CIMA - C2 Fundamentals of Financial Accounting
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130 9: Non-current assets – depreciation, revaluation and disposal ⏐ Part B Accounting systems and accounts preparation
If the original estimate of an asset's useful life is incorrect, it should be revised. Normally, no adjustment is made in
respect of the depreciation charged in previous years; but the remaining NBV of the asset should be depreciated over the
new estimate of its remaining useful life. However, if future results could be
materially
distorted, the adjustment to
accumulated depreciation should be recognised in the accounts.
1.5 Examples: depreciation
(a) A non-current asset costing $20,000, with an expected life of five years and an expected residual value of nil, will
be depreciated by $20,000 in total over the five year period.
(b) A non-current asset costing $20,000, with an expected life of five years and an expected residual value of $3,000,
will be depreciated by $17,000 in total over the five years.
(a) A depreciation charge (provision) is made in the income statement in each accounting period for every
depreciable non-current asset. Nearly all non-current assets are depreciable, the most important exceptions being
freehold land and long-term investments.
(b) The total accumulated depreciation builds up as the asset gets older. Therefore, for an asset with no residual
value, the total provision for depreciation increases until the non-current asset is fully depreciated (NBV is nil).
1.6 The ledger accounting entries for depreciation
(a) There is a provision for depreciation account for each separate category of non-current assets, eg plant
and machinery, land and buildings, fixtures and fittings.
(b) The depreciation charge for an accounting period is a charge against profit and is recorded as:
DEBIT Depreciation expense account
CREDIT Provision for depreciation account
(c) The balance on the provision for depreciation account is the total accumulated depreciation. This is always
a credit balance.
(d) The non-current asset accounts are unaffected by depreciation. Non-current assets are recorded in these
accounts at cost (or, if they are revalued, at their revalued amount).
(e) In the statement of financial position of the business, the accumulated depreciation is deducted from the
cost of non-current assets (or revalued amount) to arrive at the net book value of the non-current assets.
1.7 Example: accounting for depreciation
Using the information in Question 1 (Depreciation), write up the depreciation expense and provision for depreciation
accounts for 20X2, 20X3, 20X4 and 20X5.
Solution
DEPRECIATION EXPENSE ACCOUNT
$
$
31.12.X2
Provision
2,000
31.12.X2
I/S
2,000
31.12.X3
Provision
2,000
31.12.X3
I/S
2,000
31.12.X4
Provision
2,000
31.12.X4
I/S
2,000
31.12.X5
Provision
2,000
31.12.X5
I/S
2,000
Assessment
focus points
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Part B Accounting systems and accounts preparation ⏐ 9: Non-current assets – depreciation, revaluation and disposal 131
DEPRECIATION PROVISION ACCOUNT
$
$
31.12.X2
Balance c/d
2,000
31.12.X2
Depreciation expense a/c
2,000
2,000
2,000
1.1.X3
Balance b/d
2,000
31.12.X3
Balance c/d
4,000
31.12.X3
Depreciation expense a/c
2,000
4,000
4,000
1.1.X4
Balance b/d
4,000
31.12.X4
Balance c/d
6,000
31.12.X4
Depreciation expense a/c
2,000
6,000
6,000
1.1.X5
Balance b/d
6,000
31.12.X5
Balance c/d
8,000
31.12.X5
Depreciation expense a/c
2,000
8,000
8,000
1.8 Methods of depreciation
There are several different methods of depreciation but the straight line method and the reducing balance method are
most commonly used in practice.
There are several different methods of depreciation. The ones you need to know about are:
•
Straight-line method
•
Reducing balance method
Another method is the revaluation method, but we will look at this in Section 2.
1.8.1 Straight line method
The
straight line method
means that the total depreciable amount is charged in equal instalments to each accounting
period over the expected useful life of the asset
The straight line method is a fair allocation of the total depreciable amount, if it is reasonable to assume that the
business enjoys equal benefits from the use of the asset throughout its life.
