0452 · 4.2Accounting for depreciation and disposal of non-current assets

Non-current assets and double entry

0:00Priya’s Printworks buys equipment that will be used for several years. Paying for it happens once, but using it helps the business throughout that time. This video covers the meaning of depreciation, the need to account for it, and the straight-line, reducing balance and revaluation methods. It then covers journal entries, the three ledger accounts for a sale and the profit or loss on disposal. Assets are resources owned or controlled by a business that bring future benefit.

0:24Priya’s printing equipment, machinery and loose tools will be used for years, not sold to customers. Non-current assets are assets held for continuing use in the business rather than for resale. Delivery vehicles and premises belong in the same category. Double entry means every transaction is recorded as a debit in one account and a credit of the same amount in another. An asset account normally has a debit balance, so an increase in an asset is recorded as a debit.

0:49Money leaving the bank is recorded as a credit in the bank account. Liabilities are amounts the business owes to others. Any rise in a liability goes on the credit side. On the first of January, two thousand twenty-seven, Priya buys equipment for sixteen thousand dollars and pays through the bank. Debit the equipment account because the business gains a resource, and credit the bank account because its money falls.

1:10Buying on credit means receiving something now and agreeing to pay for it later. On the same day, Priya buys machinery costing thirty-two thousand dollars on credit from Ridge Machines. For the machinery, debit the machinery account because another resource is gained, and credit Ridge Machines because the amount owed rises. Each entry ends with a short narration that explains the transaction. Sixteen thousand dollars plus thirty-two thousand dollars equals forty-eight thousand dollars.

1:35Total debits are forty-eight thousand dollars, and total credits are also forty-eight thousand dollars.

Why depreciation is charged

1:40Revenue is the income a business earns from its main activity, such as selling goods or providing services. Using equipment to earn revenue gradually reduces its value. Expenses are the costs used up in running the business and earning revenue during a period. Profit is the amount by which revenue exceeds expenses for a period. Useful life is the estimated period for which an asset will be used by the business.

2:03Over that period, the asset gradually loses value. Depreciation is the loss in value of a non-current asset over its useful life. It is an estimate that is charged as an expense in each year of use. Equipment can lose value through wear and tear as its parts deteriorate. Passage of time can reduce usefulness even when an item receives little use. Obsolescence occurs when newer technology makes existing equipment outdated.

2:27Depletion applies when a resource is used up, such as material extracted from a quarry. The need to account for depreciation comes first from the matching concept. The matching or accruals concept means income and expenses are recorded in the period to which they relate, not when cash is received or paid. Equipment used across several years should therefore contribute an expense to each of those years. Charging the whole cost in the year of purchase would understate that year’s profit and overstate the profits of later years.

2:54Prudence means that profits and assets are not overstated, and losses and liabilities are not understated. Recording depreciation recognises that part of the equipment’s benefit has been used up. Financial statements are summaries that show a business’s profit or loss for a period and what it owns and owes at a date. Depreciation lets them show a realistic value for each non-current asset. Owner’s equity, also called capital, is the owner’s investment in the business, or the amount the business owes the owner.

3:22A statement of financial position shows assets, liabilities and owner’s equity at a particular date. Each non-current asset appears there at its carrying amount. Accumulated depreciation is the running total of depreciation charged on an asset since it was acquired. Carrying amount is the asset’s cost less its accumulated depreciation. This is a recorded value based on cost, not the price the asset would fetch if sold. Earlier depreciation has simply used up part of that cost.

3:48Charging depreciation involves no new payment from the bank. The payment occurred when Priya bought the equipment, or will occur when she settles a supplier’s account. The annual charge records the part of its cost used up during that year. Depreciation also creates no separate fund of money for buying a replacement. Residual value is the estimated amount recoverable when the useful life ends. Cost, residual value and useful life together decide how much cost is charged during ownership.

4:14Different depreciation methods spread that cost in different patterns.

Calculating depreciation methods

4:18The straight-line method charges the same amount each year. Subtract residual value from cost to find the amount expected to be used up. Then divide that amount by useful life to share it equally across the years. A question may instead specify a fixed percentage of cost as the annual charge. Priya’s equipment costs sixteen thousand dollars and has an estimated residual value of four thousand dollars. Its useful life is four years.

4:42Sixteen thousand dollars minus four thousand dollars equals twelve thousand dollars. Dividing twelve thousand dollars by four gives annual depreciation of three thousand dollars. At the end of two thousand twenty-seven, sixteen thousand dollars minus three thousand dollars leaves a carrying amount of thirteen thousand dollars. A second charge in two thousand twenty-eight brings it to ten thousand dollars, because thirteen thousand dollars minus three thousand dollars is ten thousand dollars.

5:07In two thousand twenty-nine, ten thousand dollars minus three thousand dollars leaves seven thousand dollars. Three thousand dollars plus three thousand dollars plus three thousand dollars gives accumulated depreciation of nine thousand dollars. Straight-line depreciation suits buildings, fixtures and equipment when their benefits are used up reasonably evenly. Choose the method from the expected pattern of use rather than the asset’s name alone. A printer used at a steady level each year suits this approach.

