{m}.{s}.1Fixed and current assets

Assets are classified as either fixed assets or current assets.

Fixed assets are assets purchased by a business for long-term use. They are listed in the balance sheet in order of permanence. For example:

  1. Property
  2. Plant and equipment
  3. Fixtures and fittings
  4. Motor vehicles

Motor vehicle

Current assets are those that are turning over frequently during the year. They can be thought of as being held as cash or with a view to converting them into cash. They are again listed in the balance sheet in order of permanence. For example:

  1. Stock
  2. Debtors
  3. Prepayments
  4. Deposit account
  5. Current account
  6. Cash

Cash

{m}.{s}.2Depreciation

Fixed assets are usually held by a business for several years. At the end of their period of use in the business their value will be considerably reduced. (An exception to this may be property which often appreciates in value.)

Over the period the cost to the business will be the original cost of the asset less any residual value at the end of the period of use.

Revenues and costs should be matched in the profit and loss account of the period to which they relate, to arrive at a meaningful net profit figure.

We, therefore, need some mechanism of attributing the cost of the asset over the period during which it is used.

This is done by the process of depreciation.

(Unless otherwise stated, in all the following examples the accounting year end is being taken as 31 December.)

Depreciation

{m}.{s}.3Depreciation: Example

Intro

Forklift

Consider a forklift bought in 2004 for £20,000.

It is replaced at the start of 2008 when it has a scrap value of £2,000.

The cost to the business over the years the asset has been in use, 2004 - 2007:

= Original cost - Residual value
= £20,000 - £2,000
= £18,000

We wish to spread this over the period of use. The easiest way is to divide the £18,000 evenly over time. The asset was used by the business for the 4 years 2004 - 2007, so we will attribute:

£18,000 / 4 = £4,500

to each of these years. This will be the depreciation charge in each year.

The value of the asset will be reduced each year by £4,500. The figure of cost less depreciation charged (or written off) to date is known as the net book value of the asset. Let us look at the net book value (NBV) of the asset over the years 2004 - 2007.

Depreciated forklift

 

2004

  2004 2005 2006 2007 2008
  Forklift Forklift Forklift Forklift Forklift
Start £20,000       £2,000
Depreciation (£4,500)        
End £15,500        
[{m}.{s}a]
Cost 2004 20,000
Depreciation 2004 4,500
NBV at end 2004 15,500
The NBV at the end of 2004 = the start of 2005

2005

  2004 2005 2006 2007 2008
  Forklift Forklift Forklift Forklift Forklift
Start £20,000 £15,500     £2,000
Depreciation (£4,500) (£4,500)      
End £15,500 £11,000      
[{m}.{s}b]
Depreciation 2005 4,500
NBV at end 2005 11,000
The NBV at the end of 2005 = the start of 2006

2006

  2004 2005 2006 2007 2008
  Forklift Forklift Forklift Forklift Forklift
Start £20,000 £15,500 £11,000   £2,000
Depreciation (£4,500) (£4,500) (£4,500)    
End £15,500 £11,000 £6,500    
[{m}.{s}c]
Depreciation 2006 4,500
NBV at end 2006 6,500
The NBV at the end of 2006 = the start of 2007

2007

  2004 2005 2006 2007 2008
  Forklift Forklift Forklift Forklift Forklift
Start £20,000 £15,500 £11,000 £6,500 £2,000
Depreciation (£4,500) (£4,500) (£4,500) (£4,500)  
End £15,500 £11,000 £6,500 £2,000  
[{m}.{s}d]
Depreciation 2007 4,500
NBV at end 2007 2,000
The NBV at the end of 2007 = the start of 2008

We will now look at different ways of calculating the depreciation charge.