CARA'S TIPSStraight-line, reducing-balance and revaluation methods; recording and disposal
WAECNECO
What the syllabus asks
WAEC: (1) meaning; methods: fixed instalment/straight line, diminishing/reducing balance and revaluation; (2) calculation of simple depreciation charges. Extends fa7.
NECO: (1) meaning; methods: fixed instalment/straight line, diminishing/reducing balance and revaluation; (2) calculation of simple depreciation charges. Extends fa7.
What you will learn
- Define depreciation and related terms.
- Explain the causes of depreciation and reasons for providing it.
- Calculate straight-line depreciation and draw schedules.
- Calculate reducing-balance depreciation.
- Compare the methods and choose a suitable one.
- Apply the revaluation method.
- Handle part-year depreciation and additions.
- Record depreciation and show it in the final accounts.
Key points
- Depreciation allocates cost; it is not a fall in market value or a cash payment.
- Main causes: wear and tear, obsolescence, time, depletion.
- It matches cost to revenue and prevents overstated profit.
- Straight line: (cost − residual) ÷ life.
- Reducing balance: % of opening NBV.
- Revaluation: opening + purchases − closing value.
- Part-year charges follow the stated policy.
- Provision account accumulates depreciation; asset at cost.
- Disposal compares NBV with proceeds.
- Show the charge in P&L and cost less provision in the balance sheet.
Start here: Meaning of depreciation
Depreciation is the part of the cost of a fixed asset that is used up, or consumed, during an accounting period, and is charged as an expense in that period. In simple words: a fixed asset gives service for several years, so its cost is spread over those years instead of being charged all at once.
Consider Kano Cold Room Ltd, which buys a large generator for ₦2,400,000. The generator will power the cold room for about five years and then be sold for about ₦400,000. If the whole ₦2,400,000 were charged as an expense in Year 1, Year 1 would show a huge loss and Years 2–5 would show profits that are too high, although the generator was working equally hard in every year. Depreciation charges ₦400,000 a year, matching the cost of the generator with the income it helps to earn. This is the accruals (matching) concept at work.
What depreciation is not
- It is not a fall in market value. A plot of land may rise in value; a building may be worth more than its cost; depreciation is about spreading cost, not tracking prices.
- It is not a payment of cash. No money leaves the business when depreciation is charged; the cash went out when the asset was bought.
- It is not a fund of money set aside for replacement, although a prudent owner may save for replacement separately.
Terms
| Term | Meaning |
|---|---|
| Cost | Price paid plus costs to bring the asset into use (delivery, installation, legal fees) |
| Useful life | Number of years the business expects to use the asset |
| Residual (scrap) value | Expected sale value at the end of the useful life |
| Depreciable amount | Cost − residual value |
| Accumulated depreciation | Total depreciation charged so far |
| Net book value (NBV) | Cost − accumulated depreciation; also called written-down value |
Land is normally not depreciated because it does not wear out (except land used for quarrying or mining, which is depleted).
What is included in cost?
Depreciation is based on the full cost of getting the asset ready for use, not just its price tag. A rice mill in Ibadan buys a grinding machine:
| Item | ₦ |
|---|---|
| Price of the grinding machine | 1,850,000 |
| Less trade discount | (92,500) |
| Delivery from Apapa to Ibadan | 65,000 |
| Installation and test run | 40,000 |
| Concrete base for the machine | 27,500 |
| Cost to be depreciated | 1,890,000 |
All these costs are capital expenditure because the machine could not work without them. Later costs of running the machine (diesel, operator’s wages, routine servicing) are revenue expenditure and are not depreciated.
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Practice questions
- the fall in value of a fixed asset over its useful life
- a fall in cash
- an increase in asset value
- a tax on profit
Show answer
A: the fall in value of a fixed asset over its useful life
Allocation of cost.
- ₦800,000
- ₦900,000
- ₦600,000
- ₦700,000
Show answer
D: ₦700,000
4,200,000 ÷ 6.
- ₦675,000
- ₦1,050,000
- ₦900,000
- ₦1,200,000
Show answer
C: ₦900,000
25% × 3,600,000.
- ₦1,350,000
- ₦2,025,000
- ₦2,700,000
- ₦1,200,000
Show answer
B: ₦2,025,000
4,800,000 × 0.75³.
- a loss of ₦150,000
- a profit of ₦150,000
- a loss of ₦600,000
- a profit of ₦750,000
Show answer
A: a loss of ₦150,000
600 − 750 thousand.
Key words
- Depreciation
- Cost of a fixed asset used up in a period.
- Useful life
- Years the asset is expected to be used.
- Residual value
- Expected value at the end of its life.
- Straight line
- Equal charge each year.
- Reducing balance
- Fixed % of NBV each year.
- Revaluation method
- Fall in valuation of small assets.
- Provision for depreciation
- Account accumulating depreciation.
- Net book value
- Cost less accumulated depreciation.
- Obsolescence
- Becoming out of date.
- Depletion
- Using up a natural resource.
- Disposal account
- Account showing profit or loss on sale of an asset.
- Capital allowances
- Tax deductions for fixed assets set by law.
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