Depreciation & Disposal of Non-Current Assets (Cambridge (CIE) IGCSE Accounting): Flashcards
Exam code: 0452 & 0985
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Define depreciation.
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Define depreciation.
Depreciation is the financial measure of how a non-current asset loses value over time. It spreads the cost of the asset across its expected useful life.
Give three reasons why a non-current asset loses value.
A non-current asset loses value through:
wear and tear
becoming outdated or obsolete
the reduction in its remaining useful life
being used up or depleted
True or False?
Depreciation is an expense even though no money is spent.
True.
Nothing leaves the bank when depreciation is charged. It records the loss in value the asset has already suffered, which is a real cost to the business even though no payment is made.
Which accounting principle explains why an asset's cost is spread over its useful life?
The principle is matching. The cost of the asset is set against the income it helps to earn, so a $30 000 vehicle expected to last eight years is charged over those eight years rather than all at once.
Complete the sentence about choosing a depreciation method:
The principle of
means a business must keep using the same method for a type of asset year after year.The completed sentence is:
The principle of consistency means a business must keep using the same method for a type of asset year after year.
Which accounting principle says that assets must not be overstated?
The principle is prudence. Charging depreciation gives a more realistic figure for what the business's assets are actually worth.
Name the three methods of depreciation.
The three methods are:
the straight-line method
the reducing balance method
the revaluation method
Is depreciation charged in the year an asset is bought or sold?
It depends on the individual business's policy, as there is no single rule. Some charge a full year, some charge none at all, and some charge a proportion of the year.
What does the straight-line method of depreciation assume?
It assumes the asset loses value at a constant rate over its useful life. The depreciation charge is therefore the same every year.
Complete the formula used when no depreciation percentage is given:
Depreciation per year = (original value − expected value) ÷ number of
.The completed formula is:
Depreciation per year = (original value − expected value) ÷ number of years.
When is the straight-line method appropriate?
When the asset is equally useful in every year of its life, such as fixtures, fittings and equipment. Its value falls steadily rather than sharply at the start.
True or False?
An asset depreciated by the straight-line method can reach a net book value of zero.
True.
Once the total depreciation charged equals the cost, the asset is fully depreciated and its net book value is zero. That cannot happen under the reducing balance method, where each charge is only a fraction of what is left.
Define residual value.
The residual value is what a non-current asset is expected to be worth at the end of its working life. It may be zero.
How do you calculate straight-line depreciation from a given percentage?
Take that percentage of the original cost. The charge is identical every year, because the calculation always uses the original cost rather than the current value.
Machinery cost $18 000 and is depreciated at 15% per annum straight-line. What is its net book value after 3 years?
The net book value is $9900. Each year's charge is 15% × $18 000 = $2700, so three years come to $8100, and $18 000 − $8100 = $9900.
A vehicle cost $30 000 and is expected to be worth $12 000 after 3 years. What is the yearly depreciation?
The yearly charge is $6000. The loss in value is $30 000 − $12 000 = $18 000, and $18 000 ÷ 3 = $6000.
What does the reducing balance method of depreciation assume?
It assumes the asset loses value in proportion to its current value. The charge is therefore a fixed percentage of the net book value, not of the original cost.
When is the reducing balance method appropriate?
When an asset loses value quickly at first and more slowly later, such as a vehicle. The pattern of the charge then matches the pattern of the real loss in value.
How do you calculate reducing balance depreciation over several years?
Work one year at a time. Take the percentage of the net book value at the start of the year, subtract it to get the new net book value, then repeat for the next year.
True or False?
An asset depreciated by the reducing balance method eventually reaches a net book value of zero.
False.
Each year's charge is a percentage of what is left, so some value always remains. The net book value gets smaller and smaller but never quite reaches zero.
Complete the shortcut for finding a net book value under reducing balance:
Subtract the rate from 100%, write it as a decimal, raise it to the power of the number of
, then multiply by the original cost.The completed shortcut is:
Subtract the rate from 100%, write it as a decimal, raise it to the power of the number of years, then multiply by the original cost.
A vehicle cost $16 000 and is depreciated at 25% per annum reducing balance. What is its net book value after 3 years?
The net book value is $6750. Taking 25% off each year gives $12 000, then $9000, then $6750, and the same answer comes from $16 000 × 0.75 cubed.
Why does the depreciation charge get smaller every year under this method?
The percentage is applied to the net book value, which falls each year. A fixed percentage of a shrinking figure gives a shrinking charge.
What does the revaluation method of depreciation involve?
The assets are valued at the end of the financial year, and the fall in value is taken as the depreciation charge. Nothing is worked out from a rate or a formula.
Complete the sentence about calculating revaluation depreciation:
The depreciation charge is the value
the revaluation minus the value it.The completed sentence is:
The depreciation charge is the value before the revaluation minus the value after it.
When is the revaluation method of depreciation used?
For low-value items that would be impractical to track individually, such as loose tools and packing cases. Valuing the whole collection is simpler than depreciating each item separately.
