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You are familiar with the distinction between fixed and
current assets, a fixed asset being one bought for ongoing use
in the business.
Fixed assets are held and used by a business for a number of
years, but they wear out or lose their usefulness over time.
Every tangible fixed asset has a limited life. The only
exception is land held freehold or on a very long leasehold.

The accounts of a business recognize that the cost of a fixed

asset is consumed as the asset wears out, by writing off the
asset¶s cost in the profit and loss account over several
accounting periods. For example, a machine costs £1,000 and
is expected to wear out after ten years. We can reduce the
balance sheet value by £100 each year. This process is
known as µ ¶.
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1) Definition of depreciation

2) Causes of depreciation

3) Factors that affect the calculation of depreciation

4) Methods of depreciation
a) Straight-line method
i) Equation ii) Fixed percentage of cost of asset
b) Reducing balance method (Fixed percentage)

5) Double entry records for depreciation and the disposal of

fixed assets
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µDepreciation¶ is an example of the µmatching¶
principle in action. It represents the diminution in
value of a fixed asset over a period of time. Since
depreciation is a provision, it is important to calculate
this figure as accurately as possible. The Net Book
Value is the reduced fixed asset value at any point in
time after depreciation.

As a fixed asset has a life of over 1 year and is

expected to produce revenue over a number of
years, it is important to spread the cost of the fixed
asset over these years.
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The depreciation charge in the profit and loss account
represents a cost of expense and can be viewed as the
cost of using the fixed asset over the period that the
profit and loss account covers. This follows the
matching concept which requires that revenues are
matched with expenses in the year they are incurred.
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Fixed assets are those assets bought by the company
for the intention to be used for a long period of time.
Fixed assets are said to depreciate over a period of
time due to the following factors:
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i) 
 
 ± When a motor vehicle or machinery
or fixtures and fittings are used, they eventually wear
out. Some last many years, others last only a few year.
ii) &
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! ± Land may be eroded or
wasted away by the action of wind, rain, sun and other
elements of nature. Similarly, the metals in motor
vehicles or machinery will rust away.
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i) Obsolescence ± This is the process of becoming out of date.

For instance, replacing a computer with old
operating system with a new computer
with XP system.

ii) Inadequacy ± This arises when an asset is no longer used

because of the growth and changes in the
size of the firm. For instance, a small
ferryboat that is operated by a firm at a
coastal resort will become entirely
inadequate when the resort becomes more
popular, to be more efficient and
economical, the firm may replace it with a
large ferryboat.
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Some assets might have a legal life fixed in terms of years.
For example, the patents, and leasehold. You may agree to
rent some buildings for 10 years. This is normally called a
lease. When the years are finished, the lease is worth nothing
to you, as it has finished. Whatever you paid for the lease is
now of no value.

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Other assets are of wasting character, perhaps due to the
extraction of raw materials from them. These materials are
then either used by the firm to make something else, or are
sold in their raw state to other firms. Natural resources such
as mines, quarries and oil wells come under this heading.
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1) Cost of asset (include expenses and capital expenditure
incurred eg. The installation fees, the legal fees)

2) Estimated useful life of asset

This is the number of years that the asset is expected to be used)

3) Residual or scrap value of the asset

This is the value of the asset at the end of its life.

4) Method of calculating depreciation

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Straight-line method of depreciation is based on the cost of an
asset that is then depreciated, by the same amount, over the
estimated useful life of the asset.

Cost ± Estimated Disposal Value

Depreciation per annum =
Expected useful life
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ABC Ltd. Bought a machine at a cost of £80,000. The
machine has an expected useful life of 5 years and at the end
of the 5th year, it can be sold for £10,000.

Depreciation per annum =

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Depreciation for 5 years would be:

Cost Annual Provision for NBV
Depreciation Depreciation

Date of purchase 80,000 80,000

End of 1st year 80,000 14,000 14,000 66,000

End of 2cd year 80,000 14,000 28,000 52,000

End of 3rd year 80,000 14,000 42,000 38,000

End of 4th year 80,000 14,000 56,000 24,000

End of 5th year 80,000 14,000 70,000 10,000

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The depreciation expense can also be calculated by writing
off a fixed percentage of cost of the asset.

