CHAPTER 12

DEPRECIATION OF NON CURRENT ASSETS

INTRODUCTION
Depreciation is an estimate of the loss in value of a non current asset over its expected working life.

Most of the non current assets of a business lose value over a period of time they are used by the
business. If the accounting records continue to show these assets at their cost prices then the
accounts will provide misleading information.

Special case for LAND… it doesn’t usually lose value (unless it is something like a well or mine
when value is removed from the land).

The cost of the NCA is spread over the years which benefit from the use of that asset.
For example:
At 1 January 2011, the company bought a new machinery cost at $1000. It has useful life for 4
years with no residual value. The company could allocate the depreciation of the machinery equally
$250 per year. The company received income from using the machinery $1,200 per year.

Calculation of profit
Profit 2011 = $1200 - $250 = $950
Profit 2012 = $1200 - $250 = $950
Profit 2013 = $1200 - $250 = $950
Profit 2014 = $1200 - $250 = $950

WRONG ANSWER
Profit 2011 = $1200 - $1000 = $200 (profit would be undertated)
Profit 2012 = $1200 - $0 = $1200 (profit would be overstated)
Profit 2013 = $1200 - $0 = $1200 (profit would be overstated)
Profit 2014 = $1200 - $0 = $1200 (profit would be overstated)

The depreciation is included as part of expenses in the Income Statement.

CAUSES OF DEPRECIATION
1. Physical deterioration (wear and tear)
This is the result due to the normal usage of the NCA.

2. Economic reason
The NCA may become inadequate as it can no longer meet the needs of the business.

3. Passage of time
This arises where a NCA has fixed life of a set number of years

4. Depletion
This arises in connection with non current assets such as wells and mines. The worth of the
asset reduces as value is taken from the asset.

METHODS TO CALCULATE DEPRECIATION

a. Straight line method
1st formula: (Cost – Residual Value) / Useful life
2nd formula: % depreciation x Cost
Example: On 1 July 2003, Kavita purchased fixtures costing $25000 and paid by cheque.
She estimated that she would be able to use the fixtures for 4 years and then be able
to sell them for $3000

Answer: Depreciation each year = ($25000 - $3000) / 4 years = $5500 per year

This method commonly used to calculate the depreciation of building.

b. Reducing balance method
1st formula: % depreciation x (Cost – Provision for Depreciation)
2nd formula: % depreciation x Book Value
Example: On 1 July 2003, Kavita purchased fixtures costing $25000 and paid by cheque.
She estimated that she would be able to use the fixtures for 4 years and then be able
to sell them for $3000. Rate of depreciation = 40% per annum

Answer: Depreciation for the year ended 30 June 2004 = 40% x ($25000 – 0) = $10000
Depreciation for the year ended 30 June 2005 = 40% x ($25000 – $10000) = $6000
Depreciation for the year ended 30 June 2006 = 40% x ($25000 – $16000) = $3600
Depreciation for the year ended 30 June 2007 = 40% x ($25000 – $19600) = $2160

This method commonly used to calculate the depreciation of equipment, machinery and
motor vehicles.

c. Revaluation method
Formula: Opening book value of NCA + Purchase new NCA – Closing
book value of NCA
Example: On 1 July 2003, Kavita purchased loose tools costing $25000 and paid by cheque.
She decided to revalue the loose tools at the end of each year.
On 30 June 2004, the fixtures were valued at $20500

Answer: Depreciation for the year ended 30 June 2004 = $0 + $25000 - $20500 = $4500

This method commonly used to calculate the depreciation of loose tools (small equipment)
The price is quite cheap.

CASE 1

CASE 2

CASE 3
On 1 January 2018, Nainci Ltd bought a machinery for $75 000 paid by cheque.
Nainci Ltd will use the machinery for three years, and then sell the machinery for $15 000.

The machinery is depreciated by 20% per annum using straight line method.

CASE 4
On 1 January 2018, Jumbo Ltd bought a machinery for $50 000 paid by cheque.
Jumbo Ltd will use the machinery for three years, and then sell the machinery for $15 000.

The machinery is depreciated by 25% per annum using reducing balance method.