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 obsolescence (outdated/old fashion)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
