Explain determinants of the amount of depreciation.
The determination of the amount of depreciation depends primarily on three parameters: cost, estimated useful life, and probable salvage value.
1. Cost of Asset: The cost, also known as the original or historical cost, includes the invoice price and all other costs necessary to put the asset in use or working condition. This comprises the purchase price, freight and transportation cost, transit insurance, installation cost, registration cost, and commission paid. In the case of a second-hand asset, it also includes the initial repair costs to make the asset workable.
2. Estimated Useful Life: This refers to the period over which the asset is expected to be used by the enterprise. Depreciable assets are defined as those expected to be used during more than one accounting period and have a limited useful life.
3. Probable Salvage Value: This is the estimated residual value of the asset at the end of its useful life.
Additionally, the method of charging depreciation (Straight Line or Written Down Value) affects the amount charged per year. The selection of this method depends on the type of asset, the nature of its use, and the circumstances prevailing in the business.
Explanation
The answer is derived directly from Section 7.5 'Factors Affecting the Amount of Depreciation' in the provided context. The context explicitly lists 'cost, estimated useful life and probable salvage value' as the three parameters. It provides detailed information on 'Cost' (7.5.1). For 'Useful Life', it references the definition of depreciable assets having a 'limited useful life'. The answer also incorporates the 'Methods of charging depreciation' and the factors for selecting them (type of asset, nature of use, circumstances) as these influence the depreciation amount calculated.
Solution Steps
Step 1: Identify the three main parameters from the text (Cost, Useful Life, Salvage Value).
Step 2: Detail the components of 'Cost' using the provided list (invoice price, freight, installation, etc.).
Step 3: Define 'Useful Life' and 'Salvage Value' based on the text descriptions.
Step 4: Include the influence of depreciation methods (Straight Line vs Written Down Value) and selection factors to ensure a comprehensive 6-mark answer.