Depreciation
Editorial
This months students' newsletter focuses on the concept of Depreciation a knowledge of which is essential to
those studying Manual Book-Keeping Level 3 and the Level 3 Computerised test of competence.
The early part of the article explains in detail the nature and purpose of Depreciation as a book-keeping and
accounting concept.
There is mention also of the way in which its definition is embedded in the Accounting Standard FRS 15
(however students of ICB are not examined on a knowledge of such standards) but an awareness of this is
most useful in order to understand fully why we create such provisions.
I hope that you all find this interesting to read.
If any of you have other topics you wish me to cover please contact me at the Institute.
Dr Philip E Dunn.
Editor
One of the most fundamental distinctions made by accountants is between ‘revenue’ and ‘capital’ expenditure.
This distinction derives from that by convention, financial statements are produced on an annual basis.
Capital expenditure is incurred on the acquisition of fixed assets required for use in the business or that
expenditure on existing fixed assets which increase their earning capacity. Revenue expenditure is that
incurred on items consumed in the course of ‘doing’ business. It includes amounts paid for raw materials, the
cost of power, light and other bought out goods and services.
Revenue expenditure is subject to adjustments and is ultimately charged to the profit and loss account when it
is deducted from sales income in arriving at profit.
Capital expenditure on the other hand is not treated as a direct charge against profit but is held on the balance
sheet under the heading of ‘Fixed Assets’, as either tangibles or intangibles.
Such assets do not last forever and must eventually be replaced. Any realistic estimation of profits must
include a charge for the use of fixed assets, effectively spreading their cost over their revenue producing lives.
This charge for ‘use’ is termed Depreciation. It is a notional charge calculated on the basis of a realistic
assessment of the life of the assets concerned. Debited to the profit and loss account it is credited to a
depreciation provision account where it is held as a balance item – an accumulating deduction from the balance
sheet value of the assets concerned.
There are rules both in the standard FRS 15, Tangible Fixed Assets, and the Companies Act requirement, which applies to the
accounts of companies of all sizes is that the cost (less any residual value) of all assets with a limited useful economic life,
"shall be reduced by provisions for depreciation calculated to write off that amount systematically over the period of the assets’
useful economic life".
FRS 15 incorporates many of the requirements of the former standard SSAP 12 Accounting for
Depreciation, which it has superseded.
The new standard, which applies to all accounts intended to give a ‘true and fair view’, requires all
assets with a finite economic life to be written off over that life.
The standard defines ‘depreciation’ as "the measure of the cost (or revalued amount) of the economic
benefits of the tangible fixed asset that have been consumed during the period. The depreciable amount
of an asset is its cost (or revalued amount) less its residual value".
Residual value is defined as "the net realisable value of the asset at the end of its useful economic life".
