


2006 £

Original net profit 72,000Add back old method 11,100

83,100Deduct new method 13,040Revised net profit 70,060


Summary Calculate depreciation using the original method.

Calculate depreciation using the new method.

Add back the depreciation using the old method to the net profit, deduct the depreciation using the new method.

We have now calculated the revised net profit.


TipsAlways show your workings.


TasksComplete the task sheet.

Accounting Adjustments

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