CMA Foundation · Fundamentals of Financial and Cost Accounting

Depreciation (Straight Line and Diminishing Balance Methods): formula sheet

Full chapter guide

Key formulas

Depreciable amount: Depreciable amount = Cost of asset − Estimated residual (scrap) value; This is the total amount to be written off over the useful life. Cost includes purchase price plus freight, installation and other costs to bring the asset into use.
Book value (written down value): Book value = Cost − Accumulated depreciation; This is the value shown in the balance sheet. It need not equal market value.
Depreciation vs depletion vs amortisation: Depreciation: tangible fixed assets | Depletion: natural resources | Amortisation: intangible assets; Depreciation applies to machinery, buildings, vehicles. Depletion applies to mines, quarries, oil wells. Amortisation applies to intangibles such as patents, copyrights and goodwill. Fixed-term rights such as a lease or a patent lose value with passage of time, and their cost is amortised over the term. Leasehold land is generally amortised over the lease period, while buildings on it are depreciated.
Main causes: Wear and tear, obsolescence, passage of time, accident, exhaustion; Learn these as the standard list of reasons an asset loses value.
Cost of asset: Cost = Purchase price + Freight + Installation + Other costs to make it ready for use; Include only costs needed to bring the asset to working condition. Routine repairs are expenses, not cost.
Depreciable amount: Depreciable amount = Cost − Residual (scrap) value; Residual value is the expected net disposal value at the end of useful life.
Annual depreciation (straight line): Annual depreciation = (Cost − Residual value) ÷ Estimated useful life in years; Use this to check the effect of the factors. Longer life or higher scrap value lowers the yearly charge.
Effect of factors: Higher cost ↑ depreciation; longer life ↓ depreciation per year; higher residual value ↓ depreciation; Holds when the other two factors stay the same.
Annual depreciation (straight line): Annual depreciation = (Cost − Scrap value) ÷ Estimated useful life (years); Cost includes freight, installation and other costs to make the asset ready for use.
Rate of depreciation: Rate % = (Annual depreciation ÷ Cost) × 100; The rate is applied on original cost every year, not on the reducing book value.
Depreciation as a percentage of cost: Annual depreciation = Cost × Rate % (when scrap value is ignored or the rate is given); If a rate is given on cost, use it directly. Do not deduct scrap value again unless the question says so.
Part-year depreciation: Depreciation for the period = Annual depreciation × Months used ÷ 12; Count the months from the date of purchase to the date of closing the books.
Book value: Book value = Cost − Accumulated depreciation; Book value falls by an equal amount each full year.
Depreciation for a year: Depreciation = Opening book value × Rate % ÷ 100; Base is the book value at the start of the year, not original cost (except in year one).
Book value at year end: Closing book value = Opening book value − Depreciation; This becomes the base for next year's depreciation.
Book value after n years: Book value = Cost × (1 − r)ⁿ, where r is the rate as a decimal; Useful shortcut when there are no additions or sales and the full-year charge applies each year.
Part-year depreciation: Depreciation = Book value × Rate % × Months used ÷ 12; Use for assets bought or sold during the year, if the question asks for a time-based charge.
Profit or loss on sale: Profit or loss = Sale price − Book value on date of sale; Sale price above book value is a profit. Below is a loss.
Journal entry for depreciation: Depreciation A/c Dr. to Asset A/c; Then: Profit and Loss A/c Dr. to Depreciation A/c.
Depreciation entry (asset method): Depreciation A/c Dr; To Asset A/c; Asset is shown at written down value. Then: Profit and Loss A/c Dr; To Depreciation A/c.
Depreciation entry (provision method): Depreciation A/c Dr; To Provision for Depreciation A/c; Asset stays at cost. Balance sheet shows cost less provision.
Book value at date of sale: Book value = Cost − Depreciation up to date of sale; Include depreciation for the part of the year up to the sale date.
Profit or loss on sale: Profit or loss = Sale price − Book value; Positive means profit. Negative means loss.
Disposal entries (asset method): Bank A/c Dr; To Asset A/c (sale price). Then transfer the difference to Profit and Loss A/c.; Profit: credit Profit and Loss A/c. Loss: debit Profit and Loss A/c.
Disposal entries (provision method): 1) Asset Disposal A/c Dr; To Asset A/c (cost). 2) Provision for Depreciation A/c Dr; To Asset Disposal A/c (depreciation on that asset). 3) Bank A/c Dr; To Asset Disposal A/c (sale price).; The balance on Asset Disposal A/c is the profit (credit) or loss (debit).
Straight line depreciation: (Cost − Scrap value) ÷ Life in years; Same amount every year.
Diminishing balance depreciation: Rate × Opening book value; Amount falls every year.
Change of method, retrospective (AS 6): Adjustment = Depreciation under new method from first use − Depreciation actually charged, for past years; Surplus (excess charged earlier) is written back. Deficiency (shortfall) is charged in the year of change.

