Depreciation: The Slow Death of Non-Current Assets
How do you calculate Net Book Value (NBV)?
Table of Contents
Every year, millions of students lose marks simply because they multiply the percentage by the wrong number. If the examiner asks for Reducing Balance, and you multiply the original cost instead of the Net Book Value, your entire Income Statement is ruined. This guide from our Ultimate O-Level Accounting Guide provides foolproof step-by-step algorithms.
1. Why must we depreciate? (The Prudence Concept)
If you buy a delivery van for $50,000, you cannot write it off as an instant $50k 'expense' in year 1. The van is going to last you 5 years! According to the Matching Principle, the cost should be spread across the 5 years it actually generates revenue.
Furthermore, the Prudence Concept states we must never overstate our assets. If we pretend the 4-year-old van is still worth $50,000 on our Statement of Financial Position, our company looks artificially wealthy. We must ruthlessly drop its value every year to show reality.
2. Straight Line Method (The Equal Drop)
The easiest method. The asset loses the exact same dollar amount of value every single year. Best used on assets that provide a steady, consistent benefit (like factory machinery or office furniture).
Formula 1: The Percentage Method
Depreciation = Original Cost × Given Percentage
Example: You buy machines for $100,000. Depreciation is 10% Straight Line.
Year 1 Expense: 10% of $100k = $10,000.
Year 2 Expense: 10% of $100k = $10,000.
Year 3 Expense: 10% of $100k = $10,000. It never changes!
Formula 2: The Estimated Life Method
Depreciation = (Original Cost - Residual Value) ÷ Estimated Useful Life
Example: You buy a $50k Van. You think it will last 4 years. At the end of 4 years, you think you can sell it for scrap metal for $10k (Residual Value).
(50,000 - 10,000) ÷ 4 = $10,000 expense per year.
3. Reducing Balance Method (The Heavy Start)
This is the killer. Under Reducing Balance, the asset loses massive amounts of value in its first few years, but very little in its old age. This perfectly mirrors reality for things like Cars or Computers (which lose 20% of their value the second you drive them off the lot!).
Rule: ALWAYS multiply the percentage by the current NET BOOK VALUE, never the original cost!
Scenario: $100,000 Car at 20% Reducing Balance
| Year | Calculation | Depreciation Expense (Income Stmt) | Net Book Value (SOFP) |
|---|---|---|---|
| Y1 | 20% of $100,000 | $20,000 | $80,000 |
| Y2 | 20% of $80,000 ! | $16,000 | $64,000 |
| Y3 | 20% of $64,000 ! | $12,800 | $51,200 |
Notice how the expense gets smaller every single year. The calculation resets based on the NEW Net Book Value.
📋 From the Desk of Prof. Arthur PendeltonFrequently Asked Questions
What is Depreciation?▼
What causes an asset to depreciate?▼
How does the Straight Line method work?▼
How does the Reducing Balance method work?▼
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