Depreciation

1. Introduction

1.1 When Non-current assets might be held and used by a business for a number of
years, but they wear out or lose their usefulness in the course of time. Every tangible
non-current asset has a limited life; the only exception is land.

1.2 The accounts of a business try to recognise that the cost of a non-current asset is
gradually consumed as the asset wears out. This is done by gradually writing off the
asset's cost in the income statement over several accounting periods.

1.3 Depreciation is the process of systematically distributing the cost price of a non-
current asset over its useful life to ensure that the cost of using the asset is suitably
paired or matched with the income generated by that use.

1.4 There are various methods of calculating depreciation. This tutorial is going to utilise
two of these methods, namely the straight line method and the diminishing
balance method.

2. Straight Line Method

2.1 The straight line method is a method of providing for depreciation and the cost price
of the fixed asset is accordingly written off over the estimated life span of the fixed
asset.

2.2 This means that an equal amount is written off annually and apportioned for part
financial years.

2.3 Calculation of Annual depreciation :

Cost price (Asset X) / Lifespan in years

2.4 A schedule is drafted as follows :

3. Diminishing Line Method

3.1 According to this method a fixed percentage of the diminishing value on the fixed
asset (carrying value) is written off annually. The amount written off decreases
annually as the percentage is calculated on the diminishing balance and not on the
cost price.

3.2 Calculation for Annual depreciation for nth year:

Carrying Value (Asset X) x Percentage Depreciation

3.3 A schedule is drafted as follows :

4. Calculating Depreciation for an asset acquired during the financial year

4.1 Suppose a law practice decides to acquire a library six months before the end of the
year. The provision for depreciation for the first year must be determined for the
portion of the year, which in this case is 6/12 or 50% of the year.

4.2 If the cost price of the library is $ 60 000 and the depreciation rate is 20% per year,
the depreciation to be provided for the first year will be:

$60 000 x 20/100 x 6/12 = 6000

5. Recording depreciation.

5.1 During the expected useful life of an asset, a reasonable amount must be written off
from the cost price of the asset in each financial period and debited to a
depreciation account.

5.2 The depreciation account (nominal account) is debited in the general ledger and is
reflected as an expense in the Statement of Profit or Loss.

5.3 Under the double entry system, another account has to be credited with the same
amount. In practice it is not the asset account but a contra asset account, the
accumulated depreciation account, which is credited with the annual
depreciation. [Accumulated Depreciation also known as the Provision for
Depreciation]

5.4 At the end of the period the depreciation for that year will be transferred to the Profit
and Loss Account as an expense.

Dr Profit and Loss Account

Cr Depreciation Account : Asset X

5.5 The double entry for an Asset X will be as follows

Dr Depreciation: Asset X
Cr Accumulated Depreciation: Asset X

5.6 Accumulated depreciation (statement of financial position account) is credited and is

reflected as a deduction from the cost price of an asset in the Statement of
Financial Position.

Cost of Price – Accumulated Depreciation = Net Book Value [NBV] / Net

carrying amount (Asset X)

6. Disposal of Non-current Asset

6.1 When an asset is no longer useful to a law practice, and is disposed of, it must be
removed from the books and register of assets.

6.2 The disposal of a non-current asset is recorded in a Disposal Account

a. Transfer the cost price of the asset sold to an assets disposal account :

Dr Disposal Account: Asset X

Cr Asset X

b. Transfer the depreciation already charged to the assets disposal account :

Dr Disposal Account: Asset X

Cr Depreciation Account: Asset X

c. For the amount received on disposal :

Dr Bank Account
Cr Disposal Account: Asset X

d. Transfer the difference (i.e. the amount needed to balance the disposal account)
to the profit and loss account.

i. If the computer disposals account shows a credit balance (i.e. if more has
been credited to the account than has been debited to it), there is a profit
on the sale:

Dr Disposal Account: Asset X

Cr Profit and Loss Account

ii. If the computer disposals account shows a debit balance, there is a loss
on sale:

Dr Profit and Loss Account

Cr Disposal Account: Asset X