True or False?
The revaluation method needs no percentage rate.
True.
The charge comes from an actual valuation of the assets rather than from a rate. That is exactly what makes it workable for items too numerous to depreciate one by one.
Fixtures cost $5000 and were valued at $3650 at the year end. What is the depreciation charge?
The charge is $1350. It is simply the fall in value, so $5000 − $3650 = $1350.
Why does a business keep two separate accounts for each type of non-current asset?
So that it always has a record of both the original cost and the depreciation charged so far.
Keeping the two figures apart means neither one is lost, and the statement of financial position can show both.
True or False?
Depreciation is recorded in the non-current asset account.
False.
Entries are made in the non-current asset account only when assets are bought, sold or otherwise disposed of. The depreciation is collected in a separate provision for depreciation account.
What is the double entry to record the year's depreciation charge?
Debit the statement of profit or loss and credit the provision for depreciation account.
The debit records the year's depreciation as an expense, and the credit reduces the value of the asset.
The book of prime entry is the journal.
Complete the sentence by naming the two accounts:
The net book value is the balance of the
account minus the balance of the account.The completed sentence is:
The net book value is the balance of the non-current asset account minus the balance of the provision for depreciation account.
A provision for depreciation account opens with a balance of $4000 and this year's charge is $4200. What is the closing balance, and what amount goes to the statement of profit or loss?
The closing balance is $8200 and the amount in the statement of profit or loss is $4200.
The account collects every year's charge, so $4000 + $4200 = $8200, but only the current year's charge is an expense.
A business buys extra equipment part-way through the year and charges a full year's depreciation on it. Why can the new and the old equipment be depreciated together?
Because both are being charged for a full year, so there is nothing to be gained by working them out separately.
The new purchase is simply added to the existing equipment before the year's charge is calculated.
Which three values are shown for a non-current asset in the statement of financial position?
The three values are:
the cost
the provision for depreciation
the net book value
Define the proceeds of the sale.
The proceeds of the sale are the money received when a non-current asset is sold.
They are a capital receipt, not sales revenue.
How do you work out the profit or loss when a non-current asset is sold?
Compare the proceeds of the sale with the net book value of the asset.
Proceeds above the net book value give a profit, and proceeds below it give a loss.
True or False?
The sale of a non-current asset is recorded in the sales account.
False.
The sales account is only for the sale of goods. A non-current asset that is sold is dealt with in a separate disposal account.
Equipment costing $30 000 with $18 000 of depreciation charged is sold for $13 000. What is the profit or loss on the sale?
There is a profit of $1000.
The net book value is $30 000 − $18 000 = $12 000, and the proceeds of $13 000 are $1000 above it.
What does a profit on disposal tell you about the depreciation charged?
That too much depreciation was charged over the asset's life.
Each year's charge was larger than the asset's real fall in value, so it ended up carried in the books at less than it was worth.
Complete the sentence about selling a non-current asset on credit:
The buyer is recorded in an other receivables account, kept separate from the
accounts of customers who buy goods.The completed sentence is:
The buyer is recorded in an other receivables account, kept separate from the trade receivables accounts of customers who buy goods.
What happens when an old non-current asset is given in part-exchange?
The business and the supplier agree a value for the old asset.
The business hands the asset over, and the supplier reduces the cost of the new asset by that agreed value.
A business charges depreciation in the year an asset is sold. How does that affect the calculation of the profit or loss?
That year's charge must be added to the accumulated depreciation first.
Only then can the net book value be worked out and set against the proceeds of the sale.
Define disposal account.
A disposal account is the account used to work out the profit or loss on the sale of a non-current asset.
That profit or loss is then transferred to the statement of profit or loss.
What is the double entry to remove a sold asset's original cost?
Credit the non-current asset account and debit the disposal account.
The credit takes the cost out of the asset account, because the business no longer owns the asset.
What is the double entry to clear the accumulated depreciation on a sold asset?
Debit the provision for depreciation account and credit the disposal account.
The debit is the exact amount of depreciation that had built up on that asset.
Complete the sentence about entering the result of a disposal:
A profit on disposal is entered on the
side of the disposal account, and a loss on the side.The completed sentence is:
A profit on disposal is entered on the debit side of the disposal account, and a loss on the credit side.
A profit is an income and a loss is an expense, so the entry in the statement of profit or loss is the other way round.
Why must the accumulated depreciation be transferred out of the provision for depreciation account when an asset is sold?
Because that depreciation belongs to an asset the business no longer owns.
Leaving it there would overstate the depreciation held against the assets that remain.
True or False?
A disposal account has a zero balance once the profit or loss has been transferred.
True.
The cost, the depreciation, the proceeds and the profit or loss all cancel each other out, so nothing is left in the account.
Which account is debited with the money received from a disposal?
Cash if the money was received in cash, bank if it came by cheque or transfer, and other receivables if the asset was sold on credit.
The disposal account is credited in every case.
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