Accounting Environment

Chapter 7 Depreciation and Disposal of Non-

Current Assets
Getting started

• One of the basic principles of accounting is that non-current assets should be

valued at cost.
• Non-current assets might lose value for many reasons. (Depreciation)
• Two common methods: straight line method and reducing balance method
• Depreciation is expenses and closely linked to the accounting concept of
accruals/matching and consistency.
Non-current Assets
• Assets used by the business for the long-term.
• Examples are Machinery, Computer, Land, Building, Motor vehicles. Most
of the assets have limited useful life.
• Depreciation is the annual loss in value of a non-current asset over its
useful life.
• Depreciation is to be calculated annually at the end of financial year.
• Depreciation depends on the estimated useful life of the assets.
• Land should not be depreciated (increase in value and has no limited
life)
• Two common depreciation methods are straight line method and
reducing balance method.
Causes of Depreciation
• Non-current assets tend to fall in value (depreciate) for various reasons.
• Physical depreciation
• Wear and tear
• Erosion, rust, rot and decay
• Economic factors
• Obsolescence (out of date due to advanced technology/change in process)
• Inadequacy (no longer used because of the growth and change in the size of
the business due to new regulations)
• The Time factor (legal life fixed in terms of years; 10 years lease of property,
amortization)
• Depletion (wasting nature such as the extraction of raw materials from mines or
quarries, oil from oil wells)
Scrap Value of Non-current Assets
• After the asset has gone through its useful life, it may be disposed of.
• However, given that a broken down or obsolete asset may still have
some residual value, some businesses can dispose of the asset by
selling it for its current value.
• Scrap value is the worth of a physical asset’s individual components
when the asset itself is deemed no longer usable.
Straight Line Method
• Equal annual depreciation is charged over the useful life of the asset.
• Depreciation is calculated on the cost of the non-current asset.
• Depreciation charge = or (cost – scrap value) * % given

For example; a business purchases a car for $ 10000. It decides to keep it for four years. The
car is to be depreciated @ 25% per annum.

Year Annual Depreciation Accumulated Carrying Value (Net Book Value)

(Cost* %) Depreciation (Cost –Acc. Depreciation)

1 $ 10000* 25% = $ 2000 $ 2000 10000-2000 = $ 8000

2 $ 10000* 25% = $ 2000 $ 4000 10000- 4000 = $ 6000

3 $ 10000* 25% = $ 2000 $ 6000 10000-6000 = $ 4000

Case study: straight line
• On 1.1.2007, the business purchased Office Equipment $ 25000, paid
by cheque. Its estimated scrap value is $ 1000 at the end of useful life.
• Provide depreciation @ 10% straight line.
• Prepare Office Equipment Account.
• Prepare Provision for depreciation account for three years. The
business ends its financial year on 31 December.
Reducing Balance Method
• Annual depreciation Charge is higher at the earlier life of the asset and become lower
towards the end of the asset’s life time
• Percentage is applied on the carrying value (Net Book Value).
• carrying value = Cost - accumulated depreciation
• Example 2: A machine is bought for $ 10000 and depreciation is to be charged @20%
using reducing balance.
Year Annual Depreciation Accumulated Carrying Value
(Carrying Value * %) Depreciation (Cost –Acc. Depreciation)

1 $ 10000* 20% = $ 2000 $ 2000 10000-2000 = 8000

2 $ 8000 * 20% = $ 1600 $ 3600 10000-3600 = 6400

3 $ 6400 * 20% = $ 1280 $ 4880 10000-4880 = 5120

 Case study: Reducing Balance
On 1.1.2007, the business purchased Office Equipment $ 25000, paid by
cheque. Its estimated scrap value is $ 1000 at the end of useful life.
Provide depreciation @ 10% Reducing balance method.

Calculate annual depreciation for three years ended 2007, 2007, and 2009.
Prepare Provision for depreciation account for three years. The business
ends its financial year on 31 December.
 Revaluation Method
• The annual depreciation charge is based on comparing the estimated value
of a group of non-current assets at the end of a financial year with the value
at the beginning of the financial year.
• This is the case for that it is time consuming to keep detail records of some
groups of non-current assets that individually are of limited value. (tools
used by the mechanic, crockery in the restaurants)
• Example:
• Value of crockery on 1st Jan 2018 $4800;
• New crockery purchased during 2018 $ 1400;
• value of crockery on 31st December 2018 $5300
• Depreciation: Opening Value + New purchased- Closing Value
= 4800 + 1400 – 5300 = 900 (depreciation for 2018)
Recording Transactions

• When Non-current asset is purchased, the cost price is recorded in the

respective non-current account
• Any depreciation charged on that asset is
• Income Statement Dr
• Provision for Depreciation A/C – Cr
• The book value of the non-current asset account is shown on the statement
of financial position
• Example 3: Pg.90 (Edexcel)
• Example 4:
• Practice: No.10, 11, 12 (Edexcel: pg97)
• Practice: N0.1 and 2 (CIE pg.181)
End of Chapter Questions
(1) Define the term depreciation.
Depreciation is the annual charge of non-current assets.
(2) Explain the main differences between straight line and reducing balance depreciation.
Straight line depreciation means equal annual charge of depreciation over the useful life of
an asset while reducing balance depreciation means annual charge of depreciation has decreased
year by year.
(3) What two concepts are applied when calculating depreciation?
Matching concept and consistency concept
(4) What is meant by the term “carrying value”.
carrying value is the value of asset after deducting the accumulated depreciation
(5) Which account is debited and which account is credited with the annual charge of depreciation.
Annual charge of depreciation is debited in income statement and credited in provision for
depreciation account.
 Disposal of a Non-current Asset
• When an asset is sold, Profit and loss on the sale of the asset must be
calculated. Profit on disposal must be transferred to other income section of
income statement and loss on disposal must be transferred to other
expenses section of the income statement.
• Profit or loss on disposal
Cash Proceeds from disposal ……………$ 5000
(-) Net Book Value of the asset
Cost of the assets…………..$ 16000
Accumulated Depreciation (12000) 4000
Profit on disposal ……………………………….. 1000
 Example of disposal
(1) The records to 31 Dec 2016 show that the cost of the machine was $
2000. A total of $ 976 has been written off as depreciation. If the machine is
sold on 2 January 2017 for $ 1070. Calculate the profit or loss on disposal.
(2)The records to 31 Dec 2016 show that the cost of the machine was $ 2000.
A total of $ 976 has been written off as depreciation. If the machine is sold on
2 January 2017 for $ 950.
Practice for Disposal
(1) On 1 April 2017, Rosa purchased two motor van costing $ 60000
each. On 1 January 2019 she sold one of the motor van for $ 40000.
The sales proceeds were received by cheque.
Depreciation is charged at 20% per annum using the reducing balance
method.
A full year’s depreciation is charged in the year of purchases and none
in the year of disposal.
Prepare the Motor Van Account, Provision for depreciation –Motor Van
Account and Disposal of Motor Van Account for the year ended 31
March 2019.
 Practice for Disposal
(2) On 1 April 2017, Nilar purchased two motor van costing $ 40000 and $
20000 respectively. On 1 January 2019 she sold one of the motor van for
$ 18000, the original cost is $ 20000. The sales proceeds were received by
cheque.
Depreciation is charged at 20% per annum using the straight line method
A full year’s depreciation is charged in the year of purchases and none in
the year of disposal.
Prepare the Motor Van Account, Provision for depreciation –Motor Van
Account and Disposal of Motor Van Account for the year ended 31 March
2019.