4.2 Accounting for Depreciation and Disposal of Non‑Current Assets
Objective
- Prepare ledger (T‑) accounts and journal entries for the provision of depreciation using all three IGCSE methods (Straight‑Line, Reducing‑Balance, Revaluation).
- Record the disposal of non‑current assets – sale, scrapping, or trade‑in – and calculate any gain or loss.
1. Why Depreciation is Recorded
- Non‑current assets (plant, equipment, vehicles, buildings, etc.) lose value over time because of wear‑and‑tear, obsolescence or usage.
- Depreciation allocates the cost of an asset to the periods that benefit from its use – the matching principle.
- It gives a realistic Net Book Value (NBV) on the balance sheet and ensures that the profit‑or‑loss account reflects the true cost of using the asset.
2. Methods of Depreciation (Cambridge IGCSE)
2.1 Straight‑Line Method
Formula
\[
\text{Depreciation expense per year}= \frac{\text{Cost} - \text{Residual value}}{\text{Useful life (years)}}
\]
2.2 Reducing‑Balance (Written‑down) Method
Formula
\[
\text{Depreciation expense}= \text{Opening NBV} \times \text{Depreciation rate}
\]
How to obtain the rate – if the rate is not given, it is calculated from the useful life:
\[
\text{Depreciation rate}= \frac{1}{\text{Useful life (years)}} \times 100\%
\]
2.3 Revaluation Method (IGCSE)
- Used when an asset’s fair value has increased (or decreased) substantially and the company wishes to restate the asset to that new value.
- Increase in NBV is credited to a Revaluation Reserve (equity). A decrease is first charged against any existing reserve; any remainder is recognised as a loss in the profit‑or‑loss account.
- Before restating, the existing accumulated depreciation must be removed.
Journal entry – increase in value
| Account | Debit (£) | Credit (£) |
|---|
| Building (or other asset) | 30 000 | |
| Accumulated Depreciation – Building | 50 000 | |
| Revaluation Reserve – Equity | | 80 000 |
(Original cost £200 000, original accumulated depreciation £50 000, new fair value £250 000 → increase £30 000; the total credit equals the new NBV £250 000 less the original cost.)
2.4 Units‑of‑Production (A‑Level only)
This method is part of the A‑Level extension and is not examined at IGCSE. It is shown here for completeness.
Formula
\[
\text{Depreciation expense}= \frac{\text{Cost} - \text{Residual value}}{\text{Total estimated units}} \times \text{Units produced in the period}
\]
3. Standard Journal Entry for Depreciation (All Methods)
| Account | Debit (£) | Credit (£) |
|---|
| Depreciation Expense – [Asset] | ______ | |
| Accumulated Depreciation – [Asset] (contra‑asset) | | ______ |
Explanation: To record depreciation for the accounting period.
4. Ledger (T‑) Accounts for Depreciation
4.1 Depreciation Expense – [Asset]
| Debit (£) | Credit (£) |
|---|
| ______ (Depreciation amount) | |
| Balance c/d ______ |
4.2 Accumulated Depreciation – [Asset]
| Debit (£) | Credit (£) |
|---|
| ______ (Depreciation amount) |
| Balance c/d ______ | |
5. Worked Numerical Illustrations
5.1 Straight‑Line Example
ABC Ltd purchased a delivery van on 1 January 2022 for £30 000. Residual value £5 000, useful life 5 years.
- Annual depreciation = (30 000 – 5 000) / 5 = £5 000
Journal entry (year ended 31 December 2022)
| Account | Debit (£) | Credit (£) |
|---|
| Depreciation Expense – Van | 5 000 | |
| Accumulated Depreciation – Van | | 5 000 |
T‑accounts
Depreciation Expense – Van
| Debit (£) | Credit (£) |
|---|
| 5 000 | |
| Balance c/d 5 000 |
Accumulated Depreciation – Van
| Debit (£) | Credit (£) |
|---|
| 5 000 |
| Balance c/d 5 000 | |
5.2 Reducing‑Balance Example
XYZ Ltd bought a machine for £10 000. Depreciation rate = 20 % per annum (applied to opening NBV). No residual value is assumed.
- Year 1: Opening NBV = £10 000 → Depreciation = 20 % × 10 000 = £2 000
Journal: Debit Depreciation Expense £2 000; Credit Accumulated Depreciation £2 000.
- Year 2: Opening NBV = £8 000 → Depreciation = 20 % × 8 000 = £1 600.
- Year 3: Opening NBV = £6 400 → Depreciation = £1 280.
After three years, accumulated depreciation = £4 880 and NBV = £5 120.
T‑accounts after Year 3
Depreciation Expense – Machine
| Debit (£) | Credit (£) |
|---|
| 2 000 | |
| 1 600 | |
| 1 280 | |
| Balance c/d 4 880 |
Accumulated Depreciation – Machine
| Debit (£) | Credit (£) |
|---|
| 2 000 |
| 1 600 |
| 1 280 |
| Balance c/d 4 880 | |
5.3 Revaluation Example (IGCSE)
Building cost £200 000, accumulated depreciation £50 000 (NBV = £150 000). An external valuation raises the fair value to £180 000.
- Increase in NBV = £180 000 – £150 000 = £30 000.
