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How is depreciation calculated under the straight-line and reducing-balance methods, and why is it charged at all?

Calculate depreciation using the straight-line and reducing-balance methods and explain the purpose of depreciation

A focused answer to the H2 Principles of Accounting outcome on depreciation. The straight-line and reducing-balance methods, why depreciation applies the matching concept, accumulated depreciation and carrying amount, and choosing a method.

Generated by Claude Opus 4.810 min answerUpdated 2026-06-06

Reviewed by: AI editorial process; not yet individually human-reviewed

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What this dot point is asking
The answer
Examples in context
Try this

What this dot point is asking

SEAB wants you to calculate depreciation using the straight-line and reducing-balance methods and to explain why depreciation is charged. Depreciation is the single most common adjustment in the syllabus, and examiners test both the arithmetic and the concept. The central insight is that depreciation is not a valuation or a cash fund; it is the systematic allocation of an asset's cost over its useful life, an application of the matching concept.

The answer

Why depreciate

Depreciation spreads the cost of a non-current asset over the periods that benefit from using it. This applies matching: rather than charging the whole cost when the asset is bought, each year's income statement bears a fair share of the cost it helped earn. It also keeps the carrying amount (cost less accumulated depreciation) as a reasonable reflection of the asset's remaining service, consistent with prudence. Crucially, depreciation is a non-cash expense; it sets no money aside for replacement.

The straight-line method

Straight-line charges an equal amount each year:

\text{Annual depreciation} = \frac{\text{cost} - \text{residual value}}{\text{useful life in years}}

It suits assets that deliver even benefit over their life, such as buildings and fixtures. The carrying amount falls in a straight line to the residual value.

The reducing-balance method

Reducing balance applies a fixed percentage to the carrying amount (not the cost) each year:

\text{Depreciation} = \text{rate} \times \text{carrying amount at the start of the year}

This charges more in early years and less later, suiting assets that lose value quickly at first, such as vehicles and technology. The carrying amount never quite reaches zero.

Accumulated depreciation and the carrying amount

Each year's charge is debited to the income statement and credited to accumulated depreciation, a contra-asset that builds up over time. The asset is shown on the statement of financial position at:

\text{Carrying amount} = \text{cost} - \text{accumulated depreciation}

Worked example

A delivery vehicle costs $\$ 40,000 $, has a residual value of$ \ $4\,000$ and a useful life of $4$ years. Compare three years of depreciation under straight-line and under reducing balance at $40\%$ .

Step 1: Straight-line annual charge

\frac{40\,000 - 4\,000}{4} = \frac{36\,000}{4} = \$9\,000 \text{ per year}

So years 1, 2 and 3 each charge $\$ 9,000 $; carrying amounts are$ \ $31\,000$ , $\$ 22,000 $,$ \ $13\,000$ .

Step 2: Reducing-balance year 1

$40\% \times 40\,000 = \$ 16,000 $; carrying amount$ = 40,000 - 16,000 = \ $24\,000$ .

Step 3: Reducing-balance years 2 and 3

Year 2: $40\% \times 24\,000 = \$ 9,600 $; carrying amount$ = \ $14\,400$ . Year 3: $40\% \times 14\,400 = \$ 5,760 $; carrying amount$ = \ $8\,640$ .

Step 4: Compare the patterns

Year	Straight-line charge	Reducing-balance charge
1	9,000	16,000
2	9,000	9,600
3	9,000	5,760

Reducing balance front-loads the expense, matching a vehicle's rapid early value loss, while straight-line spreads it evenly. The total charged differs each year, which is why the chosen method affects reported profit.

Examples in context

Example 1. Choosing a method for a server. A company buys IT servers that become obsolete fast, losing most usefulness in the first two years. Reducing balance suits them, charging heavy depreciation early to match the rapid value loss. A straight-line charge would understate the early expense and leave too high a carrying amount for assets that are nearly obsolete, so the method choice keeps the statements faithful.

Example 2. The consistency requirement. A firm depreciates its buildings straight-line at $2\%$ every year. It cannot switch to a different rate or method simply to flatter profit, because consistency requires the same policy period to period. If a change is genuinely justified by a new usage pattern, it must be applied and disclosed so users can still compare the figures, linking depreciation to the conceptual framework.

Try this

Q1. A machine costs $\$ 25,000 $, residual value$ \ $1\,000$ , life $6$ years. Find the straight-line charge. [2 marks]

Cue. $\dfrac{25\,000 - 1\,000}{6} = \dfrac{24\,000}{6} = \$ 4,000$ per year.

Q2. An asset has a carrying amount of $\$ 20,000 $and is depreciated at$ 25%$ reducing balance. Find this year's charge and the new carrying amount. [2 marks]

Cue. Charge $= 25\% \times 20\,000 = \$ 5,000 $; new carrying amount$ = 20,000 - 5,000 = \ $15\,000$ .

Q3. Explain why depreciation does not provide the cash to replace an asset. [3 marks]

Cue. Depreciation is a book entry reducing profit and carrying amount, not a transfer of cash; replacing the asset needs real funds, which must be generated and retained separately.

Exam-style practice questions

Practice questions written in the style of SEAB exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

Original7 marksA machine costs

\

50\,000

with an estimated residual value of

5\,000

and a useful life of

5

years. (a) Calculate the annual straight-line depreciation. (b) Calculate the depreciation for the first two years using reducing balance at

30\%

. (c) State the carrying amount at the end of year 2 under each method.

Show worked answer →

(a) Straight-line $= \dfrac{\text{cost} - \text{residual}}{\text{life}} = \dfrac{50\,000 - 5\,000}{5} = \dfrac{45\,000}{5} = \$ 9,000$ per year.

Carrying amount end of year 2 (straight-line) $= 50\,000 - (2 \times 9\,000) = \$ 32,000$.

(b) Reducing balance applies the rate to the carrying amount.

Year 1: $30\% \times 50\,000 = \$ 15,000 $; carrying amount$ = 50,000 - 15,000 = \ $35\,000$ .

Year 2: $30\% \times 35\,000 = \$ 10,500 $; carrying amount$ = 35,000 - 10,500 = \ $24\,500$ .

Markers reward the straight-line formula using residual value, applying the reducing-balance rate to the carrying amount (not cost), and both carrying amounts.

Original5 marksExplain why depreciation is charged and why it does not provide cash for replacing the asset. State which method suits an asset that loses most value in its early years.

Show worked answer →

Depreciation is charged to apply the matching concept: the cost of a non-current asset is spread over the periods that benefit from its use, so each period's profit bears a fair share of the asset's cost. It also ensures the carrying amount reflects the consumption of the asset over time (prudence).

Depreciation does not provide cash. It is a non-cash expense, a book entry that reduces profit and the asset's carrying amount; no money is set aside. Replacing the asset requires actual cash, which must be funded separately. Depreciation only allocates a past cash outflow across periods.

An asset that loses most of its value early (for example a motor vehicle) suits the reducing-balance method, which charges more depreciation in the early years and less later, matching the pattern of value lost.

Markers reward the matching purpose, the point that depreciation is non-cash and sets no money aside, and reducing balance for front-loaded value loss.