We will consider the car purchased in 2006 for £5,000. Let us depreciate this in 2006 at 20% using the reducing balance method. Depreciation for 2006 is 20% x £5,000 = £1,000. As discussed earlier we are charging depreciation to profit. We must, therefore, have a new expense account to be able to do this - the Depreciation (expense) account. We want to increase our expenses (i.e. debit) by this amount. We will therefore debit the Depreciation account. Where will we make the credit entry? We want to decrease the value of the asset - we will therefore, for now, credit the asset - Motor car account. |
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We can clearly see that: Expenses (Depreciation) have increased Assets (Motor car) have decreased as part of the cost of the asset is written off as an expense. |
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When the annual accounts are prepared, the balance in the Depreciation account is transferred to the profit and loss account in the same way as any other expense account. This clears the Depreciation account to zero ready for next year's charges to be posted. The balance in our asset account will be included in the balance sheet. The balance is now £4,000 i.e. the original cost (£5,000) less the amount depreciated (£1,000). |
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The balance is now £4,000 i.e. the original cost (£5,000) less the amount depreciated (£1,000). |
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Note that once the balance of £4,000 is carried forward we have lost a lot of information. We cannot tell (without looking back to previous entries) if the asset cost £5,000 and has been depreciated by £1,000 or perhaps cost £25,000 and has been depreciated by £21,000. The only figure that is clearly shown is the net book value of £4,000. We will, therefore, look at a clearer method of recording the entries in the asset accounts. |
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Car purchased in 2006 for £5,000. Depreciation - 20% reducing balance. |
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In this method, instead of crediting the depreciation against the cost of the asset as presently shown, a new account is opened, the Accumulated Depreciation Account, and the depreciation is credited there. |
[{m}.{s}g] |
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As before, the balance in the Depreciation account is transferred to the profit and loss account. The balances in the Motor car - cost and Motor car - accumulated depreciation accounts will appear in the balance sheet. Note that the Motor car - acc depn account is also grouped with the asset accounts even though it has a credit balance. |
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The credit balance in this account decreases assets. |
The figures will show in the balance sheet [right]: The same final figure of the net book value of £4,000 is arrived at as before but much more information is readily available. |
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Let us consider the second asset purchased by the same business in 2006 for £3,200.
The depreciation being charged for 2006 is 10% straight line depreciation.
Entries will be made in the accounts in later years in the same way.
Let us consider the asset accounts for 2007. A new car is purchased, for cash, in the year for £6,500. A new item of machinery is purchased, on credit, for £1,600 (net of VAT).
Our T accounts in 2007 with these items included, will be as follows:
A1 Machinery - cost | |||
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Purchase | 3,200 | Bal c/d | 4,800 |
Creditors | 1,600 | ||
4,800 | 4,800 | ||
Bal b/d | 4,800 |
A2 Machinery - acc depn | |||
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Bal c/d | 800 | Bal b/f | 320 |
Depn | 480 | ||
800 | 800 | ||
Bal b/d | 800 |
E10 Depreciation | |||
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M/c acc dep | 480 | P&L | 2,580 |
Car acc dep | 2,100 | ||
2,580 | 2,580 | ||
A3 Motor Car - Cost | |||
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Bal b/f | 5,000 | ||
Bank | 6,500 | ||
11,500 | 11,500 | ||
Bal b/d | 11,500 |
A4 Motor Car - acc depn | |||
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Bal c/d | 3,100 | Bal b/f | 1,000 |
Depn | 2,100 | ||
3,100 | 3,100 | ||
Bal b/d | 3,100 |