Christian Alliance S. C.

Chan Memorial College

F.4 Business, Accounting and Financial Studies (2022 – 2023)
Chapter 9: Depreciation

Name: _____________________ Class: _______ ( ____ )

Expected Outcome:
(i) State the meaning and objectives of providing depreciation in accounting.
(ii) Distinguish between capital and revenue expenditures.
(iii) Compare the commonly used methods of depreciation: straight-line, reducing-balance and
depreciation based on usage; and explain the effect of depreciation charge (including disposal) on
profits. Students are expected to be able to record disposals of non-current assets including trade-in.

1. Capital Expenditure v.s. Revenue Expenditure

(a) Capital Expenditure
 Expenditure that generates long-term benefits for an entity
 Usually once-and-for-all (payment is made once only)
 Refers to money spent on:
 Acquisition / Production
 Extension / Improvement
 It includes:
 Purchase Price
 Directly Attributable Costs (costs that are necessary to bring the assets to the location and
condition for its intended use)
 Double Entry:
Dr. Non-current Assets
Cr. Cash / Bank / Accounts Payables

(b) Revenue Expenditure

 Expenditure that generates short-term benefits only
 Usually recurring (payments are made periodically)
 Refer to money spent on daily operation
 Double Entry:
Step 1 Step 2 (at year-end)
Dr. Expenses Dr. Profit and Loss
Cr. Cash / Bank / Accounts Payables Cr. Expenses

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Summary:
Capital Expenditure Revenue Expenditure

Effects on values of
Increases / Decreases / No changes Increases / Decreases / No changes
non-current assets

Will be reflected on income statement / Will be reflected on income statement /

Effects on financial
statement of financial position as the statement of financial position as
statements
value of non-current assets expenses

 Purchase costs (after deducting  Repairs / maintenance (since it

trade discounts from the list price) only maintains / recovers / restores
 Legal / professional fees the asset to its original condition,
 Delivery / freight charges but not upgrades it)
Examples
 Installation costs  Training for the staffs (for daily
 Testing fees operation only, it does not affect
 Upgrading costs (e.g. adding a new the value of the asset)
component on the asset)  Insurance

2. Capitalisation of Costs
 It refers to the classification of the expenditure related to the purchases of the non-current assets
 All capital expenditure would be included in the costs of the non-current assets

Example 1
On 1 January 2022, Firm X purchased a machine for $30,000 and paid freight charges of $1,200, an
installation cost of $600 and an annual maintenance fee of $1,000. Which of the costs incurred on the
machine are to be capitalised?

Costs to be capitalised = Purchases price + Freight charges + Installation cost

= $30,000 + $1,200 + $600
= $31,800

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3. Matching Concept
 The expenses recognised in each accounting period should be matched with the revenues or benefits
that they generate in the same period

4. Depreciation
 A systematic allocation of the cost of a tangible non-current asset over its estimated useful life
 Since non-current assets are acquired for long-term use, their costs will be allocated over a number of
year until they are disposed
 Under matching concept, the cost allocated to each accounting period (i.e. depreciation) should be
matched with the benefits generated in that period (i.e. usage) of that non-current asset

5. Factors Affecting Useful Life

Physical Deterioration Assets are subject to wear and tear
Obsolescence Assets become outdated
Inadequacy Assets are unable to support the expansion of the business
Depletion Assets are exhaustible (normally for extracting natural resources)

6. Different Methods of Depreciation

Important terms
Residual Value / The sales proceeds that the business expects to receive when it
Disposal Value / disposes the non-current asset at the end of its estimated useful life
Scrap Value / Salvage Value

Accumulated Depreciation Total depreciation of the non-current asset already charged

in the previous years
Net Book Value / Would be calculated and shown on the statement of financial
Carrying Amount position (= Cost – Accumulated Depreciation)

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(a) Straight-line Method
 It is assumed that the non-current asset will generate
benefits evenly over its estimated useful life

𝐂𝐨𝐬𝐭 − 𝐑𝐞𝐬𝐢𝐝𝐮𝐚𝐥 𝐕𝐚𝐥𝐮𝐞

𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧 =
𝐄𝐬𝐭𝐢𝐦𝐚𝐭𝐞𝐝 𝐔𝐬𝐞𝐟𝐮𝐥 𝐋𝐢𝐟𝐞

Example 2
Suppose Firm A bought a lorry for $160,000 and adopted the straight-line depreciation method. The
lorry was estimated to have a useful life of 4 years and a residual value of $10,000.