5:33Ordinary land is generally not depreciated because its useful life is normally unlimited. Under the reducing balance method, a fixed percentage is applied to the carrying amount at the start of each year. After one charge, a smaller amount remains for the next calculation. The percentage stays unchanged, but the annual expense falls. This pattern suits assets that lose more value or give greater benefits during their earlier years. Priya applies reducing balance depreciation at twenty-five per cent to the machinery costing thirty-two thousand dollars.

6:01In two thousand twenty-seven, twenty-five per cent of thirty-two thousand dollars is eight thousand dollars. Thirty-two thousand dollars minus eight thousand dollars leaves a carrying amount of twenty-four thousand dollars. That remaining amount becomes the base for the next year. During two thousand twenty-eight, twenty-five per cent of twenty-four thousand dollars is six thousand dollars. Subtracting six thousand dollars from twenty-four thousand dollars leaves eighteen thousand dollars. For two thousand twenty-nine, the charge is twenty-five per cent of eighteen thousand dollars, which is four thousand five hundred dollars.

6:32Eighteen thousand dollars minus four thousand five hundred dollars leaves thirteen thousand five hundred dollars. Motor vehicles, machinery and computers usually suit reducing balance depreciation. They lose more value in their early years, and their productive benefits often decline as they age. The method therefore places a larger expense in the earlier periods. Each year, apply the stated percentage to the carrying amount at the start of that year. Under the revaluation method, depreciation equals opening valuation plus purchases minus closing valuation.

7:03It is used for many small items, such as loose tools. Calculating a separate charge for every tool would take too long. Instead, the business values the whole collection at the beginning and end of the year. Priya’s loose tools have an opening valuation of seventeen hundred dollars. Purchases during the year cost six hundred dollars. Seventeen hundred dollars plus six hundred dollars equals two thousand three hundred dollars. The closing valuation is fourteen hundred dollars.

7:27Two thousand three hundred dollars minus fourteen hundred dollars gives depreciation of nine hundred dollars. Purchases belong in the calculation because they increase the value available during the year. The closing valuation represents what remains at the end. This method measures the fall in value of the whole collection rather than of each item. For this revaluation, debit depreciation of loose tools with nine hundred dollars as an expense, and credit the loose tools account because the tools have lost that value.

7:53Both journal totals are nine hundred dollars. The loose tools account is reduced directly, with no provision account. Their closing valuation of fourteen hundred dollars is now the amount recorded.

Recording depreciation in ledgers

8:03With straight-line and reducing balance depreciation, the non-current asset account stays at cost. A provision for depreciation account records the accumulated charges separately. Its credit balance is deducted from the asset’s cost to give carrying amount. This balance is a running total of depreciation, and no money is held in it. Return to the equipment’s annual straight-line charge of three thousand dollars. On the thirty-first of December, debit depreciation of equipment for the expense and credit provision for depreciation of equipment for the growing deduction.

8:32The same entry is made at the end of two thousand twenty-seven, two thousand twenty-eight and two thousand twenty-nine. Each of these journals totals three thousand dollars on both sides. The equipment account shows bank in its debit details column because bank is the other account in the purchase entry. Its original sixteen thousand dollars remains unchanged throughout these three years. On the thirty-first of December, two thousand twenty-nine, the balance carried down is sixteen thousand dollars.

8:56Both totals are sixteen thousand dollars, with that debit balance brought down on the first of January, two thousand thirty. This three-year view of the provision account shows depreciation of equipment as the details for every annual credit. Each credit is three thousand dollars on the thirty-first of December of its year. Their sum is nine thousand dollars, so the balance carried down on the thirty-first of December, two thousand twenty-nine, goes on the debit side.

9:18Both totals are nine thousand dollars, with a credit balance brought down on the first of January, two thousand thirty. The statement of profit or loss is the financial statement that shows the revenue, expenses and profit or loss for a period. The depreciation expense for each year is transferred there at the year end. Accumulated depreciation stays in the provision account for use in calculating carrying amount. The current year’s expense and the accumulated total therefore serve different purposes.

9:43On the thirty-first of December, two thousand twenty-nine, debit the statement of profit or loss and credit depreciation of equipment by three thousand dollars. The debit charges the year’s expense against revenue. The credit leaves the expense account with no balance, ready for next year's charge. Total debits equal total credits at three thousand dollars. In the depreciation of equipment account, provision for depreciation of equipment appears as the debit details.

10:08The credit details name the statement of profit or loss because that is the other account in the transfer. Both sides total three thousand dollars, leaving no balance to bring down. The provision account still keeps its accumulated credit balance of nine thousand dollars.

