Depreciation and disposal of non-current assets

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Cambridge O Level Accounting 7707

Depreciation and Disposal of Non-current Assets

The big idea: A non-current asset is used up over several years, so part of its cost is charged as an expense in each year it helps earn revenue. When it is sold, the disposal account compares what it was worth in the books with what it fetched.

Summary — What This Chapter Covers

Depreciation is the estimated loss in value of a non-current asset over its useful life.
It is provided to match the cost of the asset against the revenue it helps earn, and to show a realistic value in the statement of financial position.
Three methods: straight-line, reducing balance and revaluation.
Entries: debit Income statement (depreciation), credit Provision for depreciation. The asset account stays at cost.
On sale, a disposal account collects cost, accumulated depreciation and proceeds; the balance is a profit or loss on disposal.

1. What Depreciation Is and Why It Is Provided

Syllabus 4.2 · Paper 1 & 2

Spreading the cost over the useful life

Depreciation is the estimated loss in value of a non-current asset over its useful economic life. The causes are wear and tear through use, obsolescence (the asset is out of date or replaced by better technology), the passage of time (a ten-year lease runs out) and depletion (a mine is worked out).

Reasons for accounting for depreciation:

Matching: the cost of the asset is charged against the revenue of each year it helps to earn.
The statement of financial position shows the asset at a more realistic value (net book value = cost − accumulated depreciation).
Prudence: profit is not overstated, so the owner does not take out too much as drawings.

Depreciation is a non-cash expense: no money leaves the business when it is charged.

Practice Question 1

Explain two reasons why a business should provide for depreciation on its delivery vans.

2. The Three Methods

Syllabus 4.2 · Paper 1 & 2

Straight-line, reducing balance, revaluation

Straight-line (same charge every year) Annual depreciation = (Cost − Residual value) ÷ Useful life in years
or a percentage of cost each year

Reducing balance (bigger charge in early years) Annual depreciation = Rate % × Net book value at the start of the year

Revaluation (small items such as loose tools) Depreciation = Opening value + Purchases in the year − Closing valuation

Worked Example: straight-line

Machinery costs $24,000, has a residual value of $4,000 and a useful life of 5 years. Calculate the annual depreciation.

Worked example: reducing balance

A van costs $30,000 and is depreciated at 20% a year using the reducing balance method. Calculate the depreciation for each of the first three years.

	Net book value at start $	Depreciation (20%) $	Net book value at end $
Year 1	30,000	6,000	24,000
Year 2	24,000	4,800	19,200
Year 3	19,200	3,840	15,360

Worked Example: revaluation

Loose tools were valued at $2,400 on 1 January. Tools costing $900 were bought during the year. On 31 December they were valued at $2,650. Calculate the depreciation.

Method	Suits	Feature
Straight-line	Assets used evenly, e.g. fixtures, buildings	Same charge each year; easy to calculate
Reducing balance	Assets that lose more value early, e.g. vehicles, computers
Revaluation

4. Disposal of Non-current Assets

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Also in the full note

The asset stays at cost; the provision builds up
The disposal account finds the profit or loss

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Depreciation and disposal of non-current assets