End of Net Book Value Depreciation Accumulated

Year (Cost – Accumulated Depreciation) Expenses Depreciation

0 $160,000 / /

1 $122,500 $37,500 $37,500

2 $85,000 $37,500 $75,000

3 $47,500 $37,500 $112,500

4 $10,000 $37,500 $150,000

(b) Reducing-balance Method

 Cost of the non-current asset is written off as depreciation at diminishing rate over its estimated
useful life

𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧
= ∗ (𝐂𝐨𝐬𝐭 − 𝐀𝐜𝐜𝐮𝐦𝐮𝐥𝐚𝐭𝐞𝐝 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧)
× 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧 𝐑𝐚𝐭𝐞

* Cost – Accumulated Depreciation = Net Book Value

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Example 3
Suppose Firm A bought a lorry for $160,000 and adopted the reducing-balance depreciation method
with a depreciation rate of 50% per annum. The lorry was estimated to have a useful life of 4 years and
a residual value of $10,000.

End of Net Book Value Depreciation Accumulated

Year (Cost – Accumulated Depreciation) Expenses Depreciation

0 $160,000 / /

1 $80,000 $80,000 $80,000

2 $40,000 $40,000 $120,000

3 $20,000 $20,000 $140,000

4 $10,000 $10,000 $150,000

Example 4
The financial year for Victor Company ends on 31 December each year. The following non-current
assets schedule was prepared on 31 December 2022.

Estimated Depreciation Expense

Estimated
Useful Life /
Non-current Acquisition Cost Salvage Depreciation
Annual 2021 2022
Assets Date ($) Value Method
Depreciation ($) ($)
($)
Rate
(1) (2)
Furniture A 1 Jan 2021 100,000 12,000 Straight-line 4 years 22,000 22,000

(3) (4)
Office Reducing-
1 Jan 2021 200,000 33,614 30% 60,000 42,000
Equipment X balance

(5) (6)
Furniture B 1 Jan 2021 45,000 5,000 Straight-line 5 years 8,000 8,000

(7)
Office Reducing-
1 Jan 2022 280,000 - 20% - 56,000
Equipment Y balance

(Extracted from HKCEE 2009, amended)

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(c) Usage-based Method
 Cost of the non-current asset is written off as depreciation
at a rate equal to its usage over its estimated useful life
 Depreciation rate can be fixed or variable, depending on
the output produced each year

𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧
= (𝐂𝐨𝐬𝐭 − 𝐑𝐞𝐬𝐢𝐝𝐮𝐚𝐥 𝐕𝐚𝐥𝐮𝐞)
× 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧 𝐑𝐚𝐭𝐞

Example 5
Suppose Firm A bought a lorry for $160,000 and adopted the usage-based depreciation method. The
lorry was estimated to have a useful life of 4 years and a residual value of $10,000. It would produce
200,000 units of output. The following units of output were recorded in each of the four years:

Year Units of output

1 70,000
2 60,000
3 40,000
4 30,000

End of Net Book Value Depreciation Accumulated

Year (Cost – Accumulated Depreciation) Expenses Depreciation

0 $160,000 / /

1 $107,500 $52,500 $52,500

2 $62,500 $45,000 $97,500

3 $32,500 $30,000 $127,500

4 $10,000 $22,500 $150,000

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6. Accounting Entries for Depreciation
 For recording depreciation, we need to open two accounts for each type of non-current assets
(a) Depreciation
 An expense account

