Depreciation Methods Explained: Straight Line, Reducing Balance, and Revaluation

Depreciation is one of the most frequently tested topics in CAIE Accounting (9706) and O Level Accounting (7707). Every exam series includes at least one question on calculating depreciation, preparing ledger accounts, and showing the impact on financial statements.

Yet students consistently lose marks here — not because depreciation is difficult, but because they confuse methods and forget the accounting treatment.

What Is Depreciation?

Depreciation is the systematic allocation of the cost of a non-current asset over its useful economic life. It reflects the fact that assets like machinery, vehicles, and equipment lose value through wear and tear, obsolescence, and time.

Key principle: Depreciation is an expense, not a cash payment. No money leaves the business when depreciation is charged — but it reduces reported profit and the carrying value of the asset.

Under IAS 16 (relevant at A2 Level), non-current assets are carried at cost less accumulated depreciation (the cost model) or revalued amount less accumulated depreciation (the revaluation model).

Method 1: Straight-Line Depreciation

Formula: (Cost − Residual value) / Useful life in years

Annual depreciation charge is constant.

Example: Machine purchased for $50,000. Residual value $5,000. Useful life 5 years.

• Annual depreciation = ($50,000 − $5,000) / 5 = $9,000 per year.

Journal entry:

• Debit: Depreciation expense (income statement) $9,000 • Credit: Accumulated depreciation (statement of financial position) $9,000

When to use: Assets that lose value evenly over time — office furniture, buildings, fixtures.

Method 2: Reducing Balance Method

Formula: Carrying value × Depreciation rate (%)

Annual depreciation charge decreases each year because it is applied to a declining balance.

Example: Vehicle purchased for $40,000. Depreciation rate 25% reducing balance.

When to use: Assets that lose value faster in early years — vehicles, IT equipment, machinery with high initial obsolescence risk.

Method 3: Revaluation

Under the revaluation model (IAS 16), an asset is carried at its fair value at the date of revaluation, less subsequent depreciation and impairment.

If an asset is revalued upward:

• Debit: Non-current asset (increase in value) • Credit: Revaluation reserve (equity — statement of changes in equity)

Depreciation after revaluation is based on the new carrying value and remaining useful life.

Revaluation is tested at A2 Level in published accounts and company account questions.

Depreciation and Disposal of Assets

When a non-current asset is sold or scrapped:

1. Remove the original cost from the asset account (credit). 2. Remove accumulated depreciation (debit). 3. Record proceeds received (debit cash/bank). 4. The difference is profit or loss on disposal (income statement).

Example: Machine (cost $50,000, accumulated depreciation $36,000) sold for $12,000.

• Net book value = $50,000 − $36,000 = $14,000. • Loss on disposal = $14,000 − $12,000 = $2,000.

Show the disposal account clearly in the exam. Examiners award marks for each step.

Depreciation in Financial Statements

Income statement: Depreciation expense appears under operating expenses, reducing operating profit.

Statement of financial position: Non-current assets are shown at cost less accumulated depreciation (or revalued amount less accumulated depreciation).

Cash flow statement (A2): Depreciation is added back to operating profit because it is a non-cash expense.

Exam Tips for Depreciation Questions

• Read the question carefully — straight line or reducing balance? The method is always stated. • Show the depreciation calculation before posting to accounts. • Use separate accounts: asset account, accumulated depreciation account, and depreciation expense account. • For part-year depreciation, pro-rate the annual charge (e.g., 6 months = half the annual amount). • In O Level 7707, depreciation is simpler — focus on straight line and reducing balance with clear ledger accounts.