Section 4 of 7
Depreciation is a reduction in the value of a non-current asset over its useful life. Most non-current assets decline in value over time — the exception is land (though buildings can be depreciated).
The same amount is charged every year of the asset's life. Calculated on original cost.
Formula:
$$\text{Annual depreciation} = \frac{\text{Original cost} - \text{Scrap value}}{\text{Estimated useful life (years)}}$$
Example: A machine costs £25 000, estimated life 4 years, scrap value £1 000.
Annual depreciation = (25 000 − 1 000) ÷ 4 = £6 000 per annum
As a percentage: 6 000 ÷ 25 000 × 100 = 24% per annum
NBV over the asset's life:
| Year end | Cost | Accumulated depreciation | NBV |
|---|---|---|---|
| Year 1 | 25 000 | 6 000 | 19 000 |
| Year 2 | 25 000 | 12 000 | 13 000 |
| Year 3 | 25 000 | 18 000 | 7 000 |
| Year 4 | 25 000 | 24 000 | 1 000 |
A declining amount each year — more depreciation at the start, less at the end. Suitable for assets such as motor vehicles and plant and machinery.
Calculated on the net book value each year (except year 1, when it is on original cost).
Example: A machine costs £12 500, scrap value £5 120, depreciation policy 20% per annum reducing balance.
| Year | Calculation | Depreciation | Accumulated dep | NBV |
|---|---|---|---|---|
| Year 1 | 12 500 × 20% | 2 500 | 2 500 | 10 000 |
| Year 2 | 10 000 × 20% | 2 000 | 4 500 | 8 000 |
| Year 3 | 8 000 × 20% | 1 600 | 6 100 | 6 400 |
| Year 4 | 6 400 × 20% | 1 280 | 7 380 | 5 120 |
| Statement | Treatment |
|---|---|
| Income statement | Annual depreciation charge shown as an expense in the less expenses section |
| Statement of financial position | Accumulated depreciation to date is deducted from cost in the non-current assets section to give NBV |
Key rule for accumulated depreciation: The depreciation figure in the SFP is the cumulative total from the trial balance (i.e. depreciation from previous years) plus the current year's depreciation charge calculated for the income statement.
Example: Trial balance shows office equipment depreciation £5 455 (prior years). Current year charge = £2 730. Accumulated depreciation in SFP = 5 455 + 2 730 = £8 185
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