NBV
TIME
Key term
FA
S
T F
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RWAR
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Assessment
focus point
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132 9: Non-current assets – depreciation, revaluation and disposal ⏐ Part B Accounting systems and accounts preparation
The annual depreciation charge is calculated as:
Cost of asset minus residual value
Expected useful life of the asset
1.8.2 Example: straight line depreciation
(a) A non-current asset costs $20,000 with an estimated life of 10 years and no residual value.
Depreciation =
years10
000,20$
= $2,000 per annum
(b) A fixed asset costs $60,000 with an estimated life of 5 years and a residual value of $7,000.
Depreciation =
years5
)000,7000,60$( −
= $10,600 per annum
The net book value of the fixed asset is calculated as follows.
After 1
year
After 2
years
After 3
years
After 4
years
After 5
years
$
$
$
$
$
Cost of the asset
60,000
60,000
60,000
60,000
60,000
Accumulated depreciation
10,600
21,200
31,800
42,400
53,000
Net book value
49,400
38,800
28,200
17,600
7,000
*
* ie its estimated residual value.
Since the depreciation charge per annum is the same amount every year, it is often stated that depreciation is charged at
the rate of x per cent per annum on the cost of the asset. In the example above, the depreciation charge per annum is
10% of cost (ie 10% of $20,000 = $2,000).
Assessment questions
often describe straight line depreciation in this way.
1.8.3 Reducing balance method
The
reducing balance method
of depreciation calculates the annual charge as a fixed percentage of the
net book value
of the asset, as at the end of the previous accounting period.
Reducing balance method = Net book value × X%.
NBV
TIME
Formula to
learn
Key term
Formula to
learn
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Part B Accounting systems and accounts preparation ⏐ 9: Non-current assets – depreciation, revaluation and disposal 133
1.8.4 Example: reducing balance depreciation
A business purchases a non-current asset at a cost of $10,000. Its expected useful life is 3 years and its estimated
residual value is $2,160. The business uses the reducing balance method and calculates that the rate of depreciation
should be 40% of the reducing (net book) value of the asset. (The method of deciding that 40% is a suitable annual
percentage is outside of the scope of your syllabus.)
Calculate the depreciation charge per annum and the net book value of the asset as at the end of each year.
Solution
Accumulated
depreciation
$
$
Asset at cost
10,000
Depreciation in year 1 (40%)
4,000
4,000
Net book value at end of year 1
6,000
Depreciation in year 2
(40% of reducing balance)
2,400
6,400
(4,000 + 2,400)
Net book value at end of year 2
3,600
Depreciation in year 3 (40%)
1,440
7,840
(6,400 + 1,440)
Net book value at end of year 3
2,160
With the reducing balance method, the annual charge for depreciation is higher in the earlier years of the asset
'
s life, and
lower in the later years. Therefore, it is used when it is considered fair to allocate a greater proportion of the total
depreciable amount to the earlier years. The assumption is that the benefits obtained by the business from using the
asset decline over time.
Question
Straight line and reducing balance methods
A lorry bought for a business cost $17,000. It is expected to last for five years and then be sold for scrap for $2,000.
Required
Work out the depreciation to be charged each year under the following methods.
(a) The straight line method
(b) The reducing balance method (using a rate of 35%)
Answer
(a) Under the straight line method, depreciation for each of the five years is:
Annual depreciation =
5
2,000$17,000
−
= $3,000
(b) Under the reducing balance method, depreciation for each of the five years is:
Year Depreciation
1 35% × $17,000 = $5,950
2 35% × ($17,000 – $5,950) = 35% × $11,050 = $3,868
3 35% × ($11,050 – $3,868) = 35% × $7,182 = $2,514
4 35% × ($7,182 – $2,514) = 35% × $4,668 = $1,634
5 Balance to bring book value down to $2,000 = $4,668 – $1,634 – $2,000 = $1,034
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134 9: Non-current assets – depreciation, revaluation and disposal ⏐ Part B Accounting systems and accounts preparation
1.9 Choice of method
Neither the CA 2006 nor IAS 16 states which method should be used. Management must exercise its judgement and IAS
16 states that:
'The depreciable amount of a tangible non-current asset should be allocated on a
systematic
basis over its useful
economic life. The depreciation method used should reflect as fairly as possible the pattern in which the asset's
economic benefits are consumed by the entity. The depreciation charge for each period should be recognised as an
expense in the income statement unless it is permitted to be included in the carrying amount of another asset.'
