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07. ACCOUNTING FOR DEPRECIATION AND
DISPOSAL OF NON-CURRENT ASSETS
Objective of the lesson –
a) Explain the causes of depreciation.
b) Distinguish between straight line and reducing balance methods of depreciation.
c) Calculate and record depreciation in the books of account.
d) Calculate and record profit or loss of disposal of non-current assets.
Introduction
Depreciation is the annual estimated loss in value of a non-current asset over its expected
working life.
Purchase of a non-current is a capital expenditure.
7.1 Causes of depreciation
Physical deterioration –non-current assets lose its value due to wear and tear in normal
usage.
Passage of time - assets become obsolete with time as new and more efficient assets become
available.
Depletion – the worth of the asset reduces as the value is taken from the asset. This is related
to non-current assets such as oil wells, quarries and mines.
Economic reasons – non-current assets may become inadequate as it no longer can meet the
needs of the business.
7.2 Methods of calculating depreciation
When a business selects a method of depreciation it should make sure that the cost of the non-
current asset is fairly distributed over the years which the business benefits from its use. Once a
method of depreciation is selected it should apply it year-on-year. This is an application of the
consistency principle.
A business should consider the following factors before selecting a depreciation method.
- How long is the asset expected to last?
- What will be its scrap (residual value) when it is put out of use?
- How to measure the benefits from the use of the asset?
There are two methods of depreciation
- Straight line method
- Reducing balance method
SUBJECT: EDEXCEL IGCSE ACCOUNTING
TEACHER: MURSHID MOHIDEEN
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Straight line method (Equal installment method)
The annual depreciation is calculated as a percentage on the cost of the non-current asset. The
annual depreciation is equal throughout the life of the asset. There are two formulas for
calculating depreciation using the straight line method as shown below.
1.
Cost – scrap value
_______________
Number of years
Example 1:
Steve bought machinery at a cost of $100,000 on 1st January 2013. And expects to use it for 10
years and dispose it off at a price of $ 10,000.
Calculate the annual depreciation for the years ended 31st December 2013, 2014 and 2015.
Depreciation at:
31st December 2013 (100,000-10,000) / 10years = $ 9000
31st December 2014 (100,000-10,000) / 10years = $ 9000
31st December 2015 (100,000-10,000) / 10years = $ 9000
Example 2:
Bought a motor van for $100,000 on 1st of January 2013 and it’s expected to be depreciated at a
rate of 20% per annum on cost (straight line method).
Depreciation will be calculated as follows:
Year workings depreciation Provision for depreciation Net book value
31st Dec 2013 100,000*20% 20,000 20,000 80,000
31st Dec 2014 100,000*20% 20,000 40,000 60,000
31st Dec 2015 100,000*20% 20,000 60,000 40,000
31st Dec 2016 100,000*20% 20,000 80,000 20,000
31st Dec 2017 100,000*20% 20,000 100,000 Nil.
SUBJECT: EDEXCEL IGCSE ACCOUNTING
TEACHER: MURSHID MOHIDEEN
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2. Reducing (Diminishing) balance method
The annual depreciation is calculated as a percentage of the Net Book Value of the non-current
asset. Larger proportion of the cost of the asset is depreciated in the early years of the life of the
asset.
Example 3:
Bought fixtures and fittings on 1st January 2013 at a cost of $ 50,000. And the company decides
to depreciate the asset at a rate of 20% per annum on reducing balance method.
Provision for
Year Working Depreciation Net book value
depreciation
31st Dec 2013 50,000*20% 10,000 10,000 40,000
31st Dec 2014 40,000*20% 8,000 18,000 32,000
31st Dec 2015 32,000*20% 6,400 24,400 25,600
31st Dec 2016 25,600*20% 5,120 29,520 20,480
31st Dec 2017 20,480*20% 4,096 33,616 16,384
Net Book Value = Cost – Provision for depreciation
7.3 Recording depreciation in the ledger
Recording depreciation using straight line and reducing method.
Each type of non-current asset has two ledger accounts:
- The non-current assets (cost) account (always has a debit balance)
- The provision for depreciation of the non-current asset account (recording the
depreciation) (always has a credit balance)
When the asset is purchased (during the year)
Debit – The non-current asset account
Credit – cash / bank / supplier’s account
Record depreciation of non-current asset (at the year-end)
Debit – Income statement (profit and loss account)
Credit – Provision for depreciation account
At the year-end both the ledger accounts should be balanced.
SUBJECT: EDEXCEL IGCSE ACCOUNTING
TEACHER: MURSHID MOHIDEEN
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7.4 Disposal of non-current assets
Double entry to record disposal of non- current assets
1. Eliminate the ‘cost’ of the disposing non-current asset
Debit – Disposal account
Credit – non-current asset (cost) account
2. Eliminate the provision for depreciation of the disposing non-current asset
Debit – Provision for depreciation account
Credit – Disposal account (By the provision for depreciation amount of disposing asset)
3. Record the sales proceed of fixed asset
Debit – Bank/Cash/Debtor account
Credit – Disposal account
4. Profit or loss on disposal should be calculated
If it’s a profit on disposal:
Debit – disposal account
Credit - income statement (profit and loss account)
If it’s a loss on disposal :
Debit - income statement (profit and loss account)
Credit - disposal account
Depreciation and the accounting concepts
The cost of the non-current asset is not charged in the year of purchase at it benefits the
business for several years. As per matching concept, the capital expenditure is spread among
the years the asset has helped the business to generate revenue. The cost of the non-current
asset is spread over the years which benefit from the use of that asset.
Depreciation of non-current asset is also an application of the prudence concept. Depreciating
the non-current assets helps the business to not overstate the profit of the business and not
over-value the non-current assets in the statement of financial position. This over-rides the
historic-cost concept to ensure that the non-current assets are shown a more realistic value.
SUBJECT: EDEXCEL IGCSE ACCOUNTING
TEACHER: MURSHID MOHIDEEN
