Accounting for Depreciation and Disposal of Non-Current Assets | O Level Accounting 7707 & IGCSE Accounting 0452 | Detailed Free Notes To Score An A Star (A*)

Depreciation

• Gradual decrease on the value of an asset due to use, wear and tear, obsoletion and time.
• For non-current assets
• We can not see this in actual terms of numbers
  • Instead, we approximate it every periods
    • The reason is Matching Principle
      • The wear and tear expense that has occurred in a specific periods must be matched against the revenues of the same period
    • Also under Prudence Principle
      • We need to create a provision for the depreciation as well as a vision for any losses that may occur.
• Therefore, until disposal occurs or scrap occurs
  • Depreciation is a NON-CASH expense
  • No actual cash is given out for this expense each period
  • But we assume that value of the non-current asset is reducing and account for it.
• In exams, we must consider if a FULL year depreciation will be charged in any case OR only depreciation for the months passed will be charged
  • If nothing mentioned, calculate it for the months passed.
• Important Term
  • Salvage Value
    • The value of a non-current asset at the end of the useful life.
  • Useful Life
    • Period in which a non-current asset is actually useful.
• Methods of Deprecation
  • Straight Line Method
    • A fixed percentage is accounted as depreciation each period.
    • The percentage and value does not change from period to period
    • Straight line method is calculated on COST of the asset
    • We have to account for salvage/ scrap value in such calculations
    • Best for assets that usually degrade in value uniformly over their useful life such as buildings.
    • Formula
      • (Total Cost-Salvage Value)/ Useful Life of the Asset = Depreciation per period (usually years)
  • Net Book Value Or Reducing Balance Method
    • Here, a fixed percentage is charged each periods but NOT on the cost of the asset. Instead, it is charged on the NBV of the asset.
    • NBV = Cost of the asset – total accumulated depreciation of the asset up to that point.
    • It is best for assets that require more maintenance expense as their age increases.
    • For example, car, machinery and equipment
    • (IN EXAM LOOK AT WHAT HE SAYS, IF HE SAYS USE STRAIGHT LINE, THEN USE STRAIGHT LINE)
    • When Reducing Balance methods is used, initially we charge a high depreciation as maintenance cost is low.
    • With time, as maintenance expense increases, depreciation charge decreases because the net book value is lower than the previous periods, resulting in lower value of depreciation for the same percentage.
    • Formula
      • NBV*Percentage of Depreciation
    • Salvage/ Scrap value is usually of  no concern here.
  • Revaluation Method
    • For very small assets or categories where finding straight line or net book value is difficult, we simply use the difference between the opening value and the ascertained closing value to determine the depreciation.
    • An example here is tools and stationery.
    • Formulae
      • Opening Value – Closing Value = Depreciation

Accounting For Depreciation Expense

• Remember
  • Under historic cost principle, all asset accounts ONLY include COST entries.
    • We can not directly pass a depreciation entry in the Asset’s T account and reduce the value of the asset.
    • Asset account has to remain on cost.
    • Instead, we create a separate account for provision of depreciation.
• Therefore, the general entry for depreciation is as follows
  • We debit Depreciation Expense (That gets transferred to the Income Statement at the end, as it is an expense and must be matched with its period)
    • Remember, the depreciation expense account is closed at the end of each period due to the transfer to income statement.
  • We credit Provision for depreciation account (It is a provision account (Different from liabilities)  and is recorded in the balance sheet where we first mention the historic cost of the non-current asset, then reduce the accumulated provision for depreciation to determine its net book value)
    • Remember, accumulated provision for depreciation account closes on sale of asset.
    • Provision accounts have the same treatment as liability accounts
      • Debit when decrease
      • Credit when increase
      • BD on credit side
      • CD on debit side

Disposal

• Remember, sale is the word used only for the sale of inventory as the revenue in accounting
• If any long-term, non-current asset is sold, we use the world disposal.
• There are certain entries that go into a disposal account
  • First, we credit the asset account with the historic cost of the asset, and debit the disposal account with the cost.
  • Next, we debit the accumulated provision account for that asset for the total provision of that asset to date. We credit the same amount in the disposal account.
  • Next, we debit the cash or bank account for the money received, or a disposal receivable account (NOT ACCOUNTS RECEIVABLE because that is reserved for inventory based sales only) for the amount of the sale. We credit the disposal account with the same amount.
  • There is also a part-take or exchange entry sometimes. Here, we exchange one asset for another.
    • If so, debit the asset account for the asset we are receiving. If no asset account exist for it, create one.
    • We credit the disposal account with the value of the asset received.
  • Now, we calculate if the credit side of the disposal account is larger than the debit side.
    • If the credit side is larger, we have a profit on disposal. Here, we will credit the income statement (Profit and loss account) and debit the disposal account to being the totals on both sides to an equal.
    • If the debit side is larger than the credit side of the disposal, we have a loss on disposal. As such, we will debit the profit and loss account (Income statement i.e. losses are debited when increased) and we will credit the disposal account to bring the totals to an equal.
• In the income statement, disposal loss will show under operative expenses. Disposal profit will be shown under other income.