'A variety of methods can be used to allocate the depreciable amount of a tangible non-current asset on a systematic
basis over its useful life. The method chosen should result in a
depreciation charge throughout the asset's useful
economic life and not just towards the end of its useful life or when the asset is falling in value.'
IAS 16 also states that a change from one method of providing depreciation to another is allowed only if the new method
will give a fairer presentation of the company
'
s results and financial position. Such a change is not a change of
accounting policy and so no disclosure of a prior year adjustment is needed. Instead, the asset
'
s net book amount is
written off over its remaining useful life. The change of method, the reason for the change, and its quantitative effect, is
disclosed by note to the accounts.
Many companies carry non-current assets in their statements of financial position at revalued amounts, particularly in
the case of freehold buildings. When this is done, the depreciation charge is calculated on the basis of the revalued
amount (not the original cost).
1.10 Disclosure requirements of IAS 16
The following information should be disclosed separately in the financial statements for each class of tangible non-
current assets.
•
Depreciation methods used
•
Useful lives or the depreciation rates used
•
Total depreciation charged for the period
•
Where material, the financial effect of a change during the period in either the estimate of useful economic
lives or the estimate of residual values
•
The cost or revalued amount at the beginning and end of the financial period
•
The cumulative amount of depreciation at the beginning of and end the financial period
•
A reconciliation of the movements (separately disclosing additions, disposals, revaluations, transfers,
depreciation, impairment losses, and reversals of past impairment losses written back in the financial
period)
•
The NBV at the beginning and end of the financial period
Question
Depreciation: ledger accounts
Brian Box set up his own computer software business on 1 March 20X6. He purchased a computer system, at a cost of
$16,000. The system has an expected life of three years and a residual value of $2,500.
Using the straight line method of depreciation, produce the non-current asset account, provision for depreciation
account, income statement (extract) and statement of financial position (extract) for each of the three years, 28 February
20X7, 20X8 and 20X9.
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Part B Accounting systems and accounts preparation ⏐ 9: Non-current assets – depreciation, revaluation and disposal 135
Answer
NON-CURRENT ASSET – COMPUTER EQUIPMENT
Date
$
Date
$
(a)
1.3.X6
Payable
16,000
28.2.X7
Balance c/d
16,000
(b)
1.3.X7
Balance b/d
16,000
28.2.X8
Balance c/d
16,000
(c)
1.3.X8
Balance b/d
16,000
28.2.X9
Balance c/d
16,000
(d)
1.3.X9
Balance b/d
16,000
The non-current asset has now lasted its expected useful life. However, until it is sold or scrapped, the asset still appears
in the statement of financial position at cost (less accumulated depreciation) and it remains in the ledger account for
computer equipment until disposal.
PROVISION FOR DEPRECIATION
Date
$
Date
$
(a)
28.2.X7
Balance c/d
4,500
28.2.X7
I/S
4,500
(b)
28.2.X8
Balance c/d
9,000
1.3.X7
Balance b/d
4,500
28.2.X8
I/S
4,500
9,000
9,000
(c)
28.2.X9
Balance c/d
13,500
1.3.X8
Balance b/d
9,000
28.2.X9
I/S
4,500
13,500
13,500
1 Mar 20X9
Balance b/d
13,500
The annual depreciation charge is
years3
)500,2–000,16($
= $4,500 pa
The asset is depreciated to its residual value. If it continues to be used, it will not be depreciated any further (unless its
residual value is reduced).
INCOME STATEMENT (EXTRACT)
Date
$
(a)
28 Feb 20X7
Provision for depreciation
4,500
(b)
28 Feb 20X8
Provision for depreciation
4,500
(c)
28 Feb 20X9
Provision for depreciation
4,500
STATEMENT OF FINANCIAL POSITION (EXTRACT) AS AT 28 FEBRUARY
20X7
20X8
20X9
$
$
$
Computer equipment at cost
16,000
16,000
16,000
Less accumulated depreciation
4,500
9,000
13,500
Net book value
11,500
7,000
2,500
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136 9: Non-current assets – depreciation, revaluation and disposal ⏐ Part B Accounting systems and accounts preparation
1.11 Assets acquired in the middle of an accounting period
A business can purchase new non-current assets at any time during the course of an accounting period. So it may seem
fair to charge depreciation in the period of purchase which reflects the limited amount of use the business has had in
that period.
