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DEPRECIATION

DEFINITION
DECREASE IN THE VALUE OF AN ASSET PERMANENT, CONTINUOUS & GRADUAL DIMINUTION, LOSS OR SHRINKAGE IN THE UTILITY VALUE OF AN ASSET FIXED ASSET CONSUMED OVER A NO OF YEARS EXPENSE PORTION OF THE TOTAL CHARGE ALLOCATED TO THE YEAR

CHARACTERISTICS OF DEPRECIATION

1. PERMANENT / GRADUAL & CONTINUOUS DECREASE IN THE UTILITY VALUE OF A FIXED ASSET AND IT CONTINUES TILL THE END OF USEFUL LIFE OF THE ASSET. 2. CHARGED AGAINST PROFIT (i.e.., REVENUE EARNED) FOR A PARTICULAR ACCOUNTING PERIOD 3. COMPUTED IN A SYSTEMATIC & RATIONAL MANNER SINCE IT IS NOT A SUDDEN LOSS

4. PROCESS OF ALLOCATION OF EXPIRED COST AND NOT OF VALUATION OF FIXED ASSETS 5. WHATEVER METHOD, EXACT AMOUNT CANT BE CALCULATED, BUT ONLY ESTIMATED 6. MAY BE PHYSICAL AND FUNCTIONAL 7. FUNDAMENTAL OBJECTS ARE: (a) MAINTAIN THE NORMAL CAPITAL INVESTED IN FIXED ASSETS; (b) ALLOCATE THE EXPIRED PORTION OF THE COST OF FIXED ASSETS AGAINST A NO OF ACCOUNTING PERIODS

8. ITS A MUST TAKES PLACE WHETHER THE ASSET IS CAREFULLY HANDLED OR NEGLECTED 9. MARKET VALUE OF FIXED ASSET DOES NOT AFFECT THE AMOUNT OF DEPRECIATION 10. CALCULATED IN RESPECT OF FIXED ASSETS ONLY

CAUSES OF DEPRECIATION
PHYSICAL DETERIORATION: WEAR AND TEAR ECONOMIC FACTORS: EG: OBSOLESCENCE INVENTION OF NEW TECHNIQUES, CHANGE IN TASTE / PREFERNCE, INADEQUACY DUE TO INCREASE IN VOLUME OF ACTIVITIES PASSAGE (EFFLUXION) OF TIME: EG: LEASE, PATENTS, LICENSE, COPYRIGHTS

METHODS OF DEPRECIATION
1. 2.

3. 4.

5.

FIXED INSTALMENT / STRAIGHT LINE METHOD / ORIGINAL COST METHOD WRITTEN-DOWN VALUE METHOD / DIMINISHING BALANCE METHOD / ACCELERATED DEPRECIATON METHOD SUM OF THE YEARS DIGIT METHOD SINKING FUND METHOD / DEPRECIATION FUND AMORTISATION/ REDEMPTION FUND METHOD ANNUITY METHOD

STRAIGHT LINE METHOD

A FIXED % OF ORIGINAL COST OF FIXED ASSETS MINUS SCRAP VALUE REDUCE THE ASSET A/C TO NIL OR TO ITS SCRAP VALUE AT THE END OF ESTIMATED LIFE (C-S) / L; C ORIGINAL COST S SCRAP VALUE L ESTIMATED WORKING LIFE OF FIXED ASSETS EG: PATENTS, LEASEHOLDS ETC

ADVANTAGES OF SLM
SIMPLE & EASY NO NEED TO FIND OUT YEARLY OUTPUT OF FA PATENTS, LEASEHOLDS RIGHT TIME BASED ON AGREEMENT: - UNIFORM AMOUNT EVERY YEAR - GRADUAL DECREASE ASSUMES FAVOURABLE IMPACTS OFFSET BY UNFAVOURABLE IMPACTS

DISADVANTAGES OF SLM

FA ADDITIONS DIFFICULT TO CALCULATE DEPRECIATION DEPRECIATION CONSTANT EXPIRY OF FIXED ASSETS INCREASES WITH YEARS NOT A REAL VALUATION DURING INFLATION DIFFICULT TO MAINTAIN FA EARLY YEARS HIGHER OUTPUT LATER LOWER OUTPUT NOT RECOGNISED BY IT AUTHORITIES

