Assume that the machine in Example…3.7 was owned by a business that made a profit before depreciation of £40,000 for each of the four years in which the asset was held.

Calculate the profit for the business for each year under each depreciation method, and comment on your findings.

Data from Example 3.7

To illustrate the straight-line method of depreciation, consider the following information:

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Cost of machine Estimated residual value at the end of its useful life Estimated useful life To calculate the depreciation expense for each year, the total amount to be depreciated must be calcu- lated. This will be the total cost less the estimated residual value: that is, £78,124 £2,000 = £76,124. The annual depreciation expense can then be derived by dividing the amount to be depreciated by the estimated useful life of the asset of four years. The calculation is therefore: £76,124 4 £78,124 £2,000 4 years £19,031 This means that the annual depreciation expense that appears in the income statement in relation to this asset will be £19,031 for each of the four years of the asset's life. The amount of depreciation relating to the asset will be accumulated for as long as the asset continues to be owned by the business or until the accumulated depreciation amounts to the cost less residual value. This accumulated depreciation figure will increase each year as a result of the annual deprecia- tion expense in the income statement. This accumulated amount will be deducted from the cost of the asset in the statement of financial position. At the end of the second year, for example, the accumulated depreciation will be £19,031 x 2 = £38,062. The asset details will appear on the statement of financial position as follows: Machine at cost Accumulated depreciation £ 78,124 (38,062) 40,062