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Depreciation
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Non-current assets lose value as they are used. Depreciation spreads their cost over the years they help earn income.
Causes
Wear and tear: physical use.
Passage of time: such as a lease running out.
Obsolescence: becoming out of date as better technology appears.
Depletion: using up a resource, such as a mine or quarry.
Depreciation applies the accruals concept: the cost is matched to the periods that benefit.
Passage of time: such as a lease running out.
Obsolescence: becoming out of date as better technology appears.
Depletion: using up a resource, such as a mine or quarry.
Depreciation applies the accruals concept: the cost is matched to the periods that benefit.
Two methods
Straight line: the same charge each year.
Annual depreciation = (cost − residual value) ÷ useful life in years.
Reducing balance: a fixed percentage of the carrying amount (net book value) each year, so the charge falls each year.
Carrying amount = cost − accumulated depreciation
Annual depreciation = (cost − residual value) ÷ useful life in years.
Reducing balance: a fixed percentage of the carrying amount (net book value) each year, so the charge falls each year.
Carrying amount = cost − accumulated depreciation
Recording
Each year: Dr depreciation (an expense in the income statement), Cr accumulated depreciation (also called provision for depreciation).
In the statement of financial position, the asset is shown at cost less accumulated depreciation.
In the statement of financial position, the asset is shown at cost less accumulated depreciation.
A machine costs £24 000, has a residual value of £4000 and a life of 5 years. Find the annual straight line depreciation.
- (24 000 − 4000) ÷ 5
- = 20 000 ÷ 5
Answer: £4000 a year
Causes: wear and tear, time, obsolescence, depletion. Straight line: (cost − residual value) ÷ life. Reducing balance: % × carrying amount. Dr depreciation, Cr accumulated depreciation. Carrying amount = cost − accumulated depreciation.
The interactive lesson includes the diagrams for this topic.
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