What is depreciation? Why is its calculation necessary? Give an example of straight line depreciation.

Depreciation is a periodic year end accounting adjustment (not an actual cash change), which represents the physical wearing out of Non-Current Assets (NCAs) such as vehicles and buildings. If firms did not depreciate assets then they would carry them on their Balance Sheet (BS) at the price they bought them for forever, even if the assets were no longer useful due to being old. The matching principle tells us that expenses which relate to the generation of particular revenue, must be recognised in the same period as that revenue. For example a Van allows a company to deliver goods thus generating revenue. But where do we recognise the decrease in value of the Van from that use on the Income Statement (I/S)? We cant just charge the full value of the van to that years income, as this would not represent that actual pattern of the usage of the van. The anwser is depreciation. Every year we calculate the depreciation on the Van, this is an expense on the I/S and so reduces our profit and so our tax. It also decreases the Net Book Value (NBV) of the asset on our BS, which is the original cost of the asset (or capitalised value) minus the Accumulated Depreciation. Straight Line Depreciaition Example: MyTutor Ltd purchased a computer for £2000, and expected to use it for 6 years, at which time they could sell it for £200. The Depreciable Amount (the purchase value which is attributable to their period of ownership), is £2000 - £200 = £1800. In order for the computer to have NBV equal to its scrap value (£200) at the end of the 6 years, it must be depreciated by £1800/6 = £300 per year. Thus the value of the asset decreases as its remaining Useful Economic Life reduces. The accounting entries would be: DR Depreciation Expense £300 -> This is an expense on the IS -> reduces our profit and so our tax. CR Accumulated Depreciation £300 -> This represents the total depreciation on the asset since we acquired it. It is taken away from the original value of the asset to give us the NBV. -> Depreciation decreases value of NCAs on the balance sheet.