Week 10

Depreciation of non-current assets

Learning Objectives
1. Define depreciation
2. Calculate depreciation

P3
DEPRECIATION
• A firm acquire long-term, physical economic resources
(tangible non-current) to generate revenue
• Most of these assets are depreciable
• Depreciable assets are long-term tangible assets, the
economic benefits which will expire over their useful
lives
• When a non-current asset (eg : Motor vehicle) is
acquired by means of cheque
Dr. Motor Vehicles
Cr. Cash/Bank
DEPRECIATION
• Allocation of the original cost of the purchased non-
current assets over its useful lives
• The recognition of the gradual using up of the cost
of a non-current asset over all the accounting
periods in which the non-currents assets are used
• Depreciation is treated as expense, in order to
reflect the cost of using a non-current assets in a
certain accounting period
• It should be noted that depreciation expense is not
an item not involving the movement of cash
CAUSES OF DEPRECIATION

• Physical deterioration
• Wear and tear
• Erosion, rust, rot and decay (eg : motor vehicles)
• Economic factors
• Obsolescence (eg : computer)
• Inadequacy
• Physical factor (flood, excessive heat,
excessive cold)
METHODS OF CALCULATING
DEPRECIATION
• Straight line method
• Reducing balance method
• Revaluation method – expensive & not many
• Depletion unit method – eg. quarry
• Machine hour method – life of asset’s expected
operating time
• Sum of the years’ digits method
• Units of output method
CALCULATING DEPRECIATION
• 2 main methods are:
1. Straight line method
2. Reducing balance
STRAIGHT LINE METHOD
• Equal portion of cost of the non-current asset treated
as expense in each accounting period in which non-
current asset is used
• Amount of depreciation will be same for each
accounting period
STRAIGHT LINE METHOD
• If a lorry was bought for £22,000, would be kept for four
years, and then be sold for £2,000, the depreciation to
be charged each year would be:

= Cost (£22,000) – Estimated disposal value (£2,000)

Number of expected years of use (4)
= £5,000 depreciation each year for four years.

Dr. Depreciation expense (lorry) (SOCI) 5,000

Cr. Provision for depreciation (lorry) (SFP) 5,000
 REDUCING BALANCE METHOD
• Calculates depreciation expense for each accounting
period by multiplying non-current asset book value
with fixed percentage
• Book value is also known as residual value
• This method called declining balance method or
diminishing balance method
REDUCING BALANCE METHOD
If a machine is bought for £10,000 and
depreciation is to be charged at 20%, the
calculations for the first three years would be as
follows: £
Cost 10,000
First year depreciation (2,000)
8,000
Second year depreciation (20% of £8,000) (1,600)
6,400
Third year depreciation (20% of £6,400) (1,280)
Cost not yet apportioned, end of year 3 5,120
 REDUCING BALANCE METHOD
1st year
Dr. Depreciation expense (lorry) (SOCI) 2,000
Cr. Provision for depreciation (lorry) (SFP) 2,000
2nd year
Dr. Depreciation expense (lorry) (SOCI) 1,600
Cr. Provision for depreciation (lorry) (SFP) 1,600
3rd year
Dr. Depreciation expense (lorry) (SOCI) 1,280
Cr. Provision for depreciation (lorry) (SFP) 1,280
End of Week 11