Depreciation

Depreciation is the process whereby the value of assets on the balance sheet is decreased from year to year. It ensures that assets, after years of use, are still reflected at a fair value on the balance sheet.

The calculation of the annual depreciation is as follows:

Straight-line method - Cost price of the asset divided by the number of years that the asset would be utilised by the business.

Fixed percentage or reduced balanced method.

Example of Straight Line:

Cost price:                   R100 000

Expected useful life:    5 years

Annual depreciation:  R 20 000

Example of a Fixed Percentage:

Cost price: R100 000

5 Years 50% on the reduced balance

Year 1:   R50 000 (50% on R100 000)

Year 2:  R25 000 (50% on R50 000)

Year 3:   R12 500 (50% on R25 000)

Year 4:   R6 250 (50% on R12 500)

Year 5:   Balance

Not all assets are depreciated. Some assets, e.g. fixed property, may appreciate over time.

The useful life will vary for different asset types, normally between 2 years (software) to 7 years (furniture).

Depreciation has the following influence on the financial statements:

• Depreciation reduces the value of the asset on the balance sheet.
• Since the BAE must be in balance after every transaction, another element in the equation must also be reduced.
• Since a reduction in the value of an asset reduces the value for the owners, equity is decreased by a similar amount.
• This reduction in equity is done through the income statement with depreciation expense.

The accounts debited and credited are:

• Accumulated depreciation
• Balance sheet (credit)
• Depreciation - income statement (debit)

Book value refers to the cost price of an asset, minus the actual depreciation.