Non-Current Assets and Depreciation
What depreciation is
Depreciation is the systematic allocation of the cost of a non-current asset over its useful life. It is not a fund of cash. Causes include wear and tear, obsolescence, passage of time and depletion. Common methods are the straight-line method (equal annual charge) and the reducing balance method (a fixed percentage of the carrying amount).
Recording depreciation
The asset account stays at cost. Depreciation is accumulated in a separate provision for depreciation account. The double entry is: debit depreciation expense (profit and loss), credit accumulated depreciation. On disposal, remove the asset's cost and its accumulated depreciation, record the sale proceeds, and calculate the profit or loss on disposal.
Traps to watch
Do not credit the asset account with depreciation - use the accumulated depreciation account. Under reducing balance, the charge falls each year; under straight-line, it stays constant. On disposal, compare proceeds with the carrying amount (cost − accumulated depreciation), not with cost. Remember to charge depreciation for the part of the year the asset was held if a proportionate charge is required.
Rule of thumb
Straight-line: (Cost − Residual value) ÷ Useful life. Reducing balance: Carrying amount × Percentage. Disposal profit/loss = Proceeds − Carrying amount.
Worked example
Machine costs $10,000, residual value $1,000, life 5 years. Straight-line charge = (10,000 − 1,000) ÷ 5 = $1,800 per year. After 3 years, carrying amount = 10,000 − 5,400 = $4,600.