Accounting for Fixed Assets - Depreciation: Straight-line Example
Author: Jim Riley Last updated: Sunday 23 September, 2012
Depreciation - straight line example
In our introduction to the methods available to calculate depreciation, we
suggested that there are two main methods that can be used:
- Straight- line depreciation
- Reducing balance method
We emphasised the point that these two methods simply provide an alternative
way of allocating the total depreciation charge over several accounting periods.
The total depreciation charge using either method will be the same over the
total useful economic life of the asset.
To illustrate the straight line depreciation method, we have calculated the
depreciation charge for the following asset:
A business purchases a new machine for £75,000 on 1 January 20X3. It
is estimated that the machine will have a residual value of £10,000
and a useful economic life of five years. The business has an accounting year
end of 31 December.
Straight line depreciation method
Using the straight line depreciation method, the calculation of the annual
depreciation charge is as follows:
Dpn = (C- R)/ N
Dpn = Annual straight-line depreciation charge
C = Cost of the asset
R = Residual value of the asset
N = Useful economic life of the asset (years)
So the calculation is:
Dpn = (£75,000 - £10,000) / 5
Dpn = £13,000
in the accounts of the business a depreciation charge of £13,000 will
be expensed in the profit and loss account for each of the five years of the
asset's useful economic life.
In the annual balance sheet, the machine would be shown at its original cost
less the total accumulated depreciation for the asset to date.
Example of how this would be disclosed in the accounts
At the end of the third year of ownership of the machine, the financial accounts
of the business would include the following items in relation to the machine:
In the Profit and Loss Account:
Depreciation of Machinery - Charge: £13,000
In the Balance Sheet at 31 December 20X5:
Machine at Cost
less: Accumulated Depreciation
Machine at net book value
The figure for accumulated depreciation of £39,000 at 31 December 20X5
represents three years' worth of depreciation at £13,000 per year.
The cost of the machine (£75,000) less the accumulated depreciation
charged on the machine (£39,000) is known as the "written-down
value" ("WDV") or "net book value" ("NBV").
it should be noted that WDV or NBV is simply an accounting value that is
the result of a decision about which method is used to calculate depreciation.
It does not necessarily mean that the machine is actually worth more or less
than the WDV or NBV.