Depreciation is charged to allocate the cost of a non-current asset over its useful life. It represents the amount of the asset that was consumed or used up in a period to generate revenue. Depreciation must be charged each period so that the revenues are matched with all expenses, including the cost of the asset used, to determine an accurate profit for the period. This helps provide a relevant view of the business's financial performance.

1. 16.1
WHY IS DEPRECIATION
CHARGED?

2. © Michael Allison, Trinity Grammar School.
Author’s permission required for external use
 The purpose of a business owning non-current assets is to use
them to generate revenue
 For example, a business uses a delivery vehicle for 3 years to
make sales to customers
16.1 WHY IS DEPRECIATION CHARGED?
2015 2016 2017
2015
Made sales deliveries of
$25,000
2016
Made sales deliveries of
$25,000
2017
Made sales deliveries of
$25,000

3. © Michael Allison, Trinity Grammar School.
Author’s permission required for external use
 But a non-current asset doesn’t just earn revenue – it also has
an Expense which represents its usage throughout the period
 This is called depreciation:
 The allocation of a cost of a non-current asset over its useful
working life
 Represents how much of the asset was consumed (used up) in
order to earn revenue this period
16.1 WHY IS DEPRECIATION CHARGED?

4. © Michael Allison, Trinity Grammar School.
Author’s permission required for external use
Year 1 Year 5Year 2 Year 3 Year 4
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
16.1 WHY IS DEPRECIATION CHARGED?
 Depreciation expense is:
 The amount of depreciation written off as an expense during the
reporting period
 How much of the non-current asset was consumed (used up)
during the period
 For example, you pay $10,000 for a car today that will last for the
next 5 years

5. © Michael Allison, Trinity Grammar School.
Author’s permission required for external use
Year 1 Year 5Year 2 Year 3 Year 4
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Unused, 8,000
Unused, 6,000
Unused, 4,000
Unused, 2,000
Used, 2,000
Used, 4,000
Used, 6,000
Used, 8,000
Used, 10,000
Year 1 Year 2 Year 3 Year 4 Year 5
16.1 WHY IS DEPRECIATION CHARGED?

6. © Michael Allison, Trinity Grammar School.
Author’s permission required for external use
 For example, a firm bought a $10,000 delivery van to last for the next 5
years. Each period the van will help generate revenue of $8,000.
Year 1 Year 5Year 2 Year 3 Year 4
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000
 Alternative treatment…
Year 1 Year 5Year 2 Year 3 Year 4
Depreciation
$10,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000
16.1 WHY IS DEPRECIATION CHARGED?

7. © Michael Allison, Trinity Grammar School.
Author’s permission required for external use
16.1 WHY IS DEPRECIATION CHARGED?
 Why must depreciation be charged each period?
Reporting Period Principle:
• At the end of each period, the revenues for that period must be
matched against all expenses
• Depreciation must be calculated to represent the expense (amount
used) of the non-current asset for the period
• This is then matched against the revenues generated from using
the asset in order to determine profit
Year 1 Year 5Year 2 Year 3 Year 4
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000

8. © Michael Allison, Trinity Grammar School.
Author’s permission required for external use
16.1 WHY IS DEPRECIATION CHARGED?
 Why must depreciation be charged each period?
Relevance:
• Depreciation is relevant as it represents the expense (amount used)
of the asset this period
• This enables an accurate profit to be determined
Year 1 Year 5Year 2 Year 3 Year 4
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Depreciation
$2,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000
Revenue
$8,000
Net Profit
$6,000
Net Profit
$6,000
Net Profit
$6,000
Net Profit
$6,000
Net Profit
$6,000

9. © Michael Allison, Trinity Grammar School.
Author’s permission required for external use
 Depreciation allows the revenues
of the van to be matched against
its expense (depreciation)
 For example, the delivery van
has the following details:
 Cost = $35,000
 Estimated useful life = 3 years
 Estimated residual value =
$5,000
Depreciation expense =
ResidualCost -
Useful Life
= $10,000
2015 2016 2017
Revenue = $25,000 Revenue = $25,000 Revenue = $25,000
Depreciation = $10,000-
Net Profit = $15,000=
Depreciation = $10,000-
Net Profit = $15,000=
Depreciation = $10,000-
Net Profit = $15,000=
16.1 WHY IS DEPRECIATION CHARGED?