Depreciation

Depreciation is the loss in the value of a non-current asset.

Car
Year 1 start $40,000
Estimate = Useful life (10 years)
40,000/10 = $4000

Causes of Depreciation
1. Physical (Wear and tear) deteriorate
2. Time
3. Economic reason (Inadequacy & Obsolescence) Obsolete
4. Depletion (natural resources)

Why do we depreciate (Accounting Concepts & Conventions)

1. Accruals Concept – For example, Machine’s cost $100,000. Useful
10 years. Depreciation $10,000
Q. How Depreciation is an application of Accruals Concept?
Ans. The cost of a non-current asset is not charged as an expense in the year
of purchase as it benefits the business for several years.
2. Matching Concept - This means matching the cost of a non-
current asset against the sales it has helped the business to
earn, by an annual charge of depreciation.
3. Prudence Concept - The depreciation for the year is included in
the expenses in the income statement, so the profit for the year
is not overstated.

TYPES OF DEPRECIATION
1. Straight line method
2. Reducing (Diminishing) balance method
3. Revaluation method

1. Straight line method (formula/ %age)

a) Cost – Scrap/Residual value = $40,000 - $1000

Useful life (years) 10 years

= 39,000/10 = Depreciation $3,900

b) Cost = $40,000 10% using Straight line method

$40,000 x 10% = Depreciation $4000

2. Reducing balance/ Diminishing balance method

%age COST

First year depreciation = %age on cost

Following years’ depreciation = %age on Net Book Value (NBV)

3. Revaluation Method
 Opening Vale of NCA + Purchase of NCA – Disposal of NCA –
Closing value of NCA = Depreciation

1. Straight Line Method

a) Machine Cost = $40,000
Scrap value = $5000
Useful Life = 10 years
40,000 – 5,000 = 35,000 = $3,500
10 10
b) Cost $40,000, 10% ON COST 40,000 x 10% = $4,000

Year 1 Cost 40,000

Dep (3,500)
(End of year) NBV 36,500

Year 2 NBV 36,500

Dep (3,500)
(End of year) NBV 33,000

Year 3 NBV 33,000

Dep (3,500)
(End of year) NBV 29,500

Straight line method is suitable for those assets which gives us

almost equal benefit every year for example furniture.
 2. Reducing Balance/ Diminishing Balance

Machine Cost = $100,000 50%

Year 1 Cost 100,000

Dep (50,000)
(End of year) NBV 50,000

Year 2 NBV 50,000

Dep (25,000)
(End of year) NBV 25,000

Year 3 NBV 25,000

Dep (12,500)
(End of year) NBV 12,500

Reducing balance method is more suitable for those non-current

assets which give us most benefit in their early years and their
efficiency keeps declining with the passage of time.
 3. Revaluation Method
Revaluation method is used for depreciating those non-current
assets which are insignificant in value.
2020
January 1st = $100,000
During the year purchases of computers = $50,000
Disposal of computer = $30,000
31st December = $ 110,000

The computer were valued at $130,000 on 1st January

The computer were valued at $100,000 on 31st December

100,000 + 50,000 – 30,000 – 110,000 = $10,000 Depreciation