Depreciation spreads the cost of a non-current asset over the years in which the business uses it. Once you have classified spending as capital, the next question is how that cost reaches the income statement. It does so gradually through a depreciation charge, not all at once in the year of purchase.
Within capital and revenue treatment, this lesson explains why the capital label matters. Later modules, including depreciation and asset disposal, build the full methods.
Why not charge the whole cost in year one?
An asset such as a printing press helps earn revenue for many years. If the whole cost were an expense in year one, that year’s profit would look far too low and each later year’s profit would look too high. Matching the cost of an asset to the years it helps earn income gives a fairer picture each year.
That is also the link to capital and revenue. Revenue expenditure is used up in the period, so it is charged in full in that period. Capital expenditure keeps providing benefit, so it sits in the statement of financial position at cost and moves to the income statement a little each year.
How does straight-line depreciation work?
Straight-line depreciation charges the same amount every year:
annual depreciation = (cost − residual value) ÷ useful life in years
The residual value is the amount the business expects to receive when it disposes of the asset. Net book value is cost minus accumulated depreciation. Each year the double entry is: debit Depreciation expense, credit Provision for depreciation.
Worked example
Pelangi Printing buys a printing press for RM 48,000. It expects to use it for 5 years and then sell it for RM 6,000.
Step 1, find the depreciable amount. 48,000 − 6,000 = RM 42,000.
Step 2, divide by the life. 42,000 ÷ 5 = RM 8,400 per year.
Step 3, show the net book value year by year.
| Year end | Depreciation (RM) | Accumulated (RM) | Net book value (RM) |
|---|---|---|---|
| 1 | 8,400 | 8,400 | 39,600 |
| 2 | 8,400 | 16,800 | 31,200 |
| 3 | 8,400 | 25,200 | 22,800 |
| 4 | 8,400 | 33,600 | 14,400 |
| 5 | 8,400 | 42,000 | 6,000 |
The net book value ends at the residual value of RM 6,000, as it should.
Step 4, compare the profit effect. Suppose profit before any press cost is RM 30,000 in each of the five years.
| Year 1 | Years 2 to 5 (each) | Five-year total | |
|---|---|---|---|
| Whole cost expensed in year 1 | 30,000 − 48,000 = −18,000 | 30,000 | 102,000 |
| Depreciation each year | 30,000 − 8,400 = 21,600 | 21,600 | 108,000 |
Expensing everything shows a loss of RM 18,000 in year one, then four years of RM 30,000. Depreciation shows a steady RM 21,600. The totals differ by RM 6,000, which is exactly the residual value that the business still holds at the end.
The mistake to watch for
A frequent slip is to ignore the residual value.
Mistaken answer: “48,000 ÷ 5 = RM 9,600 per year.”
The student divided the full cost and forgot that RM 6,000 is expected back at the end.
Charging RM 9,600 a year would write the press down to RM 0 after five years, even though the business expects to sell it for RM 6,000. The correct charge uses the depreciable amount: (48,000 − 6,000) ÷ 5 = RM 8,400.
A second slip is to say depreciation saves cash for a replacement, but recording it moves no cash. It only shares cost across the years.
Check yourself
Try these on paper first.
1. A machine costs RM 20,000, has a residual value of RM 2,000 and a useful life of 6 years. Find the annual straight-line depreciation.
Show answer
(20,000 − 2,000) ÷ 6 = 18,000 ÷ 6 = RM 3,000 per year.
2. Using the same machine, what is the net book value at the end of year 2?
Show answer
Accumulated depreciation is 2 × 3,000 = 6,000. Net book value = 20,000 − 6,000 = RM 14,000.
3. In two sentences, explain why a business depreciates a delivery van instead of expensing the whole cost in the year of purchase.
Show answer
The van provides benefit over several years, so its cost should be spread across those years. This matches the cost with the revenue it helps to earn and avoids making the first year’s profit look too low and later years too high.
Where this leads next
The final lesson in this module deals with questions where the facts do not settle the treatment: stating uncertainty when a fact is insufficient. When you want to follow depreciation entries in a ledger, use the double-entry and ledger trainer, then attempt the capital and revenue practice set.
Students often do the division correctly and still lose the explanation marks because the wording is vague. In online one-to-one Accounting tuition, a teacher can help you practise explanations until they are short and accurate.