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Chapter 5 Depreciation of Non-current Assets

Capital expenditure vs. revenue expenditure

 Under cash accounting, all expenditures will be wholly

expenses in the accounting period during
written off as _________
which they are paid.
 Under accrual accounting, there are two types of
expenditures with different accounting treatments:

Capital expenditure

Revenue expenditure
Capital expenditure vs. revenue expenditure

Capitalisation of costs
 To capitalise a cost is to record the cost as a
non-current asset and depreciate it over its useful life.
________________
 purchase price there are usually other costs
In addition to the ______________,
that need to be paid on the acquisition of a non-current asset.
 directly attributable costs (i.e., those costs that are
Only __________________
location and _________
necessary to bring the asset to the ________ condition for
its intended use) should be capitalised.
 In other words, they should be treated as capital / revenue
expenditures and added to the cost of the non-current asset.
Capital expenditure vs. revenue expenditure

Capitalisation of costs
Example
On 1 January 2014, Firm C purchased a machine for
$30,000 and paid freight charges of $1,200, an installation cost of
$600 and an annual maintenance fee of $1,000.
Purchase price
Which of the costs incurred on the machine are to be capitalised?
Incurred to bring the machine to
the location and condition for its
intended use?
Freight charges $1,200 Yes / No
Installation cost $600 Yes / No
Annual maintenance fee $1,000 Yes / No
Capital expenditure vs. revenue expenditure

Capitalisation of costs
Example
On 1 January 2014, Firm C purchased a machine for
$30,000 and paid freight charges of $1,200, an installation cost of
$600 and an annual maintenance fee of $1,000.
Which of the costs incurred on the machine are to be capitalised?

$
Purchase price 30,000
Add Freight charges 1,200
Installation cost 600
Total cost 31,800
Objective of charging depreciation

 When an entity acquires a non-current asset, the cost of

the asset is a capital / revenue expenditure and should
therefore be allocated over periods in which the asset is
useful life ).
used (i.e., _________
 systematic allocation of the cost
Depreciation is the ___________________
of a/an tangible / intangible non-current asset over its
useful life.
 In each accounting period, a portion of the cost of the asset is
written off as ____________
depreciation charges.
Objective of charging depreciation

 expenses
Under the matching concept, the _________
recognised in each accounting period have to be
revenues or ________
matched with the _________ benefits that they
generate in the same period.
 A non-current asset provides short-term / long-term
benefits and therefore its cost should not be wholly
recognised as an expense in the period of acquisition.
 allocated over its useful life.
Instead, it should be _________
Objective of charging depreciation

 The amount allocated to each accounting period (as

depreciation charges) should be matched with the
____________
amount of benefits generated in that period (which
usage of the non-current asset
usually refers to the ______
during that period).
 It is often impossible to tell how long a non-current asset
will last and how much of the asset is used up in any
estimated
period. Therefore, depreciation has to be __________.
Commonly used depreciation methods

1 Straight-line method

2 Reducing-balance method

3 Usage-based method
Commonly used depreciation methods

Comparison of depreciation methods

Straight-line method Reducing-balance method Usage-based method

constant amount of
A _________ diminishing amount of
A ___________ The amount of depreciation
depreciation is charged in depreciation is charged in charged in each period is based
each period. each period. actual usage during that
on ____________
period, so the amount can be
constant or variable.
 Different depreciation charges will lead to a different
________ figure for a given period.
net profit
Accounting entries for depreciation

Accounts for recording depreciation

Depreciation account Accumulated depreciation account
• It is an ________
expense account. contra-asset account.
• It is a ____________
• Its balance will be transferred • It is used together with the
profit and loss
to the ______________ non-current asset account
account at the end of an cost of
(which records the _____
accounting period. non-current assets) to
net book value
determine the _____________
of non-current assets.
 classof non-current assets should have its own
Each ______
depreciation account and accumulated depreciation account.
Accounting entries for depreciation

Double entries for depreciation

1 Record the depreciation charged for an accounting period:
Dr Depreciation account
Cr Accumulated depreciation account

2 Transfer the total of depreciation charged to the profit and loss

account at the end of the accounting period:
Dr Profit and loss account
Cr Depreciation account

