Depreciation of non-current assets (VCE Accounting Unit 3)
“Calculating and recording depreciation of non-current assets using the straight-line and reducing balance methods, and explaining the effect of depreciation on the accounting reports”
Depreciation allocates the cost of a non-current asset over its useful life to match the benefit consumed against the revenue it helps earn. The straight-line method charges an equal amount each period; the reducing balance method charges a fixed percentage of the falling carrying amount, giving higher early expense. Both reduce net profit and the asset's carrying amount.
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What this dot point is asking
VCAA wants you to calculate and record depreciation using the straight-line and reducing balance methods, distinguish them, and explain the effect on the Income Statement and Balance Sheet through accumulated depreciation and carrying amount.
Why depreciate
Depreciation is the allocation of the cost of a non-current asset over its useful life. It recognises the consumption of the asset's economic benefit as an expense, applying the accrual basis so each period bears its share of the asset's cost.
Depreciation is a non-cash expense. The cash outflow happened when the asset was purchased; depreciation simply spreads that cost across the periods that benefit from using the asset.
The two methods
Straight-line method
The straight-line method charges an equal amount each period:
Depreciation per year = (Cost minus Residual value) divided by Useful life in years
It is appropriate when the asset delivers benefits evenly across its life, such as office furniture.
Reducing balance method
The reducing balance method applies a fixed percentage to the carrying amount (cost less accumulated depreciation):
Depreciation = Carrying amount times depreciation rate
The expense is highest in the first year and falls each year. It suits assets that are most productive early and that incur rising repair costs later, such as some vehicles and technology.
The choice should reflect the pattern in which the asset's economic benefits are consumed. Straight-line suits even consumption; reducing balance suits assets that give greater benefit early. The method affects the timing of expense, not the total expense over the asset's life.
Recording depreciation
The balance day entry is the same regardless of method:
- Debit Depreciation Expense
- Credit Accumulated Depreciation
Accumulated Depreciation is a negative asset (contra asset). It is deducted from the asset's cost in the Balance Sheet to give the carrying amount. The original cost stays on the books so users can see both the historical cost and the amount consumed to date.
Scenario
A delivery van costs 40,000 dollars, has an estimated residual value of 4,000 dollars and a useful life of 6 years. Compare straight-line with reducing balance at a rate of 25 percent.
Straight-line
Depreciable amount = 40,000 minus 4,000 = 36,000 dollars. Annual depreciation = 36,000 divided by 6 = 6,000 dollars each year. After two years, accumulated depreciation = 12,000 dollars and carrying amount = 40,000 minus 12,000 = 28,000 dollars.
Reducing balance at 25 percent
Year 1 depreciation = 40,000 times 25 percent = 10,000 dollars. Carrying amount = 30,000 dollars. Year 2 depreciation = 30,000 times 25 percent = 7,500 dollars. Accumulated depreciation after two years = 10,000 plus 7,500 = 17,500 dollars and carrying amount = 22,500 dollars.
Comparison
Reducing balance charges 17,500 dollars over two years versus 12,000 dollars under straight-line, so early net profit is lower under reducing balance and the carrying amount falls faster. Over the full life both methods allocate cost, but the timing of expense differs.
Effect on the reports
Each period, depreciation lowers net profit in the Income Statement. In the Balance Sheet, accumulated depreciation grows and the carrying amount of the asset falls. Because depreciation is non-cash, it does not appear as a cash outflow in the Cash Flow Statement, which is one reason net profit and net operating cash flow differ.
Depreciation relies on estimates of useful life and residual value. If these estimates prove inaccurate, the carrying amount will not reflect the asset's remaining benefit, and a gain or loss on disposal will arise when the asset is sold.
Students sometimes credit the asset (for example, Vehicle) instead of Accumulated Depreciation. The asset must stay recorded at its original cost so the Balance Sheet shows both cost and the amount consumed. Depreciation is always credited to the separate Accumulated Depreciation contra asset account.
Exam-style questions
Questions in the style of VCAA exam questions on this dot point, each with a worked answer. They are written by ExamExplained unless tagged "Past paper"; the year shows the paper a question is modelled on.
2019 VCAA-style4 marksOn 1 April 2019, YYY purchased machinery for $220 000 (incl. GST) and installation cost $6 600 (incl. GST). The machinery had a useful life of 10 years and a residual value of $11 600. The business reports annually on 30 June. Calculate the amount of depreciation that would be recorded at 30 June 2019 using the straight-line method and the reducing balance method at 25% per annum.Show worked answer →
First find the historical cost, then apply each method for the three months (1 April to 30 June = 3/12).
- Cost
- machinery 220 000 / 11 = 6 000, so cost = $206 000.
- Straight-line
- (206 000 - 11 600) / 10 = 194 400 / 10 = 4 860**.
- Reducing balance at 25%
- 206 000 x 25% x 3/12 = $12 875 (residual is ignored in the reducing balance calculation).
Two marks per method: one for the annual or full-rate figure, one for correctly pro-rating to three months.
2021 VCAA-style3 marksState the effect on the Income Statement and Balance Sheet at 30 June 2021 if the straight-line method was used instead of the reducing balance method. Refrigeration equipment cost $540 000 (plus GST) on 1 July 2020. Reducing balance is 20% per annum; straight-line uses a 15-year life and a $120 000 residual value.Show worked answer →
Work both depreciation figures, compare, then state the report effects.
Reducing balance: 540 000 x 20% = 28 000. Straight-line is $80 000 lower in year one.
Income Statement: Depreciation expense is lower by $80 000, so total expenses fall and Net Profit is higher by $80 000.
Balance Sheet: Accumulated Depreciation is lower, so the carrying value of the equipment is higher by $80 000, and because profit is higher, owner's equity (Capital) is higher by $80 000.
One mark for the profit effect, one for the carrying-value effect, one for the owner's equity effect.
2025 VCAA-style3 marksAB Gym owns two delivery vans (cost $90 000, accumulated depreciation $52 000 at 30 June 2024) and uses straight-line depreciation at 15% per annum on cost. One van costing $40 000 was traded in on 31 December 2024 for a new van costing $48 000 (plus GST), delivered that date. Calculate the depreciation of delivery vans for the year ended 30 June 2025.Show worked answer →
Depreciate each van for the part of the year it was held, at 15% of cost.
Retained van (cost 90 000 - 40 000 = 7 500**.
Traded-in van (3 000**.
New van (3 600**.
Total depreciation for the year = 7 500 + 3 000 + 3 600 = $14 100. One mark per van, with the half-year pro-rating applied to the disposed and newly acquired vans.