I n t e r a c t I v e t e X t foundations in Accountancy/ acca financial accounting (ffa/FA) bpp learning Media is an acca approved Content Provider

 

4

   Depreciation accounting 

The cost of a non-current asset, less its estimated residual value, is allocated fairly between accounting 

periods by means of depreciation. Depreciation is both of the following. 

 

Charged against profit 

 

Deducted from the value of the non-current asset in the statement of financial position 

Two methods of depreciation are specified in your syllabus. 

 

The straight line method 

 

The reducing balance method 

4.1 What is depreciation? 

The need to depreciate non-current assets arises from the accruals assumption. If money is expended in 

purchasing an asset then the amount expended must at some time be charged against profits. If the 

business consumes economic benefits from the asset over a number of accounting periods it would be 

inappropriate to charge any single period (eg the period in which the asset was acquired) with the whole 

of the expenditure. Instead, some method must be found of spreading the cost of the asset over its 

useful life. 

This view of depreciation as a process of allocation of the cost of an asset over several accounting 

periods is the view adopted by IAS 16. It is worth mentioning here two common misconceptions about 

the purpose and effects of depreciation. 

(a) 

It is sometimes thought that the carrying amount of an asset is equal to its net realisable value (ie 

the amount the asset could be sold for less the selling costs) and that the reason for charging 

depreciation is to reflect the fall in value of an asset over its life. This misconception is the basis 

of a common, but incorrect, argument which says that freehold properties (say) need not be 

depreciated in times when property values are rising. It is true that historical cost often gives a 

misleading impression when a property's carrying amount is much below its market value, but in 

such a case the business can choose to revalue the property. This is a separate problem from 

that of allocating the property's cost over successive accounting periods. 

(b) 

Another misconception is that depreciation is provided so that an asset can be replaced at the 

end of its useful life. This is not the case. 

(i) 

If there is no intention of replacing the asset, it could then be argued that there is no need 

to provide for any depreciation at all. 

(ii) 

If prices are rising, the replacement cost of the asset will exceed the amount of 

depreciation provided. 

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CHAPTER 8  

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  TANGIBLE NON-CURRENT ASSETS