The balance of the accumulated depreciation account

will be deducted from the cost of the non-current
statement of financial position at the
assets in the ___________________________
end of the period to arrive at the net book value.
Accounting entries for depreciation

Double entries for depreciation

Exhibit 5.1

Suppose Firm A bought a lorry for $160,000 on 1 January 2014

and adopted the straight-line depreciation method.
If the lorry was estimated to have a useful life of four years and a
residual value of $10,000, the amount of depreciation charged in
each of its four years of use would be:

($160,000 – $10,000) ÷ 4 = $37,500 Depreciation rate

or = ¼ × 100%
($160,000 – $10,000) × 25% = $37,500 = 25%
Accounting entries for depreciation

Double entries for depreciation

Exhibit 5.4
1 Dr Depreciation account
Cr Accumulated depreciation account

General ledger
Depreciation: Lorries
2014 $ 2014 $
Dec 31 Accumulated
depreciation 37,500

Accumulated Depreciation: Lorries

2014 $ 2014 $
Dec 31 Depreciation 37,500
Accounting entries for depreciation

Double entries for depreciation

Exhibit 5.4
2 Dr Profit and loss account
Cr Depreciation account

General ledger
Depreciation: Lorries
2014 $ 2014 $
Dec 31 Accumulated
depreciation 37,500 Dec 31 Profit and loss 37,500

Accumulated Depreciation: Lorries

2014 $ 2014 $
Dec 31 Balance c/f 37,500 Dec 31 Depreciation 37,500
Accounting entries for depreciation

Double entries for depreciation

Exhibit 5.4
General ledger
Depreciation: Lorries
2014 $ 2014 $
Dec 31 Accumulated
depreciation 37,500 Dec 31 Profit and loss 37,500

Firm A
Income Statements for the years ended 31 December (extract)
2014 2015 2016
$ $ $
Expenses:
Depreciation: Lorries 37,500
Accounting entries for depreciation

Double entries for depreciation

Exhibit 5.4
General ledger
Accumulated Depreciation: Lorries
2014 $ 2014 $
Dec 31 Balance c/f 37,500 Dec 31 Depreciation 37,500

Firm A
Statements of Financial Position as at 31 December (extract)
2014 2015 2016
$ $ $
Non-current assets
Net book value or
Lorries at cost 160,000
carrying amount of the
Less Accumulated depreciation 37,500 non-current assets as
122,500 at the end of financial
year
General ledger Exhibit 5.4
Depreciation: Lorries
2015 $ 2015 $
Dec 31 Accumulated
depreciation 37,500 Dec 31 Profit and loss 37,500

2016 2016
Dec 31 Accumulated
depreciation 37,500 Dec 31 Profit and loss 37,500

Accumulated Depreciation: Lorries

2015 $ 2015 $
Dec 31 Balance c/f 75,000 Jan 1 Balance b/f 37,500
Dec 31 Depreciation 37,500
75,000 75,000
2016 2016
Dec 31 Balance c/f 112,500 Jan 1 Balance b/f 75,000
Dec 31 Depreciation 37,500
112,500 112,500
General ledger Exhibit 5.4
Depreciation: Lorries
2015 $ 2015 $
Dec 31 Accumulated
depreciation 37,500 Dec 31 Profit and loss 37,500

2016 2016
Dec 31 Accumulated
depreciation 37,500 Dec 31 Profit and loss 37,500

Firm A
Income Statements for the years ended 31 December (extract)
2014 2015 2016
$ $ $
Expenses:
Depreciation: Lorries 37,500 37,500 37,500
General ledger Exhibit 5.4
Accumulated Depreciation: Lorries
2015 $ 2015 $
Dec 31 Balance c/f 75,000 Jan 1 Balance b/f 37,500
Dec 31 Depreciation 37,500
75,000 75,000
2016 2016
Dec 31 Balance c/f 112,500 Jan 1 Balance b/f 75,000
Dec 31 Depreciation 37,500
112,500 112,500

Firm A
Statements of Financial Position as at 31 December (extract)
2014 2015 2016
$ $ $
Non-current assets
Lorries at cost 160,000 160,000 160,000
Less Accumulated depreciation 37,500 75,000 112,500
122,500 85,000 47,500
Accounting entries for depreciation

When does depreciation begin?