1.12 Example: depreciation charge
A business, with an accounting year ending on 31 December, purchases a new non-current asset on 1 April 20X1, at a
cost of $24,000. The expected life of the asset is 4 years, and its residual value is nil. What is the depreciation charge for
20X1?
Solution
The annual depreciation charge will be
years4
24,000
= $6,000 per annum
However, since the asset was acquired on 1 April 20X1, the business has only benefited from the use of the asset for 9
months. Therefore it seems fair to charge depreciation in 20X1 for only 9 months.
12
9
× $6,000 = $4,500
In practice, however, many businesses ignore part-year depreciation, and charge a full year
'
s depreciation in the year of
purchase and none in the year of sale.
If a question gives you the purchase date of a non-current asset, which is in the middle of an accounting period, unless
told otherwise, you should assume that depreciation will be calculated on the basis of 'part year' use.
However, be sure to read the question carefully. A question may clearly state that depreciation on office equipment is
charged at 20% per annum on the net book value at the year end. This means that any equipment introduced during the
year will have a
full year's
depreciation charge.
1.13 Example: provision for depreciation with assets acquired part-way through
the year
Brian Box purchases a car for himself and later for his chief assistant Bill Ockhead. Relevant data is as follows.
Date of purchase Cost Estimated life Estimated residual value
Brian Box car 1 June 20X6 $20,000 3 years $2,000
Bill Ockhead car 1 June 20X7 $8,000 3 years $2,000
The straight line method of depreciation is to be used.
Prepare the motor vehicles account and provision for depreciation of motor vehicle account for the years to 28 February
20X7 and 20X8. (You should allow for the part-year
'
s use of a car in computing the annual charge for depreciation.)
Calculate the net book value of the motor vehicles as at 28 February 20X8.
Assessment
focus point
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Part B Accounting systems and accounts preparation ⏐ 9: Non-current assets – depreciation, revaluation and disposal 137
Solution
(a) (i) Brian Box car Annual depreciation
years3
2,000)$(20,000
−
= $6,000 pa
Monthly depreciation $500
Depreciation 1 June 20X6 – 28 February 20X7 (9 months) $4,500
1 March 20X7 – 28 February 20X8 $6,000
(ii) Bill Ockhead car Annual depreciation
years3
2,000)$(8,000
−
= $2,000 pa
Depreciation 1 June 20X7 – 28 February 20X8 (9 months) $1,500
(b) MOTOR VEHICLES
Date
$
Date
$
1 Jun 20X6
Payables (or cash)
20,000
28 Feb 20X7
Balance c/d
20,000
1 Mar 20X7
Balance b/d
20,000
1 Jun 20X7
Payables (or cash)
8,000
28 Feb 20X8
Balance c/d
28,000
28,000
28,000
1 Mar 20X8
Balance b/d
28,000
PROVISION FOR DEPRECIATION OF MOTOR VEHICLES
Date
$
Date
$
28 Feb 20X7
Balance c/d
4,500
28 Feb 20X7
I/S
4,500
1 Mar 20X7
Balance b/d
4,500
28 Feb 20X8
Balance c/d
12,000
28 Feb 20X8
I/S
(6,000+1,500)
7,500
12,000
12,000
1 Mar 20X8
Balance b/d
12,000
STATEMENT OF FINANCIAL POSITION WORKINGS AS AT 28 FEBRUARY 20X8
Brian Box car
Bill Ockhead car
Total
$
$
$
$
$
Asset at cost
20,000
8,000
28,000
Accumulated
depreciation: (4,500 + 6,000)
10,500
1,500
12,000
Net book value
9,500
6,500
16,000
1.14 Applying a depreciation method consistently
The business has to decide which method of depreciation to use. Once that decision is made, however, it should not be
changed – the chosen method should be applied consistently from year to year. This is an example of the consistency
concept.
