Chapter 6

DEPRECIATION
1. Non-current assets
A non-current asset is an asset intended for use on a continuing basis in the business.

A tangible non-current asset is one that can be touched and refers to such items as plant, buildings and
motor vehicles.

A non-tangible non-current asset is one that cannot be touched and refers to such items as goodwill
and patents

2. Depreciation
Depreciation is the charging of the cost of a non-current asset over its useful life.
The purchase of a car for $10,000 is an expense of running the business just as electricity is an
expense. However, if the car is expected to last 5 years, it would be misleading to have one
expense in the Statement of Profit or Loss of $10,000 every 5 years and nothing in the other
years. It would be more sensible to reflect the fact that the car is being used in the business
over 5 years by charging an expense each year of (say) $2,000.
The charge of $2,000 in the Statement of Profit or Loss each year is known as depreciation.
At the same time, the Statement of Financial Position value of the car will be reduced by $2,000
each year to reflect the fact that it is being used up.
The way in which $2,000 was calculated in the above illustration is known as the straight-line
method of depreciation.
The purpose of depreciation is not to place a true value on the asset in the Statement of
Financial Position. It is a method of applying the accruals, or matching, concept by charging the
cost of the asset to the Statement of Profit or Loss as it is being used up.

3. Methods of calculating depreciation

Methods of calculating depreciation:
๏ Straight line method
๏ reducing balance method
Straight line method
Under this approach we charge an equal amount of depreciation each year.
The depreciation charge each year is calculated as:
Original cost – residual value
Estimated useful life
Example 1
Sarkans has a year end of 31 December each year.
On 1 April 2002 he purchases a car for $12,000. The car is expected to last for 5 years and to
have a scrap value at the end of 5 years of $2,000.
You are required to calculate the depreciation charge for each of the first three accounting
periods, and to show extracts from the Statement of Financial Position and Statement of
Profit or Loss for each of the three accounting periods.
Depreciation = 12,000 – 2,000 = 2,000 p.a.
5
2002: 9/12 × 2,000 1,500
2003: 2,000
2004: 2,000
31.12.2002 31.12.2003 31.12.2004
Statement of Profit or Loss:
Depreciation 1,500 2,000 2,000
Statement of Financial Position:
Cost 12,000 12,000 12,000
Less: Accumulated Depreciation (1,500) (3,500) (5,500)
10,500 8,500 6,500
(Note, in the first accounting period we have charged a fraction of the annual depreciation
because the asset was purchased during the year. A very common alternative in practice is to
charge a full year in the year of purchase, regardless of when in the year it was actually
purchased. In the examination, read the question carefully. If you are told to charge a full year
in the year of purchase then do so. If you are not told, then charge a fraction (or time
apportion) as above.)
Reducing balance method
Under this approach we charge more depreciation in the early years of an asset’s life, with a
progressively lower charge in each subsequent year.
The depreciation charge each year is a fixed percentage of the net book value (or written down
value) at the end of the previous year.
Example 2
Zils has a year end of 31 December each year.
On 5 April he purchased a machine for $15,000.
His depreciation policy is to charge 20% reducing balance, with a full years charge in the year of
purchase.
You are required to calculate the depreciation charge for each of the first three accounting
periods, and to show extracts from the Statement of Financial Position and Statement of
Profit or Loss for each of the three accounting periods.
Cost 15,000
Yr 1 Depreciation (20%) (3,000)
12,000
Yr 2 Depreciation (20%) (2,400)
9,600
Yr 3 Depreciation (20%) (1,920)
7,680
Year 1 Year 2 Year 3
Statement of Profit or Loss:
Depreciation 3,000 2,400 1,920
Statement of Financial Position:
Cost 15,000 15,000 15,000
Less: Accumulated Depreciation (3,000) (5,400) (7,320)
12,000 9,600 7,680
 4. Accounting for depreciation
Whichever method is used, the accounting entries are the same.
We will illustrate the required entries using an example, and will then summarise the entries
afterwards.
Example 3
Melns has a year end of 30 June each year.
On 1 January 2002 he purchased a car for $15,000.
The car has an expected life of 5 years, with an estimated scrap value of $1,000.
Melns depreciation policy is to use straight line depreciation.
Show the accounting entries for the first three accounting periods.
Depreciation = 15,000 – 1,000 = 2,800 p.a.
5
Y/e 30.6.02 6/12 × 2,800 = $1,400
Car Accumulated Depreciation A/C
Cash 15,000 2002 Dep Exp 1,400
2003 Balance 4,200 2003 Dep Exp 2,800
Cash 4,200 4,200
Balance 4,200
2004 Balance 7,000 2004 Dep Exp 2,800
7,000 7,000
Balance 7,000
 Depreciation Expense A/C
2002 Accum Dep 1,400 2002 SOPL 1,400
1,400 1,400
2003 Accum Dep 2,800 2003 SOPL 2,800
2,800 2,800
2004 Accum Dep 2,800 2004 SOPL 2,800
2,800 2,800
The accounting entry for charging depreciation each year is:
Debit Depreciation Expense account
Credit Accumulated Depreciation account
The balance on the Depreciation Account will appear in the Statement of Profit or Loss as an
expense.
The balance on the Accumulated Depreciation account will appear in the Statement of Financial
Position as a deduction from the cost of the asset.