 Depreciation begins when the asset is available for use
____.
Example
A manufacturing firm placed a purchase order with an
overseas supplier for a machine on 1 January 2013 and paid a
deposit. The machine arrived in Hong Kong on 1 February 2013
and was delivered to the firm on 10 February 2013. Ten days were
then spent on assembling and testing the machine. On
1 March 2013, the firm paid the supplier in full.

When should the firm start to charge

depreciation on the machine?
Accounting entries for depreciation

When does depreciation begin?

 Depreciation begins when the asset is available for use
____.
Example
 1 January 2013, when the purchase order was placed.
 1 February 2013, when the machine arrived in Hong Kong.
The machine was
 10 February 2013, when the machine was delivered
ready for use.
to the firm.

 20 February 2013, when the assembling and
testing of the machine was completed.
 1 March 2013, when full payment was made.
Date to begin charging depreciation
Learning Tips

Problem
Depreciation should start from the day when the non-current asset
is ready for use, i.e., when it has been delivered or installed (if
necessary).

• In this question, depreciation should start on 1 July 2007 and not

from the date when a payment was made (either for the deposit or
the balance of the purchase price).
• Using an incorrect date to start charging depreciation will result in
incorrect subsequent calculations. Therefore, candidates should
pay extra attention to the dates relating to the purchase of a non-
current asset.
Disposal of non-current assets

 get rid of a non-current asset before

A business may _________
it reaches the end of its estimated useful life.
 sold _________
This could happen if the asset is _____, damaged or lost in an
accident
_________.

 disposal will be opened to

A separate account called _________
record the disposal of non-current assets.
Disposal of non-current assets

 Double entries for the disposal of a non-current asset:

1 Transfer the cost of the asset to the disposal account:
Dr Disposal account
Cr Non-current asset account

2 Transfer the accumulated depreciation on the asset to the

disposal account:
Dr Accumulated depreciation account
Cr Disposal account

3 Record the proceeds from disposal (if any):

Dr Cash/Bank/Debtor’s account
Cr Disposal account
Disposal of non-current assets

 Double entries for the disposal of a non-current asset:

4 profit and loss
Transfer the profit/loss on disposal to the ______________
account at the end of the accounting period.
Proceeds from NBV of the
>/<
The profit/loss on disposal is disposal
the difference between
asset the
net book value of the asset and the _________
_____________ proceeds from
disposal.
(a) Where there is a profit on disposal:
Proceeds from NBV of the
Dr Disposal account >/<
disposal asset
Cr Profit and loss account
(b) Where there is a loss on disposal:
Dr Profit and loss account
Cr Disposal account
Disposal of non-current assets
Learning Tips

Problem
There are scenarios in public exam questions where the disposal of
a non-current asset was treated as an ordinary sale of goods, or
the entries required for the disposal were omitted or incomplete.

Candidates are usually required to work out the accumulated

depreciation in order to ascertain the profit or loss on disposal. In
this case, they should be aware of the following:
1. the starting and ending dates of depreciation; and
2. the firm’s depreciation method and policy.
If the firm adopts the reducing-balance method, all calculations will
be more complicated.
Trade-in of non-current assets

 exchanged for
Sometimes, an old non-current asset is __________
trade-in transaction.
a new asset. This is known as a ________
 trade-in value of the old asset will be deducted
The _____________
from the cost price of the new asset and only the
balance will be paid.

