Causes of Depreciation (Edexcel IGCSE Accounting)

Introduction to Depreciation

What is depreciation?

• Depreciation is applied to non-current assets to represent the reduction in their value

• Depreciation is the financial measure of how the value of an asset decreases over time

• Depreciation is an expense that accounts for the estimated loss in value of an asset during a given period

  • It is an expense that does not involve spending money

• It is used to spread the cost of the assets over their expected useful life

• You need to know two methods to calculate depreciation

  • Straight line method

  • Reducing balance method

• The accounting concept of consistency states that when a business chooses a method of depreciation for a type of non-current asset, it must use that method each year unless there is a valid reason to change to a different method

  • Different methods can be used for different types of non-current assets

Why are non-current assets depreciated?

• Depreciation is used so that the business adheres to the following accounting concepts:

• Accruals

  • The capital expenditure of a non-current asset is matched against the income that it has contributed to

    • Suppose that a business buys a vehicle for $30 000 and expects it to be useful for 8 years

    • The full $30 000 should not be charged as an expense straightaway

    • Instead, the expense should be spread out over the 8 years that it is contributing to income

• Prudence

  • The value of the assets should not be overstated

  • Depreciation allows the business to report a more realistic estimation for the valuation of its assets

Is depreciation charged in the years of purchase and sale?

• Different businesses will have different policies for dealing with depreciation for the year in which the asset is purchased and the year in which the asset is sold or disposed of

• The business could:

  • Charge a full year’s worth of depreciation

  • Charge no depreciation

  • Charge a proportion of the full year’s worth of depreciation

• The exam question will specify which rules should be used

Causes of Depreciation

What are the causes of depreciation?

• The value of a non-current asset depreciates due to:

  • Wear and tear of the asset

  • The asset becoming outdated or obsolete

  • The reduction in the expected useful lifetime of the asset

  • The asset being used up or depleted