Chapter 12- Depreciation and disposal of non-current assets

Recap - Capital and revenue expenditure and income

Expenditure:
Revenue expenditure-
Revenue expenses are costs for the day to day running of the business. Example- servicing a machine, buying goods,
paying rent, salary, depreciation etc. Revenue expenditure is charged as expenses in the income statement in an
accounting year.

Capital expenditure -
Capital expenditure is money spent by a business or organization on acquiring or maintaining fixed assets, such as
land, buildings, and equipment. These are included in the Noncurrent asset part of the statement of financial
position in an accounting year.

Capital expenditure Vs. Revenue Expenditure

The following table illustrates examples of capital and revenue expenditure

Capital expenditure Revenue Expenditure
Installation of heating system, Annual costs of heating system
Upgrades to computer system Power cost of computing system
New premises Repairs to premises
Painting new premises Repainting existing premises

Carriage inwards on new equipment Carriage inwards on stocks for resale

Installation costs of machinery Running costs of machinery

One-off license fee Annual road tax

Income:
Revenue receipt -
Revenue income is all the income you get as part of your normal trade - say from the sale of goods or services.

Capital receipt -
Capital income normally arises from the disposal of non-current assets - say if you sold one of the buildings from
which you trade then the profit would be capital income. (But if your trade was dealing in property then the profit on
the sale of a building would probably be revenue income.) moneys received as additional capital or from long term
loan is also capital receipts.

Depreciation
Recap- Non-current assets are used by the business for more than one accounting year.

What is depreciation?
Depreciation is an estimated loss in value of a non-current asset over its expected working life. It is an expense and
deducted from gross profit in the income statement to calculate profit for the year.

Causes of depreciation:
1. Physical deterioration-Some assets get worn or torn out due to its constant use in production.
2. Passage of time-Some assets has a set number of years as working life. Their value gets decreased with the
passage of time.
3. Economic reason- the NCA may become inadequate to support the production level required by the business.
Some equipment and machineries may become obsolete as newer and more efficient assets are now available.

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4. Depletion- this is for non-current assets like mine and wells. The worth of the asset reduces as value is taken from
the asset.

Reasons for providing (calculating) depreciation:

1. To calculate the correct profit or loss of a business for the year.
2. To show correct value of NCA in the statement of financial position of the business.
3. To spread the cost of non-current assets over their lives.
4. To match current year’s expenses against current years revenue (for which they were incurred). This is called
matching concept.
5. To comply with the matching and prudence concept.

Methods of depreciation:
There are three methods of providing depreciation

1. Straight line method: This is also termed as fixed instalment method. Under this method a fixed percentage on
original cost of NCA is written off every year. The depreciation charge remains the same every year.
The amount of depreciation is calculated as follows.

Formula: A. Annual depreciation = Cost of the Asset - Scrap or residual value

Expected useful life of the asset
Scrap or residual value is the estimated value of a non-current asset after the end of its useful life.

B. Annual depreciation = Cost of the NCA x Depreciation %

2. Reducing balance method: This is also known as diminishing balance method. Under this method, depreciation
is charged at a fixed rate on the netbook value of the NCA every year. The depreciation expense for the NCA will be
higher in the starting years and will get lower every year till its eventual disposal.

Annual depreciation = Net book value or Carrying value of the NCA X Depreciation %

Net book value or carrying value= Cost of NCA – Provision for depreciation of the NCA

Provision or accumulated depreciation- is the addition of all depreciation on a NCA charged every year since it was
purchased by the business till its eventual disposal.

3. Revaluation method: Sometimes it is not possible to maintain detailed records of certain types of fixed Assets,
such as very small items of equipment packing cases and hand tools. In such case the revaluation method is used.
Under this method the assets are revalued at the end of each year and this value is compared with the value at the
beginning of the period. The difference is treated as depreciation.