3 Record the payment for the new asset with the trade-in
allowance deducted from the cost price:
Dr Non-current asset account (cost price of the new asset)
Cr Cash/Bank/Creditor’s account (amount paid for the new asset)
Cr Disposal account (amount of trade-in allowance)
Trade-in of non-current assets
Exhibit 5.6

Firm A bought a lorry for $160,000 on 1 January 2014 and

adopted the straight-line depreciation method. The lorry was
estimated to have a useful life of four years and a residual value of
$10,000.
Suppose the old lorry was traded in for a new one on 1 January
2016. The trade-in value of the old lorry was $50,000 while the
cost price of the new lorry was $300,000. The
balance was paid in cash one week later.
 Exhibit 5.6
General ledger
Lorries
2016 $ 2016 $
Jan 1 Balance b/f 160,000 Jan 1 Disposal 160,000

Disposal: Lorries
2016 $ 2016 $
Jan 1 Lorries 160,000

1 Dr Disposal account
Cr Non-current asset account
 Exhibit 5.6
General ledger
Lorries
2016 $ 2016 $
Jan 1 Balance b/f 160,000 Jan 1 Disposal 160,000

Disposal: Lorries
2016 $ 2016 $
Jan 1 Lorries 160,000 Jan 1 Accumulated
depreciation 75,000

2 Dr Accumulated depreciation account

Cr Disposal account
 Exhibit 5.6
General ledger
Lorries
2016 $ 2016 $
Jan 1 Balance b/f 160,000 Jan 1 Disposal 160,000
“ 1 Disposal –
Trade-in value 50,000
“ 8 Cash 250,000
The cost price of the new lorry ($300,000)
is equal to the trade-in value of the old lorry
($50,000) plus the cash payment of theDisposal: Lorries
balance ($250,000).
2016 $ 2016 $
Jan 1 Lorries 160,000 Jan 1 Accumulated
depreciation 75,000
“ 1 Lorries –
Trade-in value 50,000

3 Dr Non-current asset account (cost price of the new asset)

Cr Cash/Bank/Creditor’s account (amount paid for the new asset)
Cr Disposal account (amount of trade-in allowance)
 Exhibit 5.6
General ledger
Lorries
2016 $ 2016 $
Jan 1 Balance b/f 160,000 Jan 1 Disposal 160,000
“ 1 Disposal –
Trade-in value 50,000
“ 8 Cash 250,000

Disposal: Lorries
2016 $ 2016 $
Jan 1 Lorries 160,000 Jan 1 Accumulated
depreciation 75,000
“ 1 Lorries –
Trade-in value 50,000
Dec 31 Profit and loss –
4 Dr Profit and loss account Loss on disposal 35,000
Cr Disposal account 160,000 160,000
 Exhibit 5.6
General ledger
Lorries
2016 $ 2016 $
Jan 1 Balance b/f 160,000 Jan 1 Disposal 160,000
“ 1 Disposal – Dec 31 Balance c/f 300,000
Trade-in value 50,000
“ 8 Cash 250,000
460,000 460,000

Disposal: Lorries
2016 $ 2016 $
Jan 1 Lorries 160,000 Jan 1 Accumulated
depreciation 75,000
“ 1 Lorries –
Trade-in value 50,000
Dec 31 Profit and loss –
Loss on disposal 35,000
160,000 160,000
More complicated examples

 Different businesses may adopt different depreciation

policies, which include:
A full year’s depreciation is charged in the year of acquisition, while no
depreciation is charged in the year of disposal.

Depreciation is charged on a monthly basis.

A full year’s depreciation is charged if the asset is acquired in the first half of
the year, while half a year’s depreciation is charged if it is acquired in the
second half of the year.
Half a year’s depreciation is charged if it is disposed of in the first half of the
year, while a full year’s depreciation is charged if it is disposed of in the
second half of the year.
More complicated examples

 consistency the same depreciation

To achieve ___________,
method or policy should be applied to all non-current
assets in the same class from period to period.
 Changing methods or policies without good reason
misleading results being reported.
would lead to ___________
Application of the firm’s depreciation policy
Learning Tips
Problem
Each firm has its own policy for calculating depreciation on assets
acquired or sold during an accounting period.

• It is expressly stated in this question that a full year’s

depreciation is charged in the year of purchase and that no
depreciation is to be charged in the year of disposal.
• Candidates only need to be concerned with the year of purchase
or disposal and not the exact date of the year.
Application of the firm’s depreciation policy
Learning Tips

If the depreciation policy is not clearly stated in the question,

candidates should assume that depreciation is charged on a
daily basis.

As the depreciation policy is not spelled out in this question, 10

months’ depreciation (from 1 March to 31 December 2011)
should be charged for the year ended 31 December 2011.