Depreciation spreads the cost of a long term asset over the years that use it. The straight line method charges the same amount each year.
The idea
The amount to be depreciated is cost minus any residual value you expect at the end. Divide that amount by the useful life in years. The result is the annual charge. A machine that costs 20,000 cedis, with a residual value of 2,000 cedis and a life of 4 years, loses 18,000 cedis of value in the accounts over those years. The yearly charge is 18,000 divided by 4, which is 4,500 cedis. Each year the profit and loss account is debited with 4,500, and the provision for depreciation is credited.
Net book value is cost minus the depreciation charged so far. After two years the provision is 9,000 cedis, so the net book value is 11,000 cedis. The asset is not "worth" 11,000 cedis in the market. The figure is an accounting allocation, not a valuation you could sell at. The reducing balance method charges a percentage of the remaining book value, so the charge falls each year. Do not use that method when the question says straight line. Read the instruction.
What earns the marks
Subtract residual value before you divide. Dividing the full cost by the life overstates the charge when a residual value was given. Show the two years if you are asked for a net book value at the end of year two. One year's charge deducted once is the year one figure. State cedis. "Provision" is the cumulative credit. The expense each year is the charge, not the whole provision, except in the first year when they are equal.
Practice questions
These are practice questions in the style of the paper, with a model answer and a mark scheme. They are not a promise of what your paper will ask.
1Question 1
4 marks
A machine costs 20,000 cedis. Residual value is 2,000 cedis. Useful life is 4 years. The straight line method is used.
(a) Calculate the annual depreciation. (2 marks)
(b) Calculate the net book value at the end of the second year. (2 marks)
Model answer
(a) (20,000 − 2,000) / 4 = 4,500 cedis a year.
(b) Depreciation for two years = 9,000. Net book value = 20,000 − 9,000 = 11,000 cedis.
Mark scheme
Depreciable amount 18,000, cost minus residual value1 mark
Annual charge 4,500 cedis1 mark
Two years charged, 9,000 cedis1 mark
Net book value 11,000 cedis1 mark
2Question 2
2 marks
State the double entry for one year's depreciation charge. (2 marks)
Model answer
Debit the profit and loss account, or the depreciation expense, with 4,500 cedis. Credit the provision for depreciation with 4,500 cedis.
Mark scheme
Debit depreciation expense, or profit and loss1 mark
Credit the provision for depreciation1 mark
3Question 3
2 marks
Why is the net book value of 11,000 cedis not necessarily the price a buyer would pay? (2 marks)
Model answer
It is cost less the depreciation allocated so far. It is not a fresh valuation. A buyer might pay more or less, depending on the market and the condition of the machine.
Mark scheme
Net book value is an allocation of cost, not a market price1 mark
A sale price depends on the market or the condition, which the method ignores1 mark
Practise Financial Accounting with Anna
More questions on this topic are inside GLearn, marked as you answer, with the reason written out. The first ones need no account.
Subtract the residual value from the cost, then divide by the useful life in years. A machine costing 20,000 cedis with a residual value of 2,000 cedis and a life of 4 years is depreciated by 4,500 cedis a year.
What is net book value?+
Cost minus depreciation charged to date. After two years at 4,500 cedis a year, 9,000 cedis has been provided, and the net book value is 11,000 cedis. That figure is an accounting balance. It is not automatically the selling price. All WASSCE Financial Accounting past questions