Journal entry – upward revaluation
| Account | Debit (£) | Credit (£) |
|---|
| Building | 30 000 | |
| Accumulated Depreciation – Building | 50 000 | |
| Revaluation Reserve – Equity | | 80 000 |
After the entry the building is shown at its new NBV (£180 000) and the revaluation reserve reflects the increase.
5.4 Trade‑In (Disposal & Acquisition in One Transaction)
Beta Ltd trades in an old computer (cost £5 000, accumulated depreciation £3 500, NBV £1 500) for a new computer costing £4 000. The dealer gives a cash discount of £500, so cash paid = £3 500.
Journal entry
| Account | Debit (£) | Credit (£) |
|---|
| New Computer (Asset) | 4 000 | |
| Cash / Bank | | 3 500 |
| Accumulated Depreciation – Old Computer | 3 500 | |
| Loss on Disposal of Old Computer | 1 000 | |
| Old Computer (Cost) | | 5 000 |
NBV of the old computer (£1 500) is less than the cash received (£3 500), giving a loss of £1 000.
5.5 Disposal – Sale at a Gain
XYZ Ltd sells the machine from the reducing‑balance example after 3 years.
- Original cost = £10 000
- Accumulated depreciation = £4 880
- NBV = £5 120
- Sale price = £6 000
- Gain = £6 000 – £5 120 = £880
Journal entry
| Account | Debit (£) | Credit (£) |
|---|
| Cash / Bank | 6 000 | |
| Accumulated Depreciation – Machine | 4 880 | |
| Machine (Cost) | | 10 000 |
| Gain on Disposal of Machine | | 880 |
Effect on T‑accounts
Machine (Cost) – Closing balance removed
| Debit (£) | Credit (£) |
|---|
| 10 000 |
| Balance c/d – | |
Accumulated Depreciation – Machine – Closing balance removed
| Debit (£) | Credit (£) |
|---|
| 4 880 | |
| Balance c/d – | |
5.6 Disposal – Scrapping at a Loss
ABC Ltd scraps the delivery van after 2 years.
- Cost = £30 000
- Annual straight‑line depreciation = £5 000 → Accumulated depreciation after 2 years = £10 000
- NBV = £20 000
- Scrap value received = £4 000
- Loss = £20 000 – £4 000 = £16 000
Journal entry
| Account | Debit (£) | Credit (£) |
|---|
| Cash / Bank | 4 000 | |
| Loss on Disposal of Van | 16 000 | |
| Accumulated Depreciation – Van | | 10 000 |
| Van (Cost) | | 30 000 |
Effect on T‑accounts
Van (Cost) – Closing balance removed
| Debit (£) | Credit (£) |
|---|
| 30 000 |
Accumulated Depreciation – Van – Closing balance removed
| Debit (£) | Credit (£) |
|---|
| 10 000 |
6. Summary Checklist for Exam Questions (AO1 & AO2)
- Identify the asset’s cost, residual value (if any) and useful life.
- Choose the appropriate depreciation method.
- Straight‑Line – use the straight‑line formula.
- Reducing‑Balance – calculate the rate (or use the given rate) and apply it to opening NBV.
- Revaluation – determine the new fair value, remove accumulated depreciation, and record the increase in a Revaluation Reserve.
- Calculate the depreciation charge for the period.
- Prepare the journal entry: Debit Depreciation Expense, Credit Accumulated Depreciation.
- Post the amounts to the two T‑accounts, showing opening balances (if any), the current charge and the closing balances.
- If a disposal is required:
- Determine Net Book Value = Cost – Accumulated Depreciation.
- Compare sale/scrap proceeds with NBV to find gain or loss.
- Prepare the full disposal journal entry (Cash/Bank, Accumulated Depreciation, Asset cost, Gain/Loss). For a trade‑in, include the acquisition of the new asset in the same entry.
- Show the removal of the asset and its accumulated depreciation in the respective T‑accounts.
- State the Net Book Value after depreciation (and after disposal, if asked).
7. Evaluation (AO3) – Choosing a Depreciation Method
Explain why a business might prefer the reducing‑balance method to the straight‑line method, and discuss one situation where the straight‑line method would be more appropriate.
- Impact on profit‑and‑loss – Reducing‑balance gives higher expense in early years, reducing early profits and tax liabilities; straight‑line spreads the expense evenly.
- Pattern of asset usage – If the asset is more productive when new (e.g., machinery that becomes less efficient), reducing‑balance matches cost to revenue more closely.
- Financial‑statement users – Investors may prefer straight‑line for its predictability; creditors may like reducing‑balance because it shows a more realistic decline in asset value.
- Tax considerations – Some tax regimes allow accelerated depreciation, favouring reducing‑balance.
- When straight‑line is better – For assets that provide a uniform service over their life (e.g., office furniture, buildings) the straight‑line method gives a fairer representation of cost per period.
8. Quick Reference – Formulas
| Method | Formula |
|---|
| Straight‑Line | \(\displaystyle \frac{\text{Cost} - \text{Residual}}{\text{Useful life}}\) |
| Reducing‑Balance | \(\displaystyle \text{Opening NBV} \times \text{Rate}\) ( Rate = \(\frac{1}{\text{Useful life}}\times100\%\) if not given) |
| Revaluation (increase) | New Fair Value – Current NBV = Increase → Credit Revaluation Reserve |
| Units‑of‑Production (A‑Level) | \(\displaystyle \frac{\text{Cost} - \text{Residual}}{\text{Total units}} \times \text{Units produced}\) |