Accounting For Depreciation And Disposal of Non-Current Assets (Copy)

4. Accounting Procedures

4.2 Accounting for Depreciation and Disposal of Non-Current Assets

Definition of Depreciation

• Depreciation is the process of allocating the cost of a non-current asset over its useful life.
• It accounts for:
  • Loss in value of the asset over time
  • Wear and tear
  • Obsolescence

Reasons for Charging Depreciation

• To match expense with revenue in the period the asset is used (matching principle).
• To show a more accurate value of assets in the statement of financial position.
• To avoid overstating profits by recognising part of the asset’s cost as an expense annually.
• To comply with accounting principles, especially accruals and prudence.

Important Terms

• Cost: Original purchase price including all expenses necessary to bring the asset into use.
• Residual value (Scrap value): Expected value of the asset at the end of its useful life.
• Useful life: Estimated period over which the asset will generate benefits.
• Depreciable amount:
  Depreciable amount = Cost - Residual value

Methods of Depreciation

1. Straight-Line Method

• Spreads the same amount of depreciation each year over the useful life.
• Formula:
  Annual Depreciation = (Cost - Residual Value) / Useful Life

Example:
Cost = 10,000
Residual value = 2,000
Useful life = 4 years
Annual depreciation = (10,000 – 2,000) / 4 = 2,000

Effect:

• Equal charge each year
• Book value reduces evenly

2. Reducing Balance Method (Diminishing Balance)

• Depreciation is charged as a fixed percentage of the book value at the beginning of each year.
• Formula:
  Depreciation = Net Book Value × Depreciation Rate (%)

Example:
Cost = 10,000
Rate = 20%
Year 1: 10,000 × 20% = 2,000 → Book value = 8,000
Year 2: 8,000 × 20% = 1,600 → Book value = 6,400
And so on.

Effect:

• Higher depreciation in earlier years
• More accurate for assets that lose value quickly

3. Revaluation Method

• Commonly used for small assets like tools or livestock.
• Asset is revalued at the end of each period, and the difference is treated as depreciation.
• Formula:
  Depreciation = Value at Beginning + Additions - Revalued Closing Balance

Example:
Value at beginning = 5,000
Additions = 2,000
Value at end = 4,000
Depreciation = 5,000 + 2,000 – 4,000 = 3,000

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course

Journal Entries for Depreciation

Method 1: Directly reducing the asset

Dr Depreciation Expense  
Cr Non-Current Asset (e.g. Machinery)

Method 2: Using provision for depreciation (preferred method)

Dr Depreciation Expense  
Cr Provision for Depreciation

Ledger Accounts Example: Straight-Line

Cost of Equipment: 10,000
Useful life: 5 years
No residual value
Annual depreciation: 2,000

Machinery Account (Asset at Cost)

Provision for Depreciation Account

Depreciation Expense Account

Disposal of Non-Current Assets

When an asset is sold or scrapped, the following must be recorded:

1. Remove the asset’s original cost
2. Remove the accumulated depreciation
3. Record any sale proceeds
4. Calculate profit or loss on disposal

Use of Disposal Account

• A Disposal Account is used to bring together:
  • Original cost (credited from asset account)
  • Accumulated depreciation (debited from provision)
  • Sale proceeds (credited)
  • The resulting balance = profit or loss

Journal Entries for Disposal

Step 1: Transfer asset’s cost to disposal account
Dr Disposal A/C
Cr Asset A/C

Step 2: Transfer provision for depreciation
Dr Provision for Depreciation A/C
Cr Disposal A/C

Step 3: Record sale proceeds
Dr Bank A/C
Cr Disposal A/C

Step 4: Transfer profit or loss

• If credit balance remains → profit
  Dr Disposal A/C
Cr Profit on Disposal
• If debit balance remains → loss
  Dr Loss on Disposal
Cr Disposal A/C

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course

Worked Example: Disposal

Given:

• Equipment cost = 10,000
• Provision for depreciation = 6,000
• Sold for 5,000

Step 1:
Dr Disposal A/C 10,000
Cr Equipment A/C 10,000

Step 2:
Dr Provision for Depreciation A/C 6,000
Cr Disposal A/C 6,000

Step 3:
Dr Bank A/C 5,000
Cr Disposal A/C 5,000

Step 4:
Disposal A/C total = Dr 10,000
Credits = 11,000 (6,000 + 5,000)
→ Profit of 1,000
Dr Disposal A/C 1,000
Cr Profit on Disposal A/C 1,000

Effect on Financial Statements