Similarly, the business has to decide a sensible life span for a non-current asset. Once that life span is chosen, it should
not be changed unless something unexpected happens to the non-current asset.
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138 9: Non-current assets – depreciation, revaluation and disposal ⏐ Part B Accounting systems and accounts preparation
However a business can depreciate different categories of non-current assets in different ways. If a business owns three
cars, then each car is depreciated in the same way (eg the straight line method) but another category of non-current
asset (photocopiers) can be depreciated using a different method (eg by the reducing balance).
1.15 Changes in residual value or remaining useful life
If there is a change in residual value or remaining useful life, depreciation is recalculated using the following formula:
life useful Revised
any) (if valueresidual revised valuebook Net
−
(a) Depreciation is a measure of the 'wearing out' of a non-current asset.
(b) The accruals concept requires that depreciation be charged over the useful life of an asset.
(c) Two common methods of calculating depreciation are straight line and reducing balance.
(d) To record depreciation:
DEBIT Depreciation expense account
CREDIT Depreciation provision
Then to get the charge into the income statement
DEBIT Income statement
CREDIT Depreciation expense account
2 Revaluation of non-current assets
When a non-current asset is revalued, depreciation is charged on the revised amount.
2.1 Revaluations
Due to inflation, it is now quite common for the market value of certain non-current assets to go up. The most obvious
example of rising market values is land and buildings.
A business is not obliged to revalue non-current assets. However, in order to give a
'
true and fair view
'
it may decide to
revalue some non-current assets upwards. When non-current assets are revalued, depreciation is charged on the
revalued amount.
2.2 Example: the revaluation of non-current assets
Ira Vann commenced trading on 1 January 20X1 and purchased freehold premises for $50,000.
For the purpose of accounting for depreciation, he decided that
(a) the freehold land part of the business premises was worth $20,000 and would not be depreciated.
(b) the building part of the business premises was worth the remaining $30,000. This would be depreciated by the
straight-line method to a nil residual value over 30 years.
FA
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Assessment
focus point
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Part B Accounting systems and accounts preparation ⏐ 9: Non-current assets – depreciation, revaluation and disposal 139
After five years, on 1 January 20X6, the business premise is now worth $150,000.
$
Land
75,000
Building
75,000
150,000
He estimates that the building still has a further 25 years of useful life remaining.
Calculate the annual charge for depreciation in each of the 30 years of its life, and the statement of financial position
value of the land and building as at the end of each year.
Solution
Before the revaluation
, the annual depreciation charge is $1,000 ($30,000/30) per annum on the building. This charge is
made in each of the first five years of the asset
'
s life.
The net book value of the total asset will decline by $1,000 per annum.
(a) $49,000 as at 31.12.X1
(b) $48,000 as at 31.12.X2
(c) $47,000 as at 31.12.X3
(d) $46,000 as at 31.12.X4
(e) $45,000 as at 31.12.X5
When the revaluation takes place
, the amount of the revaluation is:
$
New asset value
150,000
Net book value as at end of 20X5
45,000
Amount of revaluation
105,000
The asset will be revalued by $105,000 to $150,000. If you remember the accounting equation, you will realise that if
assets go up in value by $105,000, capital or liabilities must increase by the same amount. Since the increased value
benefits the owner of the business, the amount of the revaluation is added to capital, usually as a separate
revaluation
reserve
.
After a revaluation, depreciation is calculated using the following formula:
life useful Remaining
any) (if valueresidual amount Revalued
−
After the revaluation
, depreciation will be charged on the building at a new rate.
years25
$75,000
= $3,000 per annum
The net book value of the property will then fall by $3,000 per annum over 25 years, from $150,000 as at 1 January
20X6 to only $75,000 at the end of the 25 years – ie the building part of the property value will be fully depreciated.
The consequence of an upwards revaluation is therefore a higher annual depreciation charge.
2.3 Revaluation method of depreciation
Under the revaluation method of depreciation, an asset is revalued at the end of every year. The difference between the
two amounts is then taken as depreciation.
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