5. Sale of non-current assets

In practice it is unlikely that an asset will be kept for the precise useful life that was estimated for
depreciation purposes – it might be kept for a longer period or for a shorter period. It is also extremely
unlikely that any sale proceeds will exactly equal the value of the asset as shown in the financial
statements.

On sale, we remove the asset from our books and calculate any difference between the proceeds and
the value in the financial statements. This difference (which is really the effective over or under charge
of depreciation) is called the profit or loss on sale and is shown in the Statement of Profit or Loss.

Example 4

In example 3, Melns sells the car on 30 September 2004 for $6,500.

Write up the ledger accounts for his fourth accounting period and show extracts from his Statement
of Financial Position and Statement of Profit or Loss.
 Car Accumulated Depreciation

Balance 15,000 Disposal 15,000 Balance 7,000

Balance 7,700 Dep Exp

(3/12 × 2,800) 700

15,000 15,000 7,700 7,700

Disposal 7,700 Balance 7,700

7,700 7,700

Depreciation Expense Disposal A/C

Accum Depr 700 SOPL 700 Car 15,000 Accum Depr 7,700

700 700 Cash 6,500

SOPL

(Loss on sale) 800

15,000 15,000

Note that in this example we have charged depreciation in the year of sale for the 3 months the car was
owned. Very often you will be told that the depreciation policy is to charge no depreciation in the year
of sale. The net result in the Statement of Profit or Loss will be exactly the same.

Summary of the accounting entries for the sale of a non-current asset:

DR Disposal Account

CR Asset Account

with the cost of the asset sold

DR Accumulated Depreciation Account

CR Disposal Account

with the accumulated depreciation on the asset sold

DR Cash

CR Disposal Account

with the proceeds of sale

The balance remaining on the Disposal Account is the profit or loss on sale. This should be transferred to
the Statement of Profit or Loss.
 6. Revaluation of non-current assets
During a period of high-inflation, the value of non-current assets may be well in excess of their carrying
value (net book value).

In this situation a company may choose to show the current worth of such assets on their Statement of
Financial Position.

Any profit resulting from such revaluation is an unrealized profit (in that the asset has not been sold and
therefore no real profit has actually been made). As a result, the profit is shown separately from the
Statement of Profit or Loss in a revaluation reserve. (For a limited company this must be the case. For a
sole trader, where the owner has unlimited liability, this is not a rule even though it is good practice.)

IAS 16 Property, Plant and Equipment requires that when an item of property, plant or equipment is
revalued, then the entire class of property, plant and equipment to which the asset belongs must be
revalued.

When a non-current asset has been revalued, the future charge for depreciation should be based on the
revalued amount and the remaining economic life of the asset.

The depreciation charge will be higher than it was before the revaluation, and the excess of the new
charge over the old charge should be transferred from the revaluation reserve to retained earnings.

Example 5

Purpurs has a year end of 31 December each year.

In his Statement of Financial Position as at 31 December 2002 he has buildings at a cost of $3,600,000
and accumulated depreciation of $1,080,000.

His depreciation policy is to charge 2% straight line.

On 30 June 2003, the building is to be revalued at $3,072,000. There is no change in the remaining
estimated useful life of the building.

Show the relevant ledger accounts for the year to 31 December 2003.
 Buildings Accumulated Depreciation

Balance 3,600,000 Revaluation

a/c 528,000 Balance 1,080,000

Balance 3,072,000 Balance 1,116,000 Dep Exp

(W1) 36,000

3,600,000 3,600,000 1,116,000 1,116,000

Balance 3,072,000 Revaluation 1,116,000 Balance 1,116,000

1,116,000 1,116,000

Dep Exp

(W2) 44,522

Depreciation Expense Revaluation A/C

Accum Dep 36,000 Building 528,000 Accum Dep 1,116,000

Accum Dep 44,522 SOPL 80,522 Proft on

reval. 588,000

80,522 80,522 1,116,000 1,116,000

(W1) Dep Exp = 6/12 × 2% × 3,600,000 = $36,000

(W2) Dep Exp = 6/12 × 3,072,000 = $44,522

34.5

With depreciation at 2% p.a., expected life of building was 50 years.

At date of revaluation, the accumulated depreciation is $1,116,000. At the rate of $72,000 p.a..

This is 1,116,000 = 15.5 years

72,000

So expected life remaining = 50 – 15.5 = 34.5 years.

 7. The non-current assets register
In its nominal ledge, a business will typically have accounts for the cost of each class of noncurrent asset
e.g. buildings, plant and machinery. There will also be accounts for the accumulated depreciation for
each class of non-current asset.

