A delivery van can help a business earn income for several years. Charging its entire purchase cost as an ordinary expense in one year would not describe that pattern of use well. Depreciation allocates the depreciable amount of a non-current asset across its useful life.
Two familiar O Level methods are straight-line and reducing-balance depreciation. Straight-line produces a constant annual charge when the underlying estimates remain unchanged. Reducing balance applies a fixed percentage to the asset’s carrying amount, so the annual charge usually falls over time.
The important skill is understanding the base to which a rate applies. A correctly remembered percentage can still give a wrong answer if it is applied to cost instead of carrying amount. For structured foundations, explore O Levels Accounting at Abeel Eschool.
What depreciation measures in accounting
Depreciation is an allocation process. It is not normally an attempt to calculate the exact market value of an asset at each reporting date. A carrying amount can therefore differ from the amount a buyer would currently offer.
The charge recognises that the asset’s useful economic benefit is consumed over time or through use. Useful life and residual value are estimates, and the method should reflect the relevant pattern of consumption within the accounting framework being studied.
In a simplified introductory exercise, you are usually given the method, rate or useful life. Apply those stated assumptions consistently rather than inventing your own estimate.
Land and buildings should not automatically be treated as a single undifferentiated depreciating amount. Follow the asset classification and facts supplied. This guide concentrates on ordinary depreciable equipment and vehicle examples.
Separate cost, residual value and carrying amount
Cost is the amount recognised for the asset when it is acquired, including the costs that the question requires to bring it into the appropriate condition and location. Do not assume every later payment belongs in asset cost.
Residual value is the estimated amount expected at the end of useful life after relevant disposal costs, under the assumptions being used. Depreciable amount is cost less residual value.
Accumulated depreciation is the total depreciation recognised on the asset to date. Carrying amount is cost less accumulated depreciation in the simplified cost-model examples used here, assuming no other adjustments.
Write these labels beside your figures. Students sometimes subtract the current year’s charge from cost and call that the closing carrying amount even when earlier years’ depreciation also exists.
Calculate straight-line depreciation from useful life
Suppose equipment costs PKR 120,000, has an estimated residual value of PKR 20,000 and a useful life of five years. The depreciable amount is PKR 100,000.
Annual straight-line depreciation is (PKR 120,000 − PKR 20,000)/5 = PKR 20,000. The charge is constant each full year if the estimates and policy remain unchanged.
At the end of year one, accumulated depreciation is PKR 20,000 and carrying amount is PKR 100,000. At the end of year two, accumulated depreciation is PKR 40,000 and carrying amount is PKR 80,000.
After five full years, the carrying amount reaches the estimated residual value of PKR 20,000. It does not become zero in this example because the depreciable amount excluded that residual value.
Read what a straight-line percentage applies to
A question may give a percentage instead of a useful life. If it states depreciation at twenty per cent of cost per year, apply twenty per cent to cost, subject to the question’s policy and any time apportionment.
Do not automatically subtract a residual value before applying a stated cost-based rate unless the problem requires that treatment. A rate on cost and a calculation based on depreciable amount are not interchangeable descriptions.
For example, twenty per cent of a PKR 100,000 cost is PKR 20,000 annually. If another problem specifies a PKR 10,000 residual value and a five-year useful life, the straight-line charge is PKR 18,000 annually instead.
The label “straight-line” tells you about a constant allocation under stable assumptions. You still need to read the detailed calculation policy rather than assuming every straight-line question supplies the same base.
Calculate reducing-balance depreciation year by year
Suppose a vehicle costs PKR 100,000 and depreciation is twenty per cent per year using the reducing-balance method. Assume full-year charges and no other adjustments.
Year one depreciation is twenty per cent of PKR 100,000, which is PKR 20,000. Closing carrying amount is PKR 80,000.
Year two depreciation is twenty per cent of PKR 80,000, which is PKR 16,000. Closing carrying amount becomes PKR 64,000. In year three, depreciation is PKR 12,800, leaving PKR 51,200.
The percentage stays the same while its base reduces. Applying twenty per cent of the original cost every year would produce a straight-line-style constant charge, not the reducing-balance calculation specified here.
Compare the two methods on the same asset
Consider a PKR 100,000 asset and compare a straight-line charge of twenty per cent of cost with reducing-balance depreciation at twenty per cent. Assume full years and no residual-value complication for this comparison.
Both methods charge PKR 20,000 in year one. In year two, straight-line still charges PKR 20,000 while reducing balance charges PKR 16,000. The closing carrying amounts after two years are PKR 60,000 and PKR 64,000 respectively.
This does not establish that one method always gives a larger charge in every possible comparison. Rates and assumptions matter. The useful observation is that equal percentages on different bases produce different later-year charges.
When explaining the difference, name the bases: original cost under the stated straight-line policy and opening carrying amount under reducing balance. A sentence saying only “reducing balance is lower” misses the reason.
