Year 12 Accounting

Revision Lesson
Depreciation
What is depreciation?
Depreciation occurs when a non-current asset falls in
value over time, for a variety of reasons including
wear and tear.

We consider two methods of estimating the value of

depreciation:
a) The straight line method, and
b) The reducing balance method
 The Straight Line Method
This method results in the SAME amount of depreciation
being calculated for each year that the asset is used.

The 2 formulae are:

Annual depreciation = % x original cost
Annual depreciation = original cost – estimated sales proceeds
Number of years use

The formula you choose depends on the information you are given
in the question…
 The Straight Line Method

Example 1
A machine cost £12,000 to buy, and will be depreciated by 20% per
annum. What is the depreciation for one year?
12,000 x 20% = £2,400
Example 2
A machine cost £15,000 to buy and is expected to be sold for £1,000
when it is planned to be sold in 7 years time. What is the
depreciation for one year?
(15000 – 1,000) ÷ 7 = £2,000
The Reducing Balance Method
This method results in a DIFFERENT amount of
depreciation being calculated for each year that the asset
is used.

The formula is:

Annual depreciation = % x Net Book Value
What is Net Book Value?
It is calculated as Original Cost – Accumulated Depreciation

This is the balance on the

Provision for Depreciation
Account
The Reducing Balance Method
Example
Information from the trial balance tells you that:
Original cost of a vehicle £45,000
Provision for Depreciation £12,195
Depreciation is to be calculated using the reducing balance method
at 10% per annum.

How much is the annual depreciation for the following year?

Annual depreciation = 10% x (45,000 – 12,195)
= £3,281 (round to the nearest £)
The Financial Statements
The amount of annual depreciation you calculate using the formula is
shown as an EXPENSE in the Income Statement.
This section
applies to
BOTH
The double entry is: methods
Debit Depreciation (expense)
Credit Provision for Depreciation (reduces the asset value in the SOFP)

The provision for depreciation builds up over time, because each year
another year’s worth of depreciation is added to the balance.

Example: Refer to the bottom of page 211, and page 212 in the
textbook
Example
Let’s use the previous example to be clear about what the financial
statements will look like:

The Income Statement will show (this is an extract):

Expenses:
Rent x
Insurance x
Depreciation: Vehicles 3,281
etc
Example

The SOFP will have the following format for the non-
current assets section:
Non-Current Assets
Cost (£) Accumulated Net Book Value (£)
Depreciation (£)
Vehicles x x x
Calculated
Machinery
as: Original
etc This figure is calculated as follows: Cost –
This figure is always the Last year’s provision for depreciation Accumulated
original cost of the (as shown in the trial balance) PLUS Depreciation
asset. It does not This year’s (calculated from the
change as the years go formula) depreciation
by
Example

The SOFP will have the following format for the non-
current assets section:
Non-Current Assets
Cost (£) Accumulated Net Book Value (£)
Depreciation (£)
Vehicles 45,000 15,476 29,524
Machinery
etc 12,195 + 3,281 45,000 – 15,476
How is this examined?
It is possible that you might be asked to prepare a
depreciation or provision for depreciation account.

It is more likely that this will be tested as part of a

longer question on Adjustments to Financial
Statements where you are asked to prepare an
Income Statement and/or a SOFP.
What’s next?
Before we practise some longer questions, please
make sure that you have watched the other revisionl
lessons on the other sections of this topic:

a) Accruals and Prepayments

b) Writing off an Irrecoverable Debt and Provision
for Doubtful Debts