Slide 8.

Depreciation
Non-current (fixed) assets

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Definitions
Asset
⚫ Resource… from which future economic benefits are
expected to flow.
Non-current (fixed) assets
⚫ Held for use in profit generating process.
⚫ On a continuing basis.
⚫ Not for sale in ordinary course of business.

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.4

Examples of Non-Current Asset

⚫ Property,
⚫ Plant
⚫ Equipment
⚫ Motor Vehicle
⚫ Fixtures and Fittings
⚫ Machinery
⚫ Motor van

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.5

Cost of non-current (fixed) assets

At acquisition
⚫ Purchase price of an asset plus the cost of preparing it for
use.
⚫ Legal costs of acquisition and installation and
commissioning costs.

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.6

Depreciation
⚫ Non-current (fixed) assets are gradually used up in
providing goods and services over time.
⚫ Purpose of accounting depreciation is to spread the cost of a
non-current (fixed) asset over its expected useful life.
⚫ Depreciation is the reduction of the original purchase cost of
a fixed asset during its period of life.

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.7

Depreciation (Continued)
In historical cost (traditional) accounting:
⚫ the Net Book Value (NBV) is the result of a calculation.
(Original cost – Accumulated depreciation)
⚫ it is not intended to represent the asset’s market value.

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.8

Causes of Depreciation
⚫ Wear and tear
⚫ Rust, rot, erosion
⚫ Obsolescence
⚫ Inadequacy
⚫ Time factor e.g. Lease
⚫ Depletion e.g. natural resources

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.9

Yearly depreciation,
Accumulated depreciation
⚫ Each year that a non-current (fixed) asset is in use, a
portion of its cost is deducted from the balance sheet
value. That portion of cost is ‘matched’ against the
revenues of that year. This gives the depreciation
charge of the year. (Trading, profit and loss account).
⚫ The depreciation of the non-current (fixed) asset in each
year is added to the depreciation of earlier years to
arrive at the Accumulated depreciation. (Balance
sheet).

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.10

Calculation of depreciation
Requires three items of information:
⚫ the cost of the non-current (fixed) asset.
⚫ the estimated useful life.
⚫ the estimated residual value/scrap value (the value
remaining at the end of the useful life).

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.11

Purpose and methods

The purpose of the depreciation calculation is to spread the
total depreciation over the estimated useful life.
Methods of depreciation
(a) Straight-line method
(b) Reducing balance method

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Slide 8.12

Straight-line depreciation
⚫ Those who believe that a non-current (fixed) asset
is used evenly over time apply a method of
calculation called straight-line depreciation.

The formula is:

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.13

Straight-line depreciation
(Continued)
Non-current (fixed) asset, which has a cost of
$5,000 and an expected life of 5 years. The
expected residual value is $1000. The
calculation of the annual depreciation charge
is:
= £800 per annum

Accounting policy:
Depreciation is charged on a straight-line
basis at a rate of 20% of cost per annum.

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
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Solution
Yr 1 Cost = $5000
Less Dep: -$800
Yr 2 NBV $4200
Less Dep: -$800
Yr 3 Cost : $3400
Less Dep: -$800
Yr 4 Cost: $2600
Less Dep: -$800
Yr 5 Cost : $1800
Less Dep: -$800
Yr 6 Cost : $1000 Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
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Straight-line with residual value

The Removals Company was set up on 1 January Year 2,
purchased van for £60,000, and started to trade.
The manager estimates that:
1. The van will be used for 3 years; and
2. Estimated residual value of £6,000 (second hand or scrap
value).

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
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Calculation
⚫ Net cost of the van
= (£60,000 – £6,000) = £54,000.
⚫ Net cost has to be depreciated over 3 years.
i.e. (54,000/3) = £18,000 per year.

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
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Reducing-balance depreciation
⚫ Those who believe that the non-current (fixed) asset
depreciates faster in the earlier years of its life would
calculate the depreciation. Formula:

Fixed percentage ×
the net book value at the start of the year

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
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Example

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Activity

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26.2 answers

Straight line method:

Cost- disposal value
# of years

$8000- $2400= $5600/5= $1120 depreciation charge per year

Yr 1 cost- $8000
Less Dep: ($1120)
Yr 2 NBV $6880
Less Dep ($1120)
Yr 3 NBV $5760
Less Dep ($1120)
Yr 4 NBV $4640
Less Dep ($1120)
Yr 5 NBV $3520
Less Dep ($1120)
Disposal value $2400

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
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Activities

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⚫ Cost : 9600
⚫ Yr 1 Dep - 4800 (50% x 9600)
NBV 4800
Yr 2 Dep - 2400
NBV 2400
Yr 3 Dep - 1200
NBV 1200

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
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26.4A

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Provision for Depreciation

Double entry records for accumulated depreciation

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Provision for Depreciation

⚫ Businesses usually keep records of the cost of the
non-currents assets and their accumulated
depreciation.
⚫ The following two accounts are used:
⚫ The non-current asset
⚫ Provision for depreciation

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Provision for Depreciation

⚫ The fixed asset account is always kept for showing the
assets at cost price.

⚫ Depreciation is shown in a separate Provision for

Depreciation a/c. Most ltd. Companies use this
because the company balance sheets show fixed assets
at cost, less total depreciation to date.

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
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Double entry recording

1. Debit the non-current asset account
2. Credit the bank/cash account
3. Debit the profit and loss account with the amount of
depreciation each year
4. Credit the provision for depreciation non-current asset
account with the amount of depreciation each year

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.29

For example
⚫ A business bought an equipment for $50,000. The policy
is to depreciate the equipment by 20% per annum using
the straight line method.
⚫ Show the equipment, provision for depreciation account
for Year 1 and 2

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
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Solution
Depreciation charge: 20% x 50,000 = 10,000

***Each year the equipment will depreciate by $10,000

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Solution

c/d

Year 2 b/d
Dec 31 balance c/d 20,000

Year 3
Jan 1 balance b/d 20,000
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
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Solution cont’d

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Activities in Textbook pg. 252

⚫ Exercise 24.1
⚫ Exercise 24.3x

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Activity

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Activity

Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011