Page 317 - Agriculture_Form_Three

Agriculture for Secondary Schools

The extent of decrease in value of the assets in monetary terms has to be estimated
yearly. This amount is termed as depreciation charges. These charges are the amount
of money set aside annually on farm assets on the ground that the use of farm capital
assets is one of the costs of earning the revenues of the business. Annual depreciation
charges have to be distributed over all years of the entire useful life of the durable
capital asset. It is considered as an annual expense and is regarded as variable cost
of production.

Advantages of depreciation is that it enables a farmer to easily replace farm assets
such as machines and equipment. This is because depreciation determines how long,
in terms of time, capital asset needs to be replaced by the new one. Thus, this enables
the farmer to get prepared to replace the asset. Another advantage is spreading of
the depreciation charges as cost of asset enables the farmer to have a true picture of
farm profit. For example, if the total cost of a tractor was added to the other costs of
a particular crop in one year, then the enterprise is likely to appear to be unprofitable.
The other advantage is that since depreciation is regarded as cost and is always made
before the calculation of profit, it will greatly reduce the amount of tax paid by the
farm business owner.

Estimation of depreciation charges
To estimate depreciation, one should know how long a capital good is going to
last. This will depend on its quality, the standard of maintenance and the way the
capital good is handled. Since one may not clearly know in advance how long a
capital good is going to last, hence estimate depreciation, one has to use averages
based on the experience from others. There are three common methods of estimating
annual depreciation charges. These include straight line method, declining balance
or diminishing balance method and sum of the year digit method. The only method
covered in this chapter is straight line as it is the most common method used in farm
accounting. Moreover, it is the simplest method and can easily be used. It is used in
situations with relatively low inflation rate, that is, prices remain almost the same.
The depreciation is calculated as if the value decreases by the same amount each
year hence named ‘straight line methodʼ. Straight line method is also called fixed-
instalment method.
Straight line method involves deducting the estimated salvage value of an asset from
its original cost and the balance divided by the number of years of estimated life
span of the asset. Mathematically, it is represented by the following formula:

Original cost of the asset (C) Salvage value (S)
−
Annual depreciation =
Useful life in years (N)

Student’s Book Form Three
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