Depreciation is the systematic allocation of the cost of a long‑term asset over its useful life. Think of it like a car’s mileage: each year you use the car a bit more, so its value goes down.
The straight‑line method spreads the cost evenly each year:
\$ \text{Depreciation} = \dfrac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}} \$
All numbers are in the same currency unit (e.g., £).
Depreciation reduces the Net Book Value (NBV) of the asset each year.
| Year | NBV at Start | Depreciation Expense | NBV at End |
|---|---|---|---|
| Year 1 | £10,000 | £1,600 | £8,400 |
| Year 2 | £8,400 | £1,600 | £6,800 |
Depreciation is recorded as an expense each year, reducing the company’s profit.
\$ \text{Profit Before Depreciation} - \text{Depreciation Expense} = \text{Profit After Depreciation} \$
📉 Example: If profit before depreciation is £5,000, after £1,600 depreciation the profit becomes £3,400.
Imagine a school buys a projector for £10,000, expects it to last 5 years, and thinks it will still be worth £2,000 at the end.
Remember depreciation is an expense, not a cash outflow.
Check that the asset is still in use before applying depreciation.
Show both the expense on the income statement and the reduction in NBV on the balance sheet.
Use the straight‑line formula only – no other methods for this paper.
Explain the effect on profit and on the asset’s value in plain language.