Depreciation
You saw in the statement of comprehensive income that it included a figure for depreciation.
Depreciation is a way of calculating the cost of using fixed assets over a year. This is necessary to ensure that the value of assets decreases as they age and are used. It is shown as a cost on the statement of comprehensive income – you can think of it as the 'cost' of using a fixed asset that you own.
Depreciation can be calculated in two ways. It does not matter which method is used but for consistency, the same method should be used every time.
Straight line deprecation
To calculate depreciation using the straight-line method it is necessary to subtract the residual value of the asset (its value at the end of its 'life') from the original price and then divide by the number of years the asset is expected to be used.
 Original asset price – final value of asset Â
Asset lifetime in years
Rholiau Rhian bought a van for £20,000 and its value is expected to be £2,000 after 6 years.
The depreciation is therefore
£20,000 – £2,000 = £3,000
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The value of the van will decrease by £3,000 each year and a cost of £3,000 will appear as an overhead on the statement of comprehensive income.
Reducing balance method
The second way to calculate depreciation is to use the reducing balance method.
With this method, the value decreases by a fixed percentage each year.
Rholiau Rhian decided to use a reducing balance method at a rate of 20% per annum. The value of the van will decrease as follow:
Year 0:
£20,000
Year 1:
20% o £20,000 = £4,000
£20,000 – £4,000 =£16,000
Year 2:
20% o £16,000 = £3,200
£16,000 – £3,200= £12,800
Year 3:
20% o £12,800 = £2,560
£12,800 - £ 2,560 = £10,240
And so on until the end of the van’s life.
Adjustments for prepayments and accruals
Financial transactions have to be shown in the period in which they occur so sometimes it is necessary for the figures to be adjusted to ensure they appear in the correct period.