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ABC Ltd. Bought a machine at a cost of £80,000. The
depreciation is to be charged at a 20% per annum on cost.

Depreciation per annum = £80,000 x 20%

= £16,000 per year
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1) Appropriate for assets which lose value quickly in the
early year.
2) Appropriate for assets which become
outdated/obsolete


 

1) Asset is never completed written off
2) For assets which have a short life, the percentage used
to calculate depreciation is very large.
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îsing the answers in Example 3, write up the depreciation

expenses and provision for depreciation accounts for 2001,
2002, 2003, 2004, and 2005. Also, records the provision for
depreciation in the Balance Sheet.
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Reason for accounting entries:

îpon the sale of an asset, we will want to delete it from our
accounts. This means that the cost of that asset needs to be
taken out of the asset account. In addition, the depreciation of
the asset which has been sold will have to be taken out from
the provision for depreciation. Finally, the profit and loss on
sale, if any, will have to be calculated.
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On the sale of a fixed asset, for instance machinery, the
following entries are needed:

A) Transfer the cost price of the asset sold to an assets

disposal account:
Dr Machinery disposals A/C
Cr Machinery A/C

B) Transfer the depreciation already charged to the assets

disposals account:
Dr Provision for Depreciation A/C
Cr Machinery disposals A/C
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C) For remittance received on disposal:

Dr Cash A/C
Cr Machinery disposals A/C

D) Transfer difference to the profit and loss account. If the

machinery disposals account shows a 
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a 


":
Dr Machinery disposals A/C
Cr Profit and loss A/C

If the machinery disposals account shows a 

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":
Dr Profit and loss A/C
Cr Machinery disposals A/C
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-
In a business with financial years ended 31 December, a
machine is bought for £2,000 on 1 January 1995. It is to be
depreciated at the rate of 20% using the reducing balance
method.
The company has decided to sell the machine for 4#'565 on 2
January 1998.

21
Show the following ledger accounts for the year ended 31
December 1998:
i) Machinery A/C ii) Cash A/C
iii) Provision for Machinery A/C
iv) Disposals on Machinery A/C
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In a business with financial years ended 31 December, a
machine is bought for £2,000 on 1 January 1995. It is to be
depreciated at the rate of 20% using the reducing balance
method.
The company has decided to sell the machine for 475 on 2
January 1998.

21
Show the following ledger accounts for the year ended 31
December 1998:
i) Machinery A/C ii) Cash A/C
iii) Provision for Machinery A/C
iv) Disposals on Machinery A/C
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The financial year of Lu Ltd. ends on 31 December. On 1 January 2002, the following balances are in its Ledger Accounts that relate to fixed
assets:




 
 £
Machinery 650,000
Equipments 320,000

%
   £
Machinery 140,000
Equipments 72,000

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i) The reducing balance method of depreciation is used to depreciate the machinery. A rate of 10% per annum is used.
ii) The straight-line method of depreciation is used to depreciation the equipments at a rate of 10% per annum.
iii) When fixed assets are purchased in the first half of a financial year, a full year¶s depreciation is charged. When fixed assets are purchased
in the second half of a financial year, a half-year¶s depreciation is charged.
v) Depreciation is not charged on assets in the year in which they are sold.

During the year 2002, the following transactions took place in relation to the company¶s fixed assets:

% 

 
10 February Machinery £50,000
29 September Equipments £6,000

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On 15 August, a machine was sold for £14,000 and the proceeds were received by cheque. The machine had been purchased on 12 October 2002
for £15,000.

21
Prepare the following Ledger Accounts for the year ended 31 December 2002:
i) Machinery
ii) Equipment
iii) Provision for depreciation of machinery
iv) Provision for depreciation of equipment
v) Disposals on machinery
a)