11 Depreciation
Depreciation: loss in value of a non-current asset as a result of wear & tear, obsolescence, depletion and
passage of time.
Why?
• Distribute cost of asset over useful working life
• Matching principle- match costs (depreciation charged) with revenue earned in an accounting
year
Reason: 1. Wear & tear through usage e.g. car with high mileage->low value
2. obsolescence: development of effecient technology to produce the same good or replacement of
goods they helped produce (lose value even if completely physically capable)
3. depletion/exhaustion: depreciation from extraction of minerals/resources from non-current asset e.g.
mines, quarries, oil wells etc.
4. passage of time: non-current assets acquired for a limited time period lose value as time passes. E.g.
lease of premises for a given number of years.
=>Accounting concepts
1. Matching- cost of using asset to earn revenue matched in SOP/L with revenue earned
2. Prudence- prevents overadding profits & non-current assets
3. Consistency- method of depreciation used consistently from one accounting period to another.
Importance of consistency:
Depreciation has a major affect on profits and assets and can change how stakeholders view value and
performance of business. So, accounting method can only be changed if an accountant can
demonstrate that new method will provide a ‘true & fair’ view of the way a machine is losing value.
Example, not to raise profit to attract investors or lower profits for tax evasion. This allows fair and better
comparison of financial statements.
Methods:-
1. Straight-line method
Same depreciation on cost every year.
(cos 𝑡 − 𝑟𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒)
𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟 =
𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑢𝑠𝑒𝑓𝑢𝑙 𝑙𝑖𝑓𝑒 𝑖𝑛 𝑦𝑒𝑎𝑟𝑠
2. Reducing balance method
3. Revaluation method
For a lot of small items thats hold little value individually but high collective value
Depreciation= cos 𝑡 𝑎𝑡 𝑠𝑡𝑎𝑟𝑡 + 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 𝑑𝑢𝑟𝑖𝑛𝑔 𝑦𝑒𝑎𝑟 − 𝑣𝑎𝑙𝑢𝑎𝑡𝑖𝑜𝑛 𝑎𝑡 𝑦𝑒𝑎𝑟𝑒𝑛𝑑
Depreciation: loss in value of a non-current asset as a result of wear & tear, obsolescence, depletion and
passage of time.
Why?
• Distribute cost of asset over useful working life
• Matching principle- match costs (depreciation charged) with revenue earned in an accounting
year
Reason: 1. Wear & tear through usage e.g. car with high mileage->low value
2. obsolescence: development of effecient technology to produce the same good or replacement of
goods they helped produce (lose value even if completely physically capable)
3. depletion/exhaustion: depreciation from extraction of minerals/resources from non-current asset e.g.
mines, quarries, oil wells etc.
4. passage of time: non-current assets acquired for a limited time period lose value as time passes. E.g.
lease of premises for a given number of years.
=>Accounting concepts
1. Matching- cost of using asset to earn revenue matched in SOP/L with revenue earned
2. Prudence- prevents overadding profits & non-current assets
3. Consistency- method of depreciation used consistently from one accounting period to another.
Importance of consistency:
Depreciation has a major affect on profits and assets and can change how stakeholders view value and
performance of business. So, accounting method can only be changed if an accountant can
demonstrate that new method will provide a ‘true & fair’ view of the way a machine is losing value.
Example, not to raise profit to attract investors or lower profits for tax evasion. This allows fair and better
comparison of financial statements.
Methods:-
1. Straight-line method
Same depreciation on cost every year.
(cos 𝑡 − 𝑟𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒)
𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟 =
𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑢𝑠𝑒𝑓𝑢𝑙 𝑙𝑖𝑓𝑒 𝑖𝑛 𝑦𝑒𝑎𝑟𝑠
2. Reducing balance method
3. Revaluation method
For a lot of small items thats hold little value individually but high collective value
Depreciation= cos 𝑡 𝑎𝑡 𝑠𝑡𝑎𝑟𝑡 + 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 𝑑𝑢𝑟𝑖𝑛𝑔 𝑦𝑒𝑎𝑟 − 𝑣𝑎𝑙𝑢𝑎𝑡𝑖𝑜𝑛 𝑎𝑡 𝑦𝑒𝑎𝑟𝑒𝑛𝑑