(b) Accumulated Depreciation

 A contra-asset account

 Double Entry:
Step 1 Step 2
Dr. Depreciation Dr. Profit and Loss
Cr. Accumulated Depreciation Cr. Depreciation

Continue Example 4

Furniture
2021 $ 2021 $
Jan 1 Cash (Furniture A) 100,000 Dec 31 Balance c/d 145,000
Jan 1 Cash (Furniture B) 45,000
145,000 145,000

2022 2022
Jan 1 Balance b/d 145,000 Dec 31 Balance c/d 145,000

Office Equipment
2021 $ 2021 $
Jan 1 Cash (Office Equipment X) 200,000 Dec 31 Balance c/d 200,000

2022 2022
Jan 1 Balance b/d 200,000 Dec 31 Balance c/d 480,000
Jan 1 Cash (Office Equipment Y) 280,000
480,000 480,000

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 Accumulated Depreciation: Furniture
2021 $ 2021 $
Dec 31 Balance c/d 30,000 Dec 31 Depreciation: Furniture 30,000
($22,000 + $8,000)

2022 2022
Dec 31 Balance c/d 60,000 Jan 1 Balance b/d 30,000
Dec 31 Depreciation: Furniture 30,000
60,000 60,000

Accumulated Depreciation: Office Equipment

2021 $ 2021 $
Dec 31 Balance c/d 60,000 Dec 31 Depreciation: 60,000
Office Equipment

2022 2022
Dec 31 Balance c/d 158,000 Jan 1 Balance b/d 60,000
Dec 31 Depreciation: 98,000
Office Equipment
158,000 158,000

Depreciation: Furniture
2021 $ 2021 $
Dec 31 Accumulated Depreciation: 30,000 Dec 31 Profit and Loss 30,000
Furniture

2022 2022
Dec 31 Accumulated Depreciation: Dec 31 Profit and Loss 30,000
Furniture

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 Depreciation: Office Equipment
2021 $ 2021 $
Dec 31 Accumulated Depreciation: 60,000 Dec 31 Profit and Loss 60,000
Office Equipment

2022 2022
Dec 31 Accumulated Depreciation: 98,000 Dec 31 Profit and Loss 98,000
Office Equipment

Victor Company
Income Statement for the years ended 31 December (extracts)
2021 2022
$ $
Expenses
Depreciation: Furniture
30,000 30,000
Depreciation: Office Equipment
60,000 98,000

Victor Company
Statement of Financial Position as at 31 December 2021 (extracts)
Cost Accumulated Net book
depreciation value
Non-current assets $ $ $
Furniture 145,000 30,000 115,000
Office Equipment 200,000 60,000 140,000
345,000 90,000 255,000

Victor Company
Statement of Financial Position as at 31 December 2022 (extracts)
Cost Accumulated Net book
depreciation value
Non-current assets $ $ $
Furniture 145,000 60,000 85,000
Office Equipment 480,000 158,000 322,000
625,000 218,000 407,000

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7. Disposal of Non-current Assets
 Disposal is an account recording the sales, damage or loss of non-current assets
 When sales proceeds > net book value of the asset, there would be a gain on disposal
 When sales proceeds < net book value of the asset, there would be a loss on disposal

 Double Entry:
Step 1: Transfer the cost and accumulated depreciation to disposal account
Dr. Disposal Dr. Accumulated Depreciation
Cr. Non-current Assets Cr. Disposal

Step 2: Record the sales proceeds

Dr. Cash / Bank / Accounts Receivables
Cr. Disposal

Step 3: Record the gain or loss on disposal and close the disposal account
(a) Gain on Disposal (b) Loss on Disposal
Dr. Disposal Dr. Loss on Disposal (Expenses)
Cr. Gain on Disposal (Revenues) Cr. Disposal

Continue Example 2
Suppose the lorry was sold for $45,000 cash at the beginning of Year 3.
Cost = $160,000
Accumulated depreciation = $75,000
Sales proceeds = $45,000

Disposal: Lorries
$ $
Lorries 160,000 Accumulated depreciation: Lorries 75,000
Cash 45,000
Loss on disposal 40,000

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Example 6
On 1 January 2012, K Lee bought three machines by cheque. They cost $54,000 each. She estimated that the
machines would be used for six years, and could then be sold for $3,000 each. However, one of the
machines was damaged at the end of 2013. This machine was sold on 1 January 2014 for $24,600 in cash.
The straight-line method of depreciation was to be used. The financial year-end is 31 December.

