Depreciation: worked examples

Method and where the marks are

A non-current asset is used up gradually, and that use is an expense of each year the asset helps to earn revenue. This is the matching concept. The cost of a machine is spread across the years that benefit from it, not charged in full when it is bought.

Keep three figures apart. The depreciation charge for one year goes to the income statement. The accumulated depreciation is a running total.

The carrying amount (cost minus accumulated depreciation) appears in the statement of financial position. Set up three labelled workings at the start to prevent most errors.

First decide which method the question wants. Under straight-line, the charge is the same each year: (cost minus residual value) divided by the useful life, or a stated percentage of cost. Under reducing (diminishing) balance, the charge is a percentage of the carrying amount at the start of the year, so it falls each year.

A percentage on cost signals straight-line. A percentage applied to the value each year signals reducing balance. Underline the key phrase before you start.

For example, an asset costs RM20,000 with a residual value of RM2,000 and a five-year life. The straight-line charge is (20,000 − 2,000) ÷ 5 = RM3,600 a year. At 20% reducing balance, the charge is RM4,000 in year one and RM3,200 in year two.

Work the years in sequence and show each step. For reducing balance, carry the closing carrying amount of one year into the next year as the opening figure. A slip in year one then flows through later years.

Examiners usually mark later figures as correct if they follow properly from an earlier error. So lay out each year on its own line, with cost, accumulated depreciation and carrying amount visible. If you round midway, say so.

The ledger presentation earns marks too. The provision for depreciation account (accumulated depreciation) is credited each year with the annual charge. The matching debit is the depreciation expense in the income statement, not the asset account.

The asset account keeps its original cost until the asset is sold. In the statement of financial position, show cost, less accumulated depreciation, equals carrying amount.

On disposal, open a disposal account. Debit it with the cost of the asset and credit it with the accumulated depreciation on that asset and the sale proceeds. The balancing figure is the profit or loss on disposal.

A credit balance is a profit and a debit balance is a loss. Take it to the income statement. Many candidates move only the cost and forget the accumulated depreciation, which gives a nonsensical loss.

Always move both. Also apply exactly the rule the question gives for the year of purchase and the year of sale.

A final checklist: do not deduct residual value under reducing balance, and do not apply the straight-line percentage to a falling carrying amount. Do not put the annual charge in the asset account either. Make sure the income statement expense, the accumulated total and any disposal entry all agree.

If reducing-balance figures keep coming out wrong, one of our teachers can work through your past-paper answers with you line by line. Book a trial class