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:
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:
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.)
![]() |
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 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. |
![]() |
2004 | 2005 | 2006 | 2007 | 2008 | |
![]() |
![]() |
![]() |
![]() |
![]() |
|
Start | £20,000 | £2,000 | |||
Depreciation | (£4,500) | ||||
End | £15,500 |
Cost 2004 | 20,000 |
Depreciation 2004 | 4,500 |
NBV at end 2004 | 15,500 |
2004 | 2005 | 2006 | 2007 | 2008 | |
![]() |
![]() |
![]() |
![]() |
![]() |
|
Start | £20,000 | £15,500 | £2,000 | ||
Depreciation | (£4,500) | (£4,500) | |||
End | £15,500 | £11,000 |
Depreciation 2005 | 4,500 |
NBV at end 2005 | 11,000 |
2004 | 2005 | 2006 | 2007 | 2008 | |
![]() |
![]() |
![]() |
![]() |
![]() |
|
Start | £20,000 | £15,500 | £11,000 | £2,000 | |
Depreciation | (£4,500) | (£4,500) | (£4,500) | ||
End | £15,500 | £11,000 | £6,500 |
Depreciation 2006 | 4,500 |
NBV at end 2006 | 6,500 |
2004 | 2005 | 2006 | 2007 | 2008 | |
![]() |
![]() |
![]() |
![]() |
![]() |
|
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 |
Depreciation 2007 | 4,500 |
NBV at end 2007 | 2,000 |
We will now look at different ways of calculating the depreciation charge.