Introduction

Businesses often purchase long-term assets such as machinery, vehicles, and equipment. These assets are known as non-current assets because they are used for several accounting periods.

In Cambridge O Level Accounting 7707 and Cambridge IGCSE Accounting 0452, students learn how businesses record the decrease in value of these assets over time, which is called depreciation.

Understanding depreciation helps ensure that financial statements show a realistic value of assets and accurate profit figures.

What is Depreciation?

Depreciation is the systematic reduction in the value of a non-current asset over time.

Assets lose value due to several reasons:

• Wear and tear from usage

• Passage of time

• Obsolescence due to new technology

Depreciation spreads the cost of the asset over its useful life.

Why Businesses Record Depreciation

Businesses record depreciation for several important reasons.

✔ To match the cost of assets with revenue earned
✔ To calculate accurate business profit
✔ To show a realistic value of assets in financial statements
✔ To follow accounting principles such as the matching principle

Methods of Depreciation

Students studying O Level / IGCSE Accounting (7707 / 0452) must understand the main methods of calculating depreciation.

1. Straight-Line Method

Under the straight-line method, the same amount of depreciation is charged every year.

Formula

Depreciation per year =
(Cost of asset – Residual value) ÷ Useful life

Example

Cost of machine = $10,000
Residual value = $2,000
Useful life = 4 years

Depreciation per year:

(10,000 – 2,000) ÷ 4 = $2,000 per year

2. Reducing Balance Method

Under this method, depreciation is calculated as a percentage of the asset’s book value each year.

Because the value decreases each year, the depreciation expense also decreases over time.

Example

Asset cost = $10,000
Depreciation rate = 20%

Year 1 depreciation = 2,000
Book value after year 1 = 8,000

Year 2 depreciation = 20% × 8,000 = 1,600

Recording Depreciation in Accounting

Depreciation is usually recorded through journal entries and ledger accounts.

Typical entry:

Debit → Depreciation Expense
Credit → Provision for Depreciation

This records depreciation as an expense in the income statement.

Effect of Depreciation on Financial Statements

Depreciation affects two main financial statements.

Income Statement

Depreciation is recorded as an expense, which reduces profit.

Statement of Financial Position

The value of non-current assets is reduced through accumulated depreciation.

Importance of Depreciation

Depreciation helps businesses:

✔ Report accurate profit
✔ Show realistic asset values
✔ Plan for replacement of assets
✔ Maintain proper financial records

Without depreciation, profits would be overstated and assets would appear more valuable than they actually are.

Exam Tips for Students

Students studying O Level / IGCSE Accounting (7707 / 0452) should practice:

✔ Calculating depreciation using different methods
✔ Preparing depreciation ledger accounts
✔ Understanding how depreciation affects financial statements

These calculations frequently appear in accounting exam papers.

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At IVY Online, students can master accounting through:

• Concept-based lectures

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• Topical past paper practice

Students can prepare effectively using the IVY Online learning platform.