Annual depreciation = Opening balance of NCA + Purchases of NCA during the period – Disposal of NCA– Closing
balance of NCA

Q. State the situation when reducing balance and straight line depreciation should be used.
Answer-
Reducing Balance Method:
Reducing Balance Method is a useful way of calculating depreciation on assets, which operate faster, produce more
and perform more accurately when they are new.
Straight Line Method:
This is useful for those assets which provide equal benefits to the business for each year of their lives.

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 Journal entries for purchase, depreciation and disposals of NCA
Example of Non-current assets (NCA): Land and buildings, Premises, Equipment, Furniture and fixtures, Motor
vehicle, Machinery etc.
Date Details/ particulars Debit Credit $
$
1. For purchase of non- current assets
Non-current asset a/c (any type at cost) Dr. xxx
Cash/ Bank / Payables a/c Cr. xxx
2. For charging depreciation for the period
Income Statement Dr. xxx
Provision for depreciation a/c Cr. xxx
3. For disposal of non-current assets at cost price
Disposal a/c Dr. xxx
Non-current asset a/c (at cost) Cr. xxx
4. Cash receipt from disposal of NCA
Cash / Bank a/c Dr xxx
Disposal a/c Cr. xxx
5. Provision for depreciation of disposed NCA
Prov. for dep. (Prov. for dep. related to the disposed NCA only) Dr. xxx
Disposal a/c Cr. xxx
6. Loss on disposal of NCA
Profit and loss a/.c Dr. xxx
Disposal a/c Cr. xxx
7. Profit on disposal of NCA
Disposal a/c Dr. xxx
Income Statement Cr. xxx
Example- Four vehicles were purchased for $5000 each paying through cheque. The expected life of each
vehicle was 5 years. After three years of use a vehicle was sold for $3000 cash.

Workings- Straight line depreciation per vehicle per year = cost of the NCA/ expected life
= $5000/ 5 years= 1000 per year
Profit on disposal = Sales proceed- NBV of the vehicle = $ 3000- (cost- accumulated depreciation)
= 3000-{5000- (1000×3)} =$3000- $2000=$1000
Journal entry
Date Details/ particulars Debit Credit $
$
1. For purchase of non- current assets
Motor vehicle (5000×4)Dr. 20000
Bank Cr. 20000
2. For charging depreciation for the period
Income Statement (4 vehicle one year depreciation) Dr. 4000
Provision for depreciation a/c Cr. 4000
3. For disposal of non-current assets at cost price
Disposal a/c Dr. 5000
Non-current asset a/c (at cost) Cr. 5000
4. Cash receipt from disposal of NCA
Cash Dr 3000
Disposal a/c Cr. 3000
5. Provision for depreciation of disposed NCA
Prov. for dep. motor vehicle (one vehicle depreciation for three years ) Dr. 3000
Disposal a/c Cr. 3000
7. Profit on disposal of NCA
Disposal a/c Dr. 1000
Income Statement Cr. 1000

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 NCA cost account (any NCA)
Dr. Cr.
Date Details £ Date Details £
Balance b/d xxx Disposal (cost of the disposed NCA) xxx
Addition/cash/bank xxx

Balance c/d xxx

xxx xxx

Accumulated/ Provision for depreciation (any NCA)

Date Details £ Date Details £
Disposal xxx Balance b/d xxx
(Prov. for dep. of disposed NCA part xxx
only) Income Statement (depreciation xxx
Balance c/d xxx charge for the period)
xxx xxx

Disposal a/c (NCA)

Date Details £ Date Details £

NCA (Cost part) xxx Provision for depreciation (of disposed xxx
xxx NCA only)
Cash/bank (disposal proceed) xxx
Income statement (balancing xxx Income statement (balancing figure) xxx
figure) (if profit on disposal) (if loss on disposal)
xxx xxx
Note: Disposal accounts are always temporary. So there will be no Balance b/d or c/d

