Accounting for Depreciation and Disposal of NCA

Depreciation is the measure of the wearing out, consumption, or loss of value of a non-current asset arising from use, passage of time, or obsolescence.

Why assets depreciate:

• Wear and tear: physical deterioration from use (machinery, vehicles).
• Obsolescence: the asset becomes outdated as technology advances (computers, software).
• Passage of time: some assets have a legally limited life (patents, leases).
• Depletion: extraction of natural resources reduces the asset (quarries, mines).

Accounting principle — matching (accruals) concept: The cost of the asset should be matched to the periods in which the asset generates income. Rather than writing off the full cost in year 1, depreciation spreads it over the useful life.

Key terms:

• Cost: the amount paid for the asset, including directly attributable costs (delivery, installation).
• Residual value (scrap/salvage value): the estimated amount the business expects to receive when the asset is sold or scrapped at the end of its useful life.
• Useful life: the estimated number of years the asset will be used.
• Carrying amount (Net Book Value, NBV): Cost − Accumulated Depreciation.
• Accumulated depreciation: the total depreciation charged on the asset since it was acquired.

The straight-line (SL) method charges the same amount of depreciation each year. It is used when the asset provides equal benefit in each year of its life.

Formula:

$\text{Annual depreciation} = \frac{\text{Cost} - \text{Residual value}}{\text{Useful life (years)}}$

Or equivalently:

$\text{Annual depreciation} = (\text{Cost} - \text{Residual value}) \times \text{Annual } \%$

Worked example: Machine purchased for $20 000. Estimated residual value: $2 000. Useful life: 6 years.

Annual depreciation = ($20 000 − $2 000) ÷ 6 = $18 000 ÷ 6 = $3 000 per year

Schedule of carrying amounts:

Year	Cost $	Accum. Dep. $	Carrying Amount $
Acquisition	20 000	—	20 000
End of Year 1	20 000	3 000	17 000
End of Year 2	20 000	6 000	14 000
End of Year 3	20 000	9 000	11 000
End of Year 6	20 000	18 000	2 000

At the end of Year 6, the carrying amount equals the residual value — the asset is fully depreciated.

On the SFP (statement of financial position):

Non-current assets	Cost $	Accum. Dep. $	Carrying Amount $
Machinery	20 000	(9 000)	11 000

The reducing balance (RB) method applies a fixed PERCENTAGE to the carrying amount (NBV) at the start of each year. This gives HIGHER depreciation in early years and LOWER in later years — matching assets (like vehicles or computers) that lose value faster when new.

Formula:

$\text{Annual depreciation} = \text{Carrying amount at start of year} \times \text{Rate } \%$

Worked example: Vehicle purchased for $15 000. Depreciation rate: 25% per annum reducing balance.

Year	Carrying Amount (start) $	Dep. @ 25% $	Carrying Amount (end) $
1	15 000	3 750	11 250
2	11 250	2 813	8 437
3	8 437	2 109	6 328

Note: the carrying amount NEVER reaches zero with the reducing balance method. The residual value is implicitly built into the rate.

Comparison with straight-line:

Feature	Straight-Line	Reducing Balance
Annual charge	Constant	Decreasing over time
Carrying amount	Reaches residual value exactly	Asymptotically approaches zero
Best for	Consistent-use assets	Assets losing value faster when new
Example assets	Buildings, equipment	Vehicles, computers, technology

Journal entry each year:

Date	Account	Dr $	Cr $
31 Dec	Depreciation Expense	3 000
	Accumulated Depreciation — Machinery		3 000
	Depreciation on machinery for the year

Key point: The COST account for the asset (e.g. Machinery account) is NEVER altered. Only the accumulated depreciation account changes.

Two separate accounts for each asset:

1. Asset account (at cost) — debited when asset is purchased; NEVER credited for depreciation.
2. Accumulated depreciation account — credited each year with the annual depreciation charge.

Ledger presentation on the SFP: Non-current assets are shown at cost, with accumulated depreciation deducted, giving the carrying amount (NBV):

$\text{NBV} = \text{Cost} - \text{Accumulated Depreciation}$

Income statement: The depreciation EXPENSE for the year reduces profit. It appears under expenses (alongside wages, rent, etc.).

When a non-current asset is sold or scrapped, a disposal account is opened to calculate the profit or loss on disposal.

Steps:

1. Transfer the cost of the asset:

   • Dr Disposal account (at full cost)
   • Cr Asset account (at cost)

2. Transfer accumulated depreciation up to date of disposal:

   • Dr Accumulated Depreciation account
   • Cr Disposal account

3. Record the sale proceeds:

   • Dr Cash/Bank (or Trade Receivables if sold on credit)
   • Cr Disposal account (at proceeds received)

4. Balance the disposal account:

   • If Cr side > Dr side → profit on disposal → Cr Income Statement (or P&L account)
   • If Dr side > Cr side → loss on disposal → Dr Income Statement

Example: Machine: Cost $20 000; Accumulated depreciation at disposal: $14 000; Sold for $7 500 cash.

Disposal of Machinery Account	Dr $	Cr $
Machinery (cost)	20 000	Accumulated Depreciation
		Cash (proceeds)
		Profit on disposal (balancing figure)
Total	20 000	Total

Profit on disposal = $7 500 − ($20 000 − $14 000) = $7 500 − $6 000 = $1 500 ✓

The profit of $1 500 is credited to the income statement.