Depreciation & non-current assets Flashcards
Depreciation
Definition?
Why do we need it?
Depreciation in the systematic allocation of a non-current asset over its useful economic life
We need it to spread the cost of a non current asset gradually over the years of its use and wearing out
Imagine farmer John writes a cheque and buys a tractor for £20,000. He will use it for five years and at the end of that time it will have no further use or value.
Is this purchase an example of revenue or capital expenditure?
Capital
John uses the bank a/c to buy a tractor for £20,000.
What is the double entry for this purchase?
The tractor is now in the _________ _______ as a ____ ________ ______
Each year we now need to take an element of this cost into the income statement as he is using the tractor to generate his _____
Dr Vehicles 20,000
Cr Bank 20,000
The tractor is now in the balance sheet as a non current asset
Each year we now need to take an element of this cost into the income statement as he is using the tractor to generate his sales
Calculation of Depreciation
Two common methods:
Straight line method
Charge an equal amount of depreciation every year
Reducing balance method
Charge more depreciation in the earlier years of use, less in the later years
Straight line method
What is the formula?
Example: An item costs £11,000, the residual value is £1,000 and the expected useful life is 4 years. What is the annual depreciation charge?
Annual Depreciation = Cost – Residual Value/
Estimated useful life
Annual Depreciation = 11,000 – 1,000/
4
= £2,500 p.a.
To spread the decline in value we might take the total cost of £20,000 and spread over the five years. Ie the value of the tractor in the balance sheet will reduce by £4,000 each year
Opening BS value Depreciation taken to IS Closing BS value
Year 1 £20,000 £4,000 £16,000
Year 2 £16,000 £4,000 £12,000
Year 3 £12,000 £4,000 £8,000
Year 4 £8,000 £4,000 £4,000
Year 5 £4,000 £4,000 £NIL
The Net Book Value (NBV) of a non current asset is its…
What do the terms in the formula mean?
The Net Book Value (NBV) of a non current asset is its historic cost minus all depreciation charged to date (accumulated depreciation) on that asset
Historic cost = original purchase price
Accumulated depreciation = total depreciation charged / taken to the Income Statement since purchase of the asset
Reducing balance method
What is it?
Example?
Apply a constant % of the Net Book Value every year
Example: An item costs £12,000 and is to be depreciated at a rate of 25% reducing balance
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Depreciation: Double Entry (what are the 2 effects)
What do we not do?
Dr Depreciation Charge (IS)
Cr Accumulated Depreciation (BS)
n.b we do NOT credit the non current asset directly
Disposal of non-current assets
When an asset is sold, it needs deleting from the accounts
The relevant assets must…(2)
Anything more than the NBV is a _____
Anything less than the NBV is a _____
- Cost must be removed
- Accumulated depreciation must be removed
Anything more than the NBV is a profit
Anything less than the NBV is a loss
