Non-current assets — machinery, vehicles, equipment — lose value as they are used. Depreciation spreads an asset's cost over its useful life, so each year's profit carries a fair share of that cost. This is the matching principle.
The two methods
Straight-line — the same charge every year:
$\text{Depreciation} = \frac{\text{Cost} - \text{Residual value}}{\text{Useful life}}$Reducing balance — a fixed % of the falling net book value, so more is charged in the early years:
$\text{Depreciation} = \text{Net book value} \times \text{rate}\%$Net book value (NBV) = Cost − Accumulated depreciation. This is the value shown for the asset in the balance sheet.
Worked example — reducing balance
A machine costs $10{,}000$, depreciated at $20\%$ reducing balance:
| Year | Depreciation | NBV |
|---|---|---|
| Start | — | 10,000 |
| 1 | 2,000 | 8,000 |
| 2 | 1,600 | 6,400 |
Double entry each year
Dr Depreciation (income statement) · Cr Provision for depreciation.
The provision account builds up over time; the asset itself stays recorded at cost.
Disposal. When an asset is sold, remove its cost and accumulated depreciation, then compare the proceeds with its NBV: proceeds above NBV give a profit on disposal; below NBV, a loss.
Exam tips
- Straight-line always uses cost; reducing balance uses the latest NBV.
- Depreciation is a non-cash expense — it never appears in the cash book.
- Land is normally not depreciated.