Some notes are below.
Depreciation can be defined as the writing off (to Profit and Loss Account) of the cost of a fixed asset (or cost less estimated residual value) over its estimated useful life.
Virtually every business has fixed assets and therefore depreciation applies to almost every set of accounts produced.
The most common method of depreciation is the straight line method. By this method the cost of a fixed asset (less any estimated residual sales value to be received at the end of its useful life) is written off to the profit and loss account in equal annual installments as follows:
COST OF FIXED ASSET 100,000
ESTIMATED RES1DUAL SALES VALUE 20,000
AMOUNT TO BE WRITTEN OFF 80,000
ESTIMATED EXPECTED USEFUL LIFE
OF THE FIXED ASSET 4 YEARS
(UNDER THE STRAIGHT LINE METHOD) 20,000
At the end of the four years the asset would appear in the balance sheet with a net book value of £20,000 as follows:
FIXED ASSET AT COST 100,000
DEPRECIATION PROVISION (4 X 20,000) 80,000
NET BOOK VALUE 20,000
If the asset is sold for £20,000 the fixed asset would disappear from the balance sheet and the current asset of cash would increase by £20,000.
The accounting entries for depreciation are as follows:
(i) debit a depreciation (expense) account with the annual depreciation - close off this depreciation (expense) account at the end of the financial period and transfer the charge to the profit and loss account.
(ii) credit a depreciation (provision) account with each years depreciation.
(i) the provision for depreciation account holds (as a credit balance) the total cumulative depreciation charged on the asset since its acquisition.
(ii) The fixed asset account remains at cost.
The bookkeeping entries for the above would appear as follows:-
FIXED ASSET ACCOUNT
Year I Cash at bank 100,000
DEPRECIATION (EXPENSE) ACCOUNT
Year l Depreciation provision 20,000 Year l P&L A/C 20,000
Year 2 Depreciation provision 20,000 Year 2 P&L A/C 20,000
Year 3 Depreciation provision 20,000 Year 3 P&L A/C 20,000
Year 4 Depreciation provision 20,000 Year 4 P&L A/C 20,000
DEPRECIATION (PROVISION) ACCOUNT
Year I Depreciation expense 20,000
Year 2 Depreciation expense 20,000
Year 3 Depreciation expense 20,000
Year 4 Depreciation expense 20,000
PROFIT AND LOSS ACCOUNT
Year I Depreciation charge for year 20,000
Year 2 Depredation charge for year 20,000
Year 3 Depreciation charge for year 20,000
Year 4 Depreciation charge for year 20,000
BALANCE SHEETS (EXTRACTS):-
Year l Year 2 Year 3 Year 4
£ £ £ £
FIXED ASSET 100,000 100,000 100,000 100,000
PROVISION (20,000) (40,000) (60,000) (80,000)
NET BOOK VALUE 80,000 60,000 40,000 20,000
Net Book Value (NBV) is sometimes called Written Down Value (WDV).
REDUCING BALANCE METHOD
Under the straight line method the amount to be written off (£80,000) was charged to profit and loss account in equal annual sums of £20,000. In other words a depreciation rate of 25% per annum was used.
Under the reducing balance method a fixed percentage is applied to the net book value (amount still to be written off).
Applying a fixed percentage of 60% (as an example) to the above example gives the following:-
Amount to be written off 80,000
Year 1 deprecation at 60% 48,000 (60% x 80,000)
NET BOOK VALUE 32,000
Year 2 depreciation at 60% 19,200 (60%x 32,000)
NET BOOK VALUE 12,800
Year 3 depreciation at 60% 7,680 (60%x 12,800)
NET BOOK VALUE 5,120
Year 4 depreciation at 60% 3,072 (60%x 5,120)
NET BOOK VALUE 2,048
Year 5 depreciation at 60% 1,229 (60% x 2,048)
NET BOOK VALUE 819
Year 6 depreciation at 60% 492 (60%x 819)
NET BOOK VALUE 327