A business buys a fixed asset for £10,000. The business estimates that the asset will be used for 5 years. After exactly 21/2 years, however, the asset is suddenly sold for £5,000. The business always provides a full year’s depreciation in the year of purchase and no depreciation in the year of disposal.

Required:

(a) Write up the relevant accounts (including disposal account but not profit and loss account) for each of Years 1, 2 and 3:

(i) Using the straight line depreciation method (assume 20% pa);

(ii) Using the reducing balance depreciation method (assume 40% pa).

(b) (i) What is the purpose of depreciation? In what circumstances would each of the two methods you have used be preferable?

(ii) What is the meaning of the net figure for the fixed asset in the balance sheet at the end of Year 2?

(c) If the asset was bought at the beginning of Year 1, but was not used at all until Year 2 (and it is confidently anticipated to last until Year 6), state under each method the appropriate depreciation charge in Year 1, and briefly justify your answer.