Back to: Financial Accounting
Good day, class! I trust you are well and settling comfortably into the semester.
Today, we shall continue with our study of non-current assets by focusing on Depreciation.
This is an essential topic because almost every business uses long-term assets such as machinery, vehicles, and buildings, which reduce in value over time. Understanding how to calculate and record depreciation is key for accurate financial reporting.
Let’s begin!
Depreciation of Non-Current Assets
Lesson Objectives:
By the end of this lesson, you should be able to:
Define depreciation and understand its purpose.
Identify the causes of depreciation.
Explain the different methods of calculating depreciation.
Calculate depreciation using the Straight-Line and Reducing Balance methods.
Prepare depreciation-related ledger entries.
1. What is Depreciation?
Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. It represents the wear and tear, obsolescence, or usage of a non-current asset.
Depreciable amount = Cost of Asset – Residual (Scrap) Value
2. Causes of Depreciation
Wear and tear due to use.
Obsolescence due to technology changes.
Passage of time, particularly for leases or patents.
Depletion, especially for natural resources like mines.
3. Methods of Calculating Depreciation
a. Straight-Line Method (SLM)
This method allocates equal depreciation expense every year.
Formula:
Depreciation per annum =
(Cost – Residual Value) ÷ Useful Life
Example 1:
An equipment is bought for ₦1,200,000, with a residual value of ₦200,000 and a useful life of 5 years.
Solution:
Depreciation per annum = (₦1,200,000 – ₦200,000) ÷ 5 =
₦1,000,000 ÷ 5 = ₦200,000 per year
b. Reducing Balance Method (RBM)
This method applies a fixed percentage on the book value at the beginning of each year.
Formula:
Depreciation = Book Value at Start of Year × Depreciation Rate
Example 2:
A machine costs ₦800,000. It depreciates at 25% per annum using the reducing balance method.
Year 1:
Depreciation = ₦800,000 × 25% = ₦200,000
Book Value = ₦800,000 – ₦200,000 = ₦600,000
Year 2:
Depreciation = ₦600,000 × 25% = ₦150,000
Book Value = ₦600,000 – ₦150,000 = ₦450,000
Year 3:
Depreciation = ₦450,000 × 25% = ₦112,500
And so on.
4. Ledger Entries for Depreciation
Straight-Line Method:
Each year, you debit the Depreciation Expense Account and credit the Accumulated Depreciation Account.
Example:
Dr. Depreciation Expense (P&L) ₦200,000
Cr. Accumulated Depreciation (Balance Sheet) ₦200,000
This process continues annually throughout the asset’s useful life.
5. Key Points to Remember:
Depreciation affects both the income statement (as an expense) and the balance sheet (as a reduction in asset value).
Depreciation does not involve cash outflow.
The choice of method depends on the nature and usage pattern of the asset.
Evaluation
A vehicle was purchased on 1st January 2022 for ₦2,000,000. It has a useful life of 4 years and an estimated residual value of ₦400,000.
Required:
Calculate depreciation for each year using the Straight-Line Method.
Assignment:
A machine costs ₦1,500,000 and depreciates at 20% per annum using the Reducing Balance Method.
Required:
Calculate the depreciation for the first 3 years and state the closing book value at the end of Year 3.
In our next class, we shall look at the Revaluation of Non-Current Assets. Please review today’s examples and practice additional questions from your textbook.
Keep up the good work, and don’t hesitate to ask for clarification.