Quick revision

Depreciation allocates cost less residual value over the useful life; it is not a fund and not a valuation exercise.
Causes include wear and tear, passage of time, obsolescence and exhaustion.
Depreciable amount = Cost − Residual value.
SLM: Annual depreciation = (Cost − Residual value) ÷ Useful life; the charge is equal each year.
SLM rate on cost = Annual depreciation ÷ Cost × 100.
WDV: Depreciation = Rate % × Opening book value, so the charge falls every year.
Under WDV the asset never reaches zero by the formula alone.
Book value = Cost − Accumulated depreciation.
Cost includes purchase price plus freight, installation and other costs needed to bring the asset into use.
For a part year, multiply the annual charge by months used ÷ 12.
Entry: Depreciation A/c Dr, to Asset A/c (or Provision for Depreciation A/c) Cr.
Depreciation is a non-cash expense and is transferred to the profit and loss account at year end.

Common mistakes

Saying depreciation is a fall in the market value of the asset. Fix: In accounting it is allocation of cost over useful life. Book value can differ widely from market value.
Treating depreciation as a cash expense or a fund of cash. Fix: No cash goes out. Charging depreciation only reduces profit and the book value of the asset.
Depreciating on the purchase price alone and ignoring freight and installation. Fix: Scan the question for every cost incurred before the asset is ready for use and add them.
Forgetting to deduct residual value before dividing by life. Fix: Always write depreciable amount first, then divide.
Forgetting to deduct scrap value before dividing by life. Fix: Always write (Cost − Scrap) first. Scrap is nil only if the question says so or is silent.
Leaving out installation or freight from the cost. Fix: Add all costs that are needed to bring the asset to working condition. Exclude later repairs and running costs.
Charging the rate on original cost every year Fix: From year two onwards, always use the opening book value as the base.
Taking book value as zero at the end of life Fix: Under WDV the book value keeps falling but never reaches zero. Only an asset sale or write-off removes it.
Crediting the Asset Account when the question asks for the Provision for Depreciation method. Fix: Underline the method in the question. In the provision method, the asset account never changes until disposal.
Forgetting to transfer the accumulated depreciation to the Asset Disposal Account on sale. Fix: Always do three entries: cost out, provision in, sale proceeds in. Then read the balance.

Exam tips

Learn the three terms in one line each: depreciation for tangible assets, depletion for natural resources, amortisation for intangibles.
Questions often describe a situation. Find the clue word and name the cause.
Always subtract scrap value to get the depreciable amount, but not when finding book value from accumulated depreciation.
Eliminate options that call depreciation a cash outflow or a market value measure. They are almost always wrong.
With no negative marking, answer every question even if you must guess between two options.
Expect direct questions that ask you to list or identify the factors: cost, useful life and residual value.
In numerical MCQs, check for extra costs like freight and installation. They are the usual trap.
Learn AS 6 as four ideas: systematic allocation, consistent method, charge to profit and loss, and disclosure.