Understand accumulated depreciation and the annual expense
The annual depreciation expense relates to the current reporting period. Accumulated depreciation includes charges from previous periods as well. They are connected but are not the same figure.
For the reducing-balance vehicle, expense in year two is PKR 16,000. Accumulated depreciation at the end of year two is PKR 20,000 + PKR 16,000 = PKR 36,000.
In the simplified financial statements, the expense affects profit for the period, while accumulated depreciation reduces the asset’s carrying amount in the statement of financial position. The asset cost is still PKR 100,000 in the underlying cost account unless a disposal or another adjustment changes it.
In a typical double-entry treatment, debit depreciation expense and credit accumulated depreciation. Follow the account names and presentation required in the question.
Depreciation does not create a new cash payment
Buying equipment normally involves a cash or bank payment, or a liability if purchased on credit. Depreciation is a later accounting allocation of its cost; recording the charge does not itself pay cash to anyone.
This explains why profit and cash movements can differ. A business can recognise depreciation expense in a period without making an equivalent payment during that period.
It also explains why accumulated depreciation should not be described as a bank balance saved for replacing the asset. A business may separately set aside funds, but that is a financing decision rather than an automatic result of posting depreciation.
When interpreting an exam question, distinguish the purchase transaction, any payment of the related liability and the depreciation adjustment. They happen for different accounting reasons.
Follow the stated policy for part-year ownership
An asset acquired during the year may require time-apportioned depreciation. Other questions may state a full-year charge in the year of purchase, or a specific policy for disposal. Read the policy before calculating.
For example, assume equipment costs PKR 60,000, is depreciated at ten per cent of cost annually, and the question requires six months’ depreciation. The charge is PKR 60,000 × 10% × 6/12 = PKR 3,000.
Applying a full-year PKR 6,000 charge would ignore the stated time period. Equally, automatically apportioning six months would be wrong if the question explicitly used a different permitted policy for that exercise.
Write the relevant dates and ownership period on a timeline during revision. Then connect them to the accounting year-end rather than treating a calendar year as the reporting period automatically.
Keep different asset purchases in separate workings
A question may include existing equipment and an additional purchase made during the year. The opening assets can have a different depreciation base or ownership period from the new purchase.
Build a schedule with opening cost or carrying amount, additions, applicable period, depreciation charge and closing balance. Calculate each relevant group before combining totals.
For reducing balance, be particularly careful not to apply the rate to original cost for assets already depreciated in earlier years. For straight-line, do not switch to the reduced carrying amount unless the stated method requires it.
A short schedule is easier to mark and review than one large unexplained expression. It also makes it easier to correct one acquisition date without rebuilding the entire answer.
Do not confuse depreciation with the disposal result
If an asset is sold, compare sale proceeds with the relevant carrying amount at disposal after applying the required depreciation policy. The difference is the resulting profit or loss on disposal in a simplified exercise.
Suppose an asset has a carrying amount of PKR 30,000 at disposal and is sold for PKR 26,000. The loss is PKR 4,000. The original purchase cost is not the direct comparison base for that disposal result.
Accumulated depreciation and asset cost also need to be removed from their accounts as required by the disposal entry. Do not treat the sale proceeds as ordinary sales of goods merely because money was received.
Disposal accounting deserves separate practice. First make sure the carrying amount calculation is secure, since an incorrect depreciation figure carries through into the disposal result.
Check calculations before interpreting profit
For straight-line examples with stable assumptions, check that full-year charges are constant and that the depreciable amount is allocated over the stated life. For reducing balance, check that each year begins with the previous closing carrying amount.
Reconcile cost less accumulated depreciation to the closing carrying amount. A decreasing annual charge alongside an increasing accumulated balance is entirely consistent under reducing balance.
Do not let arithmetic checks replace interpretation. Explain which year’s profit contains the expense and which statement-of-financial-position figure carries forward. These are different reporting roles.
Use Abeel’s Cambridge past-paper guide to practise independent calculations and corrections. Parents can use the progress-review guide to ask for one explained calculation rather than only a completed worksheet.
Make your next revision session specific
If you used the wrong base, practise identifying cost and opening carrying amount before calculating. If you lost earlier depreciation, prepare a two-year accumulated-depreciation schedule. If dates caused the error, practise time periods separately.
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Frequently asked questions
What is the main difference between the two methods?
Under stable assumptions, straight-line allocates a constant annual amount. Reducing balance applies a constant percentage to a falling carrying amount, producing decreasing annual charges.
Is depreciation the fall in market value?
It is an allocation of the depreciable amount over useful life. Carrying amount does not necessarily equal current resale value.
Is accumulated depreciation the current year’s expense?
No. It is the total depreciation recognised to date. The current year’s charge is only one part of that cumulative balance.
Does depreciation mean cash has been set aside?
No. Recording depreciation is not itself a cash transfer or a savings arrangement. Cash planning for replacement is a separate decision.
Should I always calculate a proportion of a year?
Follow the question’s policy. Some exercises require time apportionment, while others state a different treatment for acquisitions or disposals.
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