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Worksheet on Depreciation

ROEHAMPTON INSTITUTE LONDON An Institute Of The University Of Surrey

Worksheet written by PGCE Business students at the Roehampton Institute.

What is Depreciation?

Fixed assets (eg: cars, fixtures and fittings, plant and machinery etc) can be used again and again until they wear out. During this time the value of many assets fall. This is called depreciation. Some fixed assets (eg: land and property) do not depreciate although they still have to be maintained and repaired.

Write down 5 fixed assets that you might expect to find in a school or college:

1

2

3

4

5

Give 3 reasons (explain each) why fixed assets might fall in value:

1

2

3

Methods of Depreciation

1 Straight line method

This is the most common method used to work out depreciation. It assumes that the net cost of an asset should be written off in equal amounts over its life. The accountant needs to know the cost of the asset, its estimated 'scrap' (or residual) value and its expected life in years. The formula used is:

Original cost - scrap value
Expected life (years)

Assume you buy a vehicle for £12,000 and it has an expected life of 4 years. Its 'scrap' value is estimated to be £4,000. What is the depreciation allowance per year?

To see how this works in practice, go to the Exchange and Mart homepage (http://www.exchangeandmart.co.uk) and carry out the following steps:-

• go to the used car price guide
• choose a 3 models of cars that have been around for a few years
• fill in the table below with their value on the most recent date available, and the oldest date available
• work out the depreciation allowance each year

How much does the rate of depreciation differ?

Go back to the Exchange and Mart homepage (http://www.exchangeandmart.co.uk) and try another three cars. Try to find ones that you would expect to depreciate at different rates.

Did you succeed in finding different depreciation rates? If you did, why do you think this happened?

2 Reducing balance method

This method assumes that the depreciation charge in the early years of an asset's life should be higher than in later years. The asset must, therefore, be written off using the same percentage rate each year.

A vehicle is bought for £28,000 and has a life of 4 years. Using the reducing balance method (a 40% charge is to be made each year) calculate book value of the vehicle at the end of every year.

Plot a graph on the axes below using the information you calculated above (book value y axis, years x axis).

Note: y to the sky, so this means x axis goes along the bottom!

Would you expect cars to depreciate according to the straight line, or the reducing balance method? Why?

To test this, go back to the Exchange and Mart homepage (http://www.exchangeandmart.co.uk) and once again choose a model of car, but this time take the value for each year. Fill the results in in the table below, and work out in the last column the percentage by which the car has depreciated each year:-

Now plot this on the graph below, with the same axes as before:-

Which method of depreciation would therefore have been the most effective?

Extension activity

Go to the J Sainsbury annual report (http://www.jsainsbury.co.uk/index.asp?pageid=20) and print out the accounts.

In your own words, using your knowledge in this area so far, try and interpret this information and write below an explanation of the figures on the assumption that the person reading knows nothing about depreciation.