Every time a new item is bought, its cost will be debited to the appropriate cost account. The cost
accounts therefore keep track of the total cost of each type of non-current assets and similarly the
accumulated depreciation accounts keep track of the total accumulated depreciation for each type of
asset.

However, more detailed information is also required. For example, when an assets is sold its
depreciation to date has to be transferred to the disposals account, so records are needed of how much
depreciation attaches to each individual assets. Similarly, if we are using straight-line depreciation and
an asset is fully written down to zero book value, no more depreciation should be applied to it.

The more detailed information needed is recorded in a non-current asset register; this is a
memorandum record and is not part of the double-entry system.

The non-current assets register has a page for each non-current asset.

Typically it will list out:

Information Reason for the information

Cost Basic accounting information. Needed for depreciation calculations and on the
disposal of the asset. The sum of the costs of the assets should agree to the amount in the cost account
in the nominal ledger.

Date purchased Might be needed for depreciation calculations or the identification of old
assets.

Accumulated depreciation Basic accounting information. Needed for depreciation calculations and
on the disposal of the asset. The sum of the accumulated depreciation of the assets should agree to the
amount in the accumulated depreciation account in the nominal ledger.

Depreciation method Needed for depreciation calculations.

Estimated residual value Needed for depreciation calculations if using straight-line depreciation.

Supplier’s name, address, and the item’s serial number Needed for maintenance and renewal of
assets

Location of the asset Needed for physical inspection of the asset or for routine
maintenance checks.

Date asset last inspected Needed for auditing, maintenance and safety procedures.

Date asset scrapped or sold Needed for auditing purposes.

Question 1

What is the correct double entry to record the depreciation charge for a period?

 Dr Accumulated depreciation; Cr Depreciation expense

 Dr Depreciation expense; Cr Accumulated depreciation

The entry is: Dr Depreciation expense; Cr Accumulated depreciation

Question2

At 31 October 2013 a business had machines with a cost of $120,000 and with accumulated
depreciation of $25,000

On 1 January 2014 they sold a machine for $10,000. This machine had originally cost $30,000 on 1 April
2012

The business had a depreciation policy of charging straight-line depreciation at the rate of 20% per
annum, on a monthly basis.

What is the depreciation expense for the year ended 31 October 2014?

Depreciation from 1 November 2013 to 31 December 2013 (2 months) is:

2/12 X 20% X 120,000 = $4,000

Depreciation from 1 January 2014 to 31 October 2014 (10 months) is:

10/12 X 20% X (120,000 – 30,000) = $15,000

Total depreciation = 4,000 + 15,000 = $19,000

Question 3

A company has a year end of 31 January each year.

They purchased a car for $12,000 on 1 January 2008 and sold it for %5,000 on 31 March 2012.

Their depreciation policy is to charge 20% reducing balance, with a full charge in the year of purchase
and none in the year of sale.

What was the profit or loss on the sale of the car?

 $1,067.84 (profit)
 $1,144.00 (loss)
 $1,854.27 (profit)
 $84.80 (profit)
Depreciation to 31 Jan 2008 : 20% X 12,000 = 2,400

Depreciation to 31 Jan 2009 : 20% X (12,000 - 2,400) = 1.920

Depreciation to 31 Jan 2010 : 20% X (12,000 – (2,400 – 1,920))= 1,536

Depreciation to 31 Jan 2011 : 20% X (12,000 – (4,320 + 1,536)) = 1,228.80

Depreciation to 31 Jan 2012 : 20% X (12,000 – (5,856 + 1,228.80) = 983.04

NBV at date of sale = 12,000 – (7,084.80 + 983.04) = 3,932.16

Profit on sale = 5,000 – 3,932.16 = $1,067.84

Question 4

A non- current asset was purchased at the beginning of year 1 for $2,400 and depreciated by 20% per
annum using the reducing balance method.

At the beginning of year 4 it was sold for $1,200.

The result of this was:

__________ _____________ (profit on disposal OR loss on disposal)

(28.80 OR 240.00)

NBV at the end year 1 = 2,400 – (20% X 2,400) = 1,920

NBV at the end year 2 =1,920 – (20% X 1,920) = 1,536

NBV at the end year 3 =1,536 – (20% X 1,536) = 1,228.80

Loss on disposal = 1,228,80 – 1,200 = $28.80

Question 5

On 1 January 2000 Krin Co. bought a machine for $70,000. It was estimated that the machine useful life
would be 7 years and its residual value $7,000. Two years later the useful life was revised to three
remaining years and at 31 December 2003 the machine was sold for $30,000.

What was the profit on disposal?

 $8,000
 $2,000
 $20,000
 $12,000

Depreciation for each of the first 2 years is (70,000 – 7,000) / 7 = 9,000 per year

NBV after 2 years = 70,000 – (2 X 9,000) = 52,000

Depreciation or then next 2 years = (52,000 – 7,000) / 3 = 15,000 per year

NBV at time of sale = 52,000 – (2 X 15,000) = 22,000 ; Profit on sale = 30,000 – 22,000 = $8,000