ACCOUNTING

YEAR 1
WEEK 5

FIXED ASSETS

AND

DEPRECIATION

DR ANDRONIKI TRIANTAFYLLI

QUEEN MARY UNIVERSITY OF LONDON

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 READINGS

•Accounting and Finance: An

Introduction, 9/E
•Peter Atrill, Eddie McLaney,
Pearson Education, 2018

• CHAPTER 3, PP. 95-104

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 De-valuation of assets

LEARNING
Different methods of
OUTCOME depreciation
S

Effect on the financial

statements

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 •Capital expenditure
•To acquire fixed assets for use in
the business (not for resale)
•Expenditure on existing fixed
assets to increase their earnings capacity CAPITAL
AND
•Revenue expenditure REVENUE
•Expenditure on current assets EXPENDITUR
(stocks for resale) E
•Expenditure relating to running
the business (expenses)
•Expenditure on maintaining the
earning capacity of the business (repairs
and renewals)

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 FIXED ASSETS AND
DEPRECIATION
Types of fixed assets :
tangible and intangible
Matching – the cost of the
asset is matched against the
revenues generated by its use
Tangible assets are used by a
business for a number of
years. Assets also wear out
with use over time. Therefore
we need to spread the cost of
the fixed asset over these
years.
Depreciation is a non-cash
accounting entry
Depreciation is the measure of
the wearing out, consumption
or other reduction in the
useful economic life of a fixed
asset.
Depreciation is a non-cash
expense
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 Depreciation is based on:
Calculating A) the cost of the asset
B) the expected residual or
depreciation scrap value at the end of the
period.

Factors that affect the calculation of

depreciation

CALCULATIN Cost of asset

G
DEPRECIATI Estimated useful life of asset
ON
Residual or scrap value of the asset

Method of calculating depreciation

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7

DEPRECIATION IN THE FINANCIAL

STATEMENTS
In the Profit and Loss Account (Income Statement): Show the
annual depreciation as an expense
In the Balance Sheet : show the cost of the asset less the
accumulated depreciation (Net Book Value)
8

FIXED ASSETS IN THE BALANCE

SHEET

COST ACCUMULATED NET BOOK

DEPRECIATION VALUE

FIXED £ £ £
ASSETS

EQUIPMENT 50,000 10,000 40,000

VEHICLES 25,000 5,000 20,000

TOTAL 75,000 15,000 60,000

STRAIGHT- LINE
METHOD OF
DEPRECIATION
• This is the simplest method. The depreciation charge
is constant over the life of the asset and is calculated
as:

• Depreciation per annum= Cost- Residual Value

• Expected Useful Life

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 • An asset is purchased for £3,500. It has a
useful life of 3 years and a residual value of
EXAMPLE £500. What appears in the balance sheet and
in the income statement in respect of fixed
assets and depreciation at the end of year 3?
• Annual Depreciation= £3,500-£500 =£1,000
• Balance Sheet (Year 3):
• In the balance sheet, we present the
accumulated depreciation (i.e from all the
years we have the asset) I.e. £3,000
(because it is annual depreciation £1,000
per year * 3 years)
• Income Statement
• In the Income Statement, we present the
annual depreciation i.e. the depreciation
for one year only i.e. £1,000

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11

Graph of carrying amount against time using the

straight-line method
Carrying amount (£000) 80

60

40

20

0 1 2 3 4
Asset life (years)
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Straight-line method – an example

Cost of machine £78,124

Estimated residual value £2,000

Estimated useful life 4 years

£78,124-£2,000
Annual depreciation charge = = £19,031
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STRAIGHT-LINE
METHOD OF
DEPRECIATION
• The depreciation charge can
ALSO be calculated by writing
off a fixed percentage of the cost
of the asset.

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EXAMPLE

ABC Ltd. bought a

machine at a cost of
£4,000. The depreciation
is to be charged at a 25%
per annum on cost. It has
nil residual value.

Depreciation per
annum= £4,000* 25%=
£1,000 per year

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REDUCING BALANCE METHOD
OF DEPRECIATION

Reducing balance is useful

Under this method the
for assets which lose value
depreciation charge is
quickly in earlier years OR
higher in the earlier years
for assets which become
of the life of the asset.
outdated/obsolete quickly.

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 An item of plant is purchased for £1,000. Calculate the depreciation charge
in the first 5 years of its useful life, assuming that the depreciation rate
(based on the reducing balance) is 20% p.a.
Annual Depreciation

Year 1: £1,000*20%= £200

EXAMPL Year 2 : (£1,000- £200) *20%= £160

E Year 3 : (£1,000-£200-£160) *20%= £128

Year 4: (£1,000-£200-£160-£128) *20%= £102,4

Year 5:(£1,000-£200-£160-£128-£102,4) *20%= £81,92

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17

Graph of carrying amount against time using the

reducing-balance method

Carrying amount (£000) 80

60

40

20

0 1 2 3 4
Asset life (years)
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The reducing-balance method – an example

£
Cost of machine 78,124
Year 1 depreciation expense (60% of cost) (46,874)
Carrying amount 31,250
Year 2 depreciation expense (60% of carrying amount) (18,750)
Carrying amount 12,500
Year 3 depreciation expense (60% of carrying amount) (7,500)
Carrying amount 5,000
Year 4 depreciation expense (60% of carrying amount) (3,000)
Residual value 2,000
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Calculating an annual depreciation expense

Cost (fair value)

less

Residual value
equals

Depreciable amount

Year 1 Year 2 Year 3 Year 4

and so on
Depreciation Depreciation Depreciation Depreciation

Asset life (Number of years)

SUMMARY

Depreciation- a non cash

expense

Straight line vs Reducing

Balance

Impact on financial statements

•Do you have any questions
•Please e-mail me at:
a.triantafylli@qmul.ac.uk