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8. Trade-in of Non-current Assets
 Sometimes, we can use an old non-current asset to exchange for a new asset
 The trade-in allowance / value of the old asset will be deducted from the cost of the new asset

 Double Entry:
Step 1: Transfer the cost and accumulated depreciation of old asset to disposal account
Dr. Disposal Dr. Accumulated Depreciation
Cr. Non-current Assets Cr. Disposal

Step 2: Record the purchases of new asset

Dr. Non-current Asset
Cr. Cash / Bank / Accounts Payables
Cr. Disposal (amount of trade-in allowance)

Step 3: Record the gain or loss on disposal and close the disposal account
(a) Gain on Disposal (a) Gain on Disposal
Dr. Disposal Dr. Disposal
Cr. Gain on Disposal (Revenue) Cr. Gain on Disposal (Revenue)

Continue Example 2
Suppose the old lorry was trade in for a new one at the beginning of Year 3. The trade-in value of the old
lorry was $50,000 while the cost price of new lorry was $300,000. The balance was paid in cash.

Cost = $160,000
Accumulated depreciation = $75,000
Trade-in value of old lorry = $50,000
Amount paid for new lorry = $300,000 - $50,000 = $250,000

Lorries
$ $
Balance b/d 160,000 Disposal: Lorries 160,000
Disposal: Lorries 50,000 Balance c/d 300,000
Cash 250,000

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 Disposal: Lorries
$ $
Lorries 160,000 Accumulated depreciation: Lorries 75,000
Lorries 50,000
Loss on disposal 35,000

Example 7
Unicorn Ltd prepares its financial statements on 31 March each year. The following information related to
the machine account of the business is provided:
(i) Purchased a machine for $150,000 by cheque on 1 April 2019.
(ii) The machine was traded in for a new one on 31 January 2022. The trade-in value of the machine was
$50,000. The cost of the new machine was $180,000. The balance was not settled as at 31 March 2022.
(iii) The policy of is to charge depreciation at the rate of 20% per annum using the straight-line method.
(iv) Depreciation on machinery is charged from the date of purchase to the date of disposal.

Machinery
2019 $ 2020 $
Apr 1 Bank 150,000 Mar 31 Balance c/d 150,000
2020 2021
Apr 1 Balance b/d 150,000 Mar 31 Balance c/d 150,000
2021 2022
Apr 1 Balance b/d 150,000 Jan 31 Disposal: Machinery 150,000
2022
Jan 31 Disposal: Machinery 50,000 Mar 31 Balance c/d 180,000
– Trade-in value
“ 31 Accounts payables 130,000
330,000 330,000

Disposal: Machinery
2022 $ 2022 $
Jan 31 Machinery 150,000 Jan 31 Accumulated depreciation: 85,000
Machinery (Workings)
“ 31 Machinery – Trade-in value 50,000
Mar 31 Profit and loss 15,000
– Loss on disposal
150,000 150,000

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Workings
Accumulated Depreciation for the machine
= ($150,000 × 20%) + ($150,000 × 20%) + ($150,000 × 20% × 10/12)
= $30,000 + $30,000 + $25,000
= $85,000

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HKDSE Past Paper Questions
(Sample Paper Section A Q.1)

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(2012 Section A Q.2)

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(2013 Section A Q.2)

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(2014 Section A Q.2)

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(2015 Section C Q.8)

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(2016 Section B Q.6)

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(2017 Section A Q.3)

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(2020 Section A Q.2)

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(2022 Section A Q.1B)

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