If a fixed asset is purchased sometime after beginning of the year, depreciation charged for the first year should be proportionate to the time it is actually used in business during the year. For example, if an office machine is purchased on March 1, 2016, the depreciation to be provided at the end of the year 2016 should only be for 10 months.
On January 1,2016, XYZ company has the following balances in its ledger:
Motor vehicle, at cost: $38,000
Provision for depreciation on motor vehicle: $11,200
On April 1, 2016, the company purchases a new motor vehicle for $12,000. Motor vehicles are written down by 25% p.a. using reducing installment method.
Required: Calculate total depreciation on motor vehicle for the year 2016.
Step 1 – Compute depreciation on old motor vehicle:
The depreciation on the old motor vehicle would be computed for the full year because it has been used in the business for the full year.
Depreciation on old motor vehicle = Book value × 0.25
= $26,800* × 0.25
*We know that the depreciation under reducing installment method is calculated on the book value of the asset that is equal to cost of the motor vehicle less accumulated depreciation (i.e., $38,000 – $11,200 = $26,800). The accumulated depreciation on an asset is the balance of provision for depreciation account of that asset.
Step 2 – Compute depreciation on new motor vehicle:
The depreciation on the motor vehicle purchased on April 1, 2016 would be computed for 9 months because it has been used in the business for 9 months, not for the full year.
Depreciation on new motor vehicle = (Book value × 0.25) × 9/12
= (12,000* × 0.25) × 9/12
*The book value of the newly purchased motor vehicle is equal to its cost as there is no accumulated depreciation on it.
Step 3 – Compute total depreciation on motor vehicle for the year:
Total depreciation on motor vehicle = Depreciation on old motor vehicle + Depreciation on new motor vehicle
= $6700 + $2,250