IGCSE Depreciation of Non-Current Asset
We will learn what depreciation is and how to calculate it using the straight-line method, reducing-balance method and revaluation method. We will also learn to record depreciation in the journal and ledger accounts, how it is presented in the Income Statement and Statement of Financial Position.
Related Lessons:
Purpose of Depreciation
Depreciation is the process of accounting for the loss in value of a non-current asset. Businesses record this loss to match the cost of the asset with the revenue it helps to generate. This ensures that the true profit or loss for the accounting period is reported.
Non-current assets lose their value due to factors such as wear and tear, obsolescence, passage of time, legal limits, or depletion.
What is Depreciation
Depreciation is the allocation of the original cost of a non-current asset over its useful life. It is the amount that the non-current asset loses each year.
Accumulated depreciation is the total amount a non-current asset loses to date. It is calculated by adding up the depreciation expense for each year from the time the asset is purchased until today.
Net book value is the value of a non-current asset after deducting accumulated depreciation from its cost.
Net book value = Cost − Accumulated depreciation
Straight-line Method of Depreciation
Depreciation calculated using the straight-line method remains constant over the asset’s useful life. There are two formulae used in the calculation of depreciation by the straight-line method.
Formula 1 of straight-line method:
(Cost – Scrap value) / Useful life
Formula 2 of straight-line method:
(Cost – Scrap value) x Rate of depreciation in %
Reducing-Balance Method of Depreciation
Depreciation calculated using the reducing-balance method reduces over the asset’s useful life. This is because the cost of the asset stays the same, but accumulated depreciation increases as the asset ages. As a result, the net book value decreases, and this lower value is used to calculate depreciation.
Formula of reducing-balance method:
(Cost – Accumulated depreciation) x Rate of depreciation in %
Revaluation Method of Depreciation
Depreciation using the revaluation method does not follow a fixed pattern like the straight-line or reducing-balance methods. This is because the depreciation amount is calculated by comparing the value of the non-current asset at the beginning of the accounting period with its value at the end of the period.
As a result, the effect of depreciation on profit fluctuates, since the depreciation expense may increase or decrease in each accounting period.
Formula of revaluation method:
Value of non-current asset at the beginning of the accounting year add Purchases during the year minus Disposal during the year minus Value of non-current asset at the end of the accounting year.
Recording Depreciation
Depreciation is an expense since the business loses value on its non-current asset, while Accumulated depreciation is a contra asset as it is deducted from the cost of the non-current asset.
To record depreciation:
Dr Income statement
Cr Provision for depreciation of asset
At the end of the financial year, the balances in the provision for depreciation account are brought forward to the next accounting year.
In the financial statements:
Depreciation is recorded as an expense in the income statement.
Accumulated depreciation is recorded as a deduction against the cost of the non-current assets in the statement of financial position, to derive at the net book value of the non-current asset.