Depreciation of Non current assets

Non current assets are tangible items that are held for use in the production or supply of goods or services, for administrative purposes; and are expected to be used during more than one period. Non current assets are purchased to be used in the business for a long period of time.

For example:

Plant and Machinery

Land and Building

Fixtures and Fittings

The cost of non current assets comprises of its purchase price, including import duties and taxes and any costs directly attributable in bringing the asset to its present location and condition.

Depreciation

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life (number of years it will be used). Depreciation is an expense to the business for using non-current asset to generate economic benefits. It is provided to spread the cost of using non-current asset over its useful life. Depreciation is not the fall of value of a non-current asset.

Accounting entries to record depreciation

Debit Income Statement

Credit Provision for depreciation account

Factors affecting the useful life of non-current asset

1. wear and tear

2. obsolescence (outdated/old fashion)

3. damage by accident

4. technological improvement

Reasons for providing depreciation

1. Prudence concept: Profit will be overstated if depreciation is not charged against income during an accounting period.

2. Matching concept: Depreciation is an expense and must be properly matched against income generated during a financial year.

Methods of calculating depreciation

Straight line method

According to this method depreciation is calculated as a fixed percentage on cost. It is mostly used for non-current assets such as fixtures & fittings which is consistently used over its useful life. Under this method depreciation can also be calculated using the following formula.

Depreciation = (Cost - Residual Value) / Useful life

The residual value of a non-current asset is the estimated amount that an entity would obtain from the disposal of the asset.

 \$ Cost 1st January 2010 50 000 Depreciation for the year 2010 20/100 * 50 000 10 000 Net book value 2010 40 000 Depreciation for the year 2011 20/100 * 50 000 10 000 Net book value 2011 30 000

Reducing balance method

According to this method depreciation is a fixed percentage on its net book value each year. It is mostly used for machinery since it produces more during its first years of trading.

 \$ Cost 1st January 2010 100 000 Depreciation for the year 2010 20/100 * 100 000 20 000 Net book value 2010 80 000 Depreciation for the year 2011 20/100 * 80 000 16 000 Net book value 2011 64 000

Revaluation method

According to this method, depreciation is the difference between the value at start and the value at end. This method is appropriate for businesses that have many small items of non-current assets (example loose tools).

Depreciation = Balance at start + acquisition – disposal – Balance at end

Accounting entries

Acquisition/purchase of non-current assets

Debit Non current asset

Credit Cash / bank / trade payables

Depreciation charge for the year

Debit Income statement

Credit Provision for depreciation

Disposal of non-current assets

1. Cost of asset

Debit Disposal Account

Credit Non current asset

2. Proceeds from disposal

Debit Cash/bank

Credit Disposal

3. Accumulated depreciation

Debit Provision for depreciation

Credit Disposal