Calculating depreciation of non-current assets using the straight-line (fixed instalment) method and the reducing balance (diminishing balance) method, and showing its effect on profit and the carrying value of the asset.

What this dot point is asking

The SQA wants you to calculate depreciation of a non-current asset by two methods - the straight-line method and the reducing balance method - and to show how depreciation reduces profit and the asset's carrying value.

Why depreciate?

A business buys non-current assets - machines, vehicles, equipment - expecting to use them for years. As they wear out, become outdated, or simply age, they lose value. Depreciation records that loss by charging part of the asset's cost as an expense in each year the asset is used, so that profit reflects the true cost of running the business.

The straight-line method

The straight-line (or fixed instalment) method charges the same amount every year. It suits assets that are used evenly over their life, such as fixtures and fittings.

The reducing balance method

The reducing balance (or diminishing balance) method charges a fixed percentage of the carrying value each year. Because the carrying value falls, the charge falls too - large at first, smaller later. It suits assets that lose most value early, such as vehicles and computers.

Comparing the two methods

Both methods spread cost over time, but the pattern differs. Straight-line gives an equal charge each year and so a steady fall in carrying value. Reducing balance front-loads the charge, which better matches assets that lose value fastest when new. The method chosen affects yearly profit and the carrying value but not the total cost written off over the asset's life.

Examples in context

A delivery firm buys a van for $\pounds 20000$. Using reducing balance at $20\%$, it charges $\pounds 4000$ in year one and less each year after, matching the way a van loses most value when new. A factory depreciates a $\pounds 50000$ machine straight-line over ten years at $\pounds 5000$ a year because it is used evenly. Each year's depreciation lowers profit in the income statement and the carrying value in the statement of financial position - the two effects this dot point asks you to show.

Try this

Q1. Cost $\pounds 10000$, residual value $\pounds 2000$, life 4 years. Find the straight-line charge. [2 marks]

• Cue. $(10000 - 2000) \div 4 = \pounds 2000$ per year.

Q2. Cost $\pounds 8000$, reducing balance $25\%$. Find year 1 depreciation. [1 mark]

• Cue. $25\% \times 8000 = \pounds 2000$.

Q3. For Q2, find the year 2 depreciation. [2 marks]

• Cue. Carrying value $\pounds 6000$, so $25\% \times 6000 = \pounds 1500$.