Depreciation

Depreciation

The lives of fixed assets are not limited to a single accounting period (i.e. to 12 months).

Depreciation represents the fall in the value of these fixed assets, either due to their use, due to time, or due to obsolescence. Essentially, depreciation divides up the historic cost of a fixed asset over the number of expected years that it will be used by the business.

The most common method of depreciation is the straight-line method -this method of depreciating a fixed asset charges an equal amount to each year of its expected useful life.

The formula for its calculation is:

The depreciation charge per year

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Example:

If a new machine is purchased by a business for £100,000 and it is expected to have a useful life of 5 years, at the end of which it will be sold for a scrap value (residual value) of £10,000, then what is the depreciation charge per year?

The depreciation charge per year

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=£18,000

This means that after 1 year, the fixed asset will have a net book value (historic cost minus depreciation) of £82,000.

After 2 years, the net book value will be £64,000.

After 3 years, it will be £46,000. After 4 years, it will be £28,000.

At the end of year 5, it will have a value of £10,000 (this is the same value as the residual or scrap value).

The depreciation charge per year will be entered in the profit and loss account of the business as an expense, since it represents that part of the cost of the fixed asset that has been used-up (i.e. expired).

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