WDV

A FIXED % IS WRITTEN OFF ON THE WRITTEN DOWN VALUE OF ASSET TILL THE AMOUNT IS REDUCED TO ITS SCRAP VALUE EG: P&M, F&F LONGER LIFE DIFFICULT TO ESTIMATE W = C[(1-R)/100]n W WRITTEN DOWN VALUE C ORIGINAL COST R RATE OF DEPRECIATION n NO OF YEARS

ADVANTAGES

GRADUAL DECREASE WITH DECREASE IN SERVICES EARLY PERIOD OUTPUT INCREASES HIGHER DEPRECIATION & VICE VERSA WHEN FA ADDITIONS FRESH CALCULATIONS NOT NECESSARY RECOGNISED BY IT AUTHORITIES DEPRECIATION AMOUNT HIGHER IN INITIAL YEARS MINIMISES IMPACT OF OBSOLESCENCE

DISADVANTAGES
VERY LONG TIME TO REDUCE TO SCRAP CANT ASCERTAIN COST PRICE OF GOODS CALCULATION IS TIME CONSUMING IMPOSSIBLE TO REDUCE IT TO ZERO TOO MUCH EMPHASIS IS ON HISTORICAL COST

SUM OF THE YEARS DIGIT METHOD


VARIANT OF WDV AMOUNT OF DEPRECIATION DECREASES CONSTANTLY LIKE SLM ORIGINAL VALUE BECOMES 0 EG: LONG LIVING ASSETS S = N (N+1) / 2 S SUM OF YEARS N NO OF YEARS DEPRECIATION = (NO OF YRS OF REMAINING LIFE OF THE ASSETS / TOTAL OF THE DIGITS) X AMOUNT TO BE WRITTEN-OFF AMOUNT TO BE WRITTEN OFF = COST PRICE SALVAGE VALUE

A M/C PURCHASED FOR RS.60000 ON 1.1.1993 AND DEPRECIATION WAS CHARGED FOLLOWING SUM OF THE YEARS DIGIT METHOD. ITS USEFUL LIFE IS 3 YEARS DEPRECIATION FOR: I YEAR = 3 / (3+2+1) X 60000 = RS.30000 II YEAR = 2 / 6 X 60000 = RS.20000 III YEAR = 1 / 6 X 60000 = RS.10000

SINKING FUND METHOD


CERTAIN AMOUNT DEBITED TO P&L A/C & CREDIT DEPRECIATION TO SINKING FUND A/C DEPRECIATION AMOUNT CALCULATED BASED ON SINKING FUND TABLE IN SUCH A WAY THAT EQUAL AMT IS REALISED IF INVESTED IN SECURITIES DEPRECIATION = I / (1+i)n-1 i = RATE OF INTEREST n = NO OF YEARS

ADVANTAGES
FUND INVESTED IN RESALEABLE ASSETS ORIGINAL VALUE OF ASSET SHOWN IN B/S AMOUNT WRITTEN-OFF EVERY YEAR IS KNOWN BY DEPRECIATION FUND A/C USEFUL IF ASSET REPLACED

DISADVANTAGES
INVESTMENT WHEN SOLD INSUFFICIENT TO REPLACE THE ASSET AMOUNT INVESTED IN SECURITIES MAY BE USED FOR SOME OTHER PURPOSE

ANNUITY METHOD
MONEY INVESTED IN ASSETS INVESTMENT INTEREST ON CAPITAL ADDED TO ASSET A/C DEBITED FIXED AMOUNT OF DEPRECIATION FROM ANNUITY TABLE DEPRECIATION AMOUNT NOT INVESTED IN OUTSIDE SECURITIES INTEREST BECOMES LESSER & LESSER BCOS CALCULATED ON THE DEBIT BALANCE OF ASSET A/C

ADVANTAGES
SCIENTIFIC PURCHASE OF ASSET INVESTMENT TAKES INTEREST DEPRECIATION INCLUDES INTEREST ON CAPITAL

DISADVANTAGES
ASSET ADDITIONS NOT POSSIBLE TOTAL COST OF REPAIRS & DEPRECIATION NOT SAME EVERY YEAR ASSET IN B/S HIGHER THAN ITS ACTUAL COST