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as how long the working life of the asset is. The principal methods of depreciation used in business are:
The straight-line method: This assumes that the asset will be ‘consumed’ evenly throughout its life. If, for example, an asset is being bought for £1,200 and sold at the end of five years for £200, the amount of cost we have to write off is £1,000. Using 20 per cent, so that the whole 100 per cent of cost is allocated, we can work out the ‘book value’ for each year.
The declining-balance method: This works in a similar way, but instead of an even depreciation each year we assume the drop will be less. Some assets, motor vehicles for example, will reduce sharply in their first year and less so later on. So at the end of year 1, both these methods of depreciation will result in a £200 fall, but in year 2 the picture starts to change. The straight-line method takes a further fall of £200, while the declining-balance method reduces by 20 per cent (our agreed depreciation rate) of £800 (the balance of £1,000 minus the £200 depreciation so far), which is £160.
The sum of the digits method: This is more common in the United States than in the UK. While the declining-balance method applies a constant percentage to a declining figure, this method applies a progressively smaller percentage to the initial cost. It involves adding up the individual numbers in the expected life span of the asset to arrive at the denominator of a fraction. The numerator is year number concerned, but in reverse order.
    For example, if our computer asset bought for £1,200 had an expected useful life of five years (unlikely), then the denominator in our sum would be 1+2+3+4+5 which equals 15. In year 1 we would depreciate by 5/15 times the initial purchase price of £1,200, which equals £400. In year 2 we would depreciate by 4/15ths and so on.
    These are just three of the most common of many ways of depreciating fixed assets. In choosing which method of depreciation to use, and in practice you may have to use different methods with different types of asset, it is useful to remember what you are trying to do. You are aiming to allocate the cost of buying the asset as it should apply to each year of its working life.
    Balance sheet and other online tools
    SCORE ( www.score.org/resources/projected-balance-sheet-template.xls ) is an Excel-based spreadsheet you can use for constructing your own balance sheet. You can find guidance on depreciation, on handling stock and on the layout of the balance sheet and profit and loss account as required by the Companies Act from the Accounting Standards Board ( www.frc.org.uk > Accounting and Reporting Policy > FRSSE). Accounting Glossary ( www.accountingglossary.net ) and Accounting for Everyone ( www.accountingforeveryone.com > Accounting Glossary) have definitions of all the accounting terms you are ever likely to come across in the accounting world.
    Package of accounts
    The cash-flow statement, the profit and loss account and the balance sheet between them constitute a set of accounts, but conventionally two balance sheets, the opening and closing one, are provided to make a ‘package’. By including these balance sheets we can see the full picture of what has happened to the owner’s investment in the business.
    Table 1.10 shows a simplified package of accounts. We can see from these, that over the year the business has made £600 of profit after tax, and has invested that profit in £200 of additional fixed assets and £400 of working capital such as stock and debtors, balancing that off with the £600 put into reserves from the year’s profits.
    TABLE 1.10    A package of accounts
Balance sheet at 31 Dec 2010
P & L for year to 31 Dec 2011
Balance sheet at 2011
$/£/€

$/£/€

$/£/€
Fixed assets
1,000
Sales
10,000
Fixed assets
1,200
Working capital
1,000
less cost of sales
6,000
Working