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 Worksheet
Exercise 1

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Solution-

i) Machinery- reducing balance method depreciation= (cost – provision for depreciation)× depreciation %
={(80000-60000) ×25%} +(18000×25%)
=5000+4500=9500
ii) Office furniture straight line method depreciation= Cost × Depreciation %
= (15000-1000) ×10%
= $1400
iii) Loose tool revaluation method depreciation = Opening NBV+ Addition – Disposal- Closing NBV
= 1050+630-1400
= 280

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d) Loss on disposal of furniture = Sale proceed- NBV of furniture
= 550-{(1000- (1000×10%×2)}
=250
Working
1 May 2008 – 30 April 2009 -1st year will be charged
1 May 2009 – 30 April 2010- 2nd year will be charged
1 May 2010 – 30 April 2011- 3rd year will not be charged

e) i) Net book value of machinery at 30 April 2011 = Cost – Accumulated depreciation

ii) Net book value of furniture at 30 April 2011
= (80000+18000) - (60000+ 9500)
= 28500
= Cost – Accumulated depreciation
= (15000-1000) – (5000-200+1400)
= 7800

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Exercise 2

Solution- Journal entry

2011 Motor vehicle Dr. 24000
April 1 Villa motors Cr. 2400

Dr. Solution- Accumulated/ Provision for depreciation -motor vehicle Cr.

Date Details $ Date Details $
2012 2012
March Balance cd 4800 March 31 Income statement 4800
31 (24000×20%)
4800 4800

2013 Disposal (12000×20%) 2400 2012 Balance bd 4800

Jan 23 April 1
March Balance cd 4320 2013 Income statement {(12000- 1920
March 31 2400) ×20%}
6720 6720
2013 Balance bd 4320
April 1

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 Dr. Disposal a/c (NCA) Cr.
Date Details £ Date Details £
2013 Motor vehicle (Cost part) 12000 2013 Provision for depreciation (of 2400
Jan Jan 13 disposed NCA only)
13
Cash/bank (disposal proceed) 6500
Income statement (balancing figure) 3100
(if loss on
disposal)
12000 1200

Note: Disposal accounts are always temporary. So there will be no Balance b/d or c/d in the end.

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Coach- Mohammad Yousuf Akter, Hotline-01671089144, 01916743556 Page 10
Exercise 3

Identify by ticking the appropriate box (✓) whether each statement about depreciation is true or false. The first one
has been completed as an example.

Solution (i)
Loss on disposal = Sales proceed – NBV of the NCA
= 8400- (16000-7000) = 8400-9000
= 600

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Solution (ii)
Reducing Balance Depreciation charge for the year ended 28 February 2016
= (Cost – accumulated depreciation) ×25%
= [(50000-16000)-(18400-7000)}×25%]+(20000×25%)
= $10650

Prepare the motor vehicles provision for depreciation account for the year ended 29 February 2016.
Balance the account and bring down the balance on 1 March 2016.

Solution
Dr. Accumulated/ Provision for depreciation -motor vehicle Cr.
Date Details $ Date Details $
2015 2015
May 31 Disposal 7000 March 1 Balance bd 18400
2016 Balance cd 2016 Income statement
Feb 28 22050 Feb 28 10650
29050 29050

2016 Balance bd 22050

March 1

Exercise 4
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Solution- Profit on disposal = Sale proceed- NBV of NCA
=9500- (1400-5040) = 540

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 Solution Journal entry for disposing motor vehicle B
Date Details Debit $ Credit $
2017 Disposal Dr 14000
June 30 Motor vehicle cost ac Cr 14000
Accumulated depreciation of motor vehicle B Dr 5040
Disposal ac cr. 5040
X Garage Dr. 9500
Disposal ac Cr. 9500
Disposal ac Dr. 540
Income statement Cr. 540

Solution-Reducing Balance Depreciation charge for the year ended 31 March 2018
= (Cost- provision for depreciation) ×20%
= [{(30000-14000) - (10800-5040)} ×20%]+ (18000×20%)
= {(16000-5760) ×20%} + 3600
= 2048+3600
= 5648

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