Profit on disposal

10:22Disposal means removing a non-current asset from the business’s records when it is sold or otherwise given up. Priya sells the equipment on the first of January, two thousand thirty, for eight thousand five hundred dollars through the bank. Its cost is sixteen thousand dollars and its accumulated depreciation is nine thousand dollars. Assume no further depreciation is due before this sale. A disposal of non-current asset account collects the cost, accumulated depreciation and sale proceeds of the asset being removed.

10:49Profit on disposal is the excess of sale proceeds over carrying amount. When carrying amount is higher than the proceeds, the excess is a loss on disposal. Comparing with carrying amount recognises that earlier depreciation has already charged part of the cost. Transfer the original cost by debiting disposal of non-current asset and crediting equipment with sixteen thousand dollars. The credit removes the asset from its own account, while the debit places its cost in the disposal calculation.

11:15Next, debit provision for depreciation of equipment and credit disposal of non-current asset with nine thousand dollars. This removes the accumulated depreciation belonging to the equipment sold. Record the proceeds by debiting bank and crediting disposal of non-current asset with eight thousand five hundred dollars. Bank rises because Priya receives money, while the disposal credit records the amount recovered. Sixteen thousand dollars plus nine thousand dollars plus eight thousand five hundred dollars equals thirty-three thousand five hundred dollars.

11:43The journal has that total on both sides. The equipment account begins with a debit balance brought down of sixteen thousand dollars on the first of January, two thousand thirty. Disposal of non-current asset is the details for its credit of sixteen thousand dollars. Both sides total sixteen thousand dollars, so the equipment account closes. No equipment balance remains because this example contains only the asset sold. The provision account opens with its nine thousand dollar credit balance on the first of January, two thousand thirty.

12:10A debit of nine thousand dollars names disposal of non-current asset as the other account. Each side totals nine thousand dollars, leaving no remaining balance. Both the original cost and its accumulated depreciation have now been removed. In the disposal account, nine thousand dollars plus eight thousand five hundred dollars gives credits of seventeen thousand five hundred dollars. The cost debit is sixteen thousand dollars. Seventeen thousand five hundred dollars minus sixteen thousand dollars leaves profit on disposal of fifteen hundred dollars.

12:39Enter that transfer on the debit side, so both sides total seventeen thousand five hundred dollars. Debit disposal of non-current asset and credit the statement of profit or loss by fifteen hundred dollars. The debit closes the disposal account, while the credit records the gain for the period. Both journal totals are fifteen hundred dollars. Other income is income from activities other than the main one, such as rent received or discount received.

13:02Profit on disposal therefore appears as other income in the statement of profit or loss. Check the answer independently through carrying amount. Sixteen thousand dollars minus nine thousand dollars equals seven thousand dollars. Proceeds of eight thousand five hundred dollars minus carrying amount of seven thousand dollars gives fifteen hundred dollars. This agrees with the disposal account because both methods compare the money received with the cost not yet charged as depreciation.

Disposal errors and loss example

13:27Common examination mistakes concern the calculation base and the accounts removed. Straight-line depreciation uses the specified cost-based charge, while reducing balance uses the opening carrying amount. Transfer the full original cost and only the accumulated depreciation belonging to the asset sold. For a sale during a year, apply the depreciation policy stated in the question before calculating disposal. A provision balance may include several assets, so keep the part relating to assets still owned.

13:53Sale proceeds belong in the bank and disposal accounts. The amount transferred to the statement of profit or loss is only the resulting profit or loss on disposal. These rules keep the continuing assets separate from the asset removed. Paper One contains forty multiple-choice questions, while Paper Two contains five compulsory structured questions. Calculate means work out from given figures, and prepare means present information in a suitable format. Explain means give reasons why and how, supported by evidence.

14:20Questions can test calculations, method selection, journal entries, ledger accounts and the reasons for depreciation. Consider an alternative question where the same equipment sells for six thousand two hundred dollars. Calculate the profit or loss on disposal. The carrying amount is still sixteen thousand dollars minus nine thousand dollars, which is seven thousand dollars. Because the proceeds are lower, seven thousand dollars minus six thousand two hundred dollars gives a loss on disposal of eight hundred dollars.

14:46In this version of the disposal account, the debit side holds only the equipment cost of sixteen thousand dollars. On the credit side, nine thousand dollars plus six thousand two hundred dollars comes to fifteen thousand two hundred dollars. The missing eight hundred dollars is the balancing figure, so the loss on disposal sits on the credit side. Both sides then total sixteen thousand dollars. For this alternative, debit the statement of profit or loss and credit disposal of non-current asset by eight hundred dollars.

15:14The debit records the unrecovered cost as an expense, while the credit closes the disposal account. Both journal totals are eight hundred dollars. An explanation should state that the proceeds are below the carrying amount, so part of the cost was not recovered. Depreciation spreads the estimated cost used up across the periods that benefit. Straight-line gives equal annual charges, reducing balance gives falling charges, and revaluation compares the collection available with what remains.

15:40Where a provision account is used, accumulated depreciation is kept apart from original cost. On disposal, remove both amounts, then place a profit on the debit side of the disposal account or a loss on the credit side.