Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Application of the matching convention Measures how much of the value of fixed assets has been used up in an accounting period Matches this cost (depreciation) against the sales generated in an accounting period

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Quickwash January 20X1 - van bought for £ Van will be replaced in three years time It will be sold in January 20X4 for an estimated £5000 What is the total value used up over the three year period of ownership?

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Quickwash (continued) £ is an estimate of the van’s depreciation over the three year period

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Quickwash (continued) How is depreciation spread over the three-year period? A simple method is to split the total figure equally over the periods that benefit from the use of the asset. This gives a depreciation charge of £5000 each year This is known as the straight-line method

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Profit and loss account –Depreciation is shown as an expense Balance sheet –Depreciation is shown as a deduction from the initial cost of the asset. Over time the accumulated depreciation gets larger and the value of the asset (net book value) decreases

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Quickwash (continued) Year 1 Profit and loss account: depreciation expense of £5000 Balance sheet:

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Quickwash (continued) Year 2 Profit and loss account: depreciation expense of £5000 Balance sheet:

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Quickwash (continued) Year 3 Profit and loss account: depreciation expense of £5000 Balance sheet:

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Quickwash (continued) Summary of balance sheets

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Amortisation works in the same way as depreciation, but is applied to intangible fixed assets Examples of intangible fixed assets: Brands Mineral extraction rights Patents and licences Lease premiums on property Newspaper titles

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Bright and Shoesmith Business acquires licence for £ to manufacture Nox, a sleeping pill. The licence lasts for four years Amortisation = £ /4 = £ each year, charged as an expense in the profit and loss account

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Bright and Shoesmith (cont’d) Balance sheet

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Reducing balance method Example: Boris 1 April 20X1 - buys replacement vehicle at a cost of £ Reducing balance method of depreciation to be applied at the rate of 25% per year.

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Boris (continued) Year 1 Profit and loss account: charge = £ x 25% = £3750 Balance sheet:

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Boris (continued) Year 2 Profit and loss account: charge = £ x 25% = £2813 Balance sheet:

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Boris (continued) Year 3 Profit and loss account: charge = £8437 x 25% = £2109 Balance sheet

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning When an asset is sold, the net book value will in most cases be higher or lower than the cash price and a ‘profit’ or ‘loss’ on sale occurs Example: Ibrahim Juicing machine with a net book value of £475 Ibrahim sells it for £650

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Example: Ibrahim (continued) Profit on sale = £ = £175 Tangible fixed assets reduce by £475 Cash increases by £650 Profit (and therefore capital) increases by £175 NB: ‘Profit’ or ‘loss’ in this context is an adjustment for over- or under-depreciation of a fixed asset

Use with Business Accounting and Finance Second Edition by Catherine Gowthorpe ISBN © 2005 Thomson Learning Fixed assets are not usually held for an exact number of years. Where they are held for part of a year only, it is important to determine the policy to be adopted e.g. a whole year’s depreciation is charged in the first year of ownership regardless of the actual acquisition date of the assets OR e.g. depreciation is charged only for the number of months the asset has been owned