explain the reasons for accounting for depreciation

4.2 Accounting for depreciation and disposal of non‑current assets

Why do we depreciate assets?

📚 Depreciation spreads the cost of an asset over the period it is useful, so the books show a realistic value and a fair share of the asset’s cost each year.

• 🔄 Matching principle – match the cost of the asset with the profits it helps generate.
• 💰 Tax relief – businesses can claim depreciation as an expense, reducing taxable profit.
• 🛠️ Asset consumption – show that the asset is wearing out or becoming less useful.
• 📉 Asset disposal – record the loss or gain when the asset is sold or scrapped.

Analogy: The School Bus Example 🚐

Imagine the school bus costs £30,000 and is expected to run for 10 years. Instead of writing £30,000 as an expense in the first year, we spread it:

Annual depreciation = £30,000 ÷ 10 = £3,000 Each year we record £3,000 as an expense, showing that the bus is being used and losing value. When the bus is sold after 7 years for £5,000, we record a gain of £5,000 – (£30,000 – 7×£3,000) = £5,000 – £9,000 = -£4,000 (a loss). This keeps the books honest and useful for planning.

How to calculate depreciation (Straight‑Line Method)

The most common method is the straight‑line method:

$$\text{Depreciation per year} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}}$$

Example: Cost = £12,000, Residual Value = £2,000, Useful Life = 5 years $$\frac{12,000 - 2,000}{5} = \frac{10,000}{5} = £2,000 \text{ per year}$$

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