Depreciation

Objectives
Meaning Why

Depreciation Accounting/Why it is to be accounted Methods of Depreciation Accounting

Depreciation
Reduction

in value of asset due to its use, wear and tear or obsolescence

Why Depreciation/ Objectives

Financial

statement should be

true Ascertain the true profit Asset become useless Assets should be disposed or replaced after a period

Causes of depreciation
Wear and tear Exhaustion eg. Mineral and Mines Obsolescence Effluence of time Accident -

Features
All

fixed asset Charge against profit Percentage of depreciation differ from asset to asset as per various law also Some asset may not have any depreciation

Depreciation Vs Depletion
Depletion

removal of an available but irreplaceable resource

Depreciation Accounting
Rational

and systematic distribution of cost over the estimated useful life of the asset

How to fix
Cost

of the asset Type of the asset Useful Life Scrap value

Methods of Depreciation
Uniform

Charge Method Declining Charge or Accelerated Depreciation Other Methods

Uniform Charge Method

Fixed

Installment Method Depletion Method Machine Hour Rate Method

Declining or accelerated
Diminishing

Balance Method Sum of Years Digit Method Double Declining Method

Other Methods
Group

Depreciation Method Inventory System of Depreciation Annuity Method Depreciation Fund Method Insurance Policy Method

Uniform Charge Methods

Fixed Installment Method / SLM Depreciation is uniform or same year after year/ Same depreciation is charged throughout the life of the asset Depreciation = Initial Cost of the Asset Estimated Scrap Value.

Fixed Installment Method / SLM

Advantages and Disadvantages Simple and Easy

Value

of the asset can be reduced to zero (except scrap value) More suitable if life can be predicted more accurately eg. Patents, leasehold properties Disadvantages Effective utilization is not considered/ Not based on the use Total charge for the use of the asset is increasing even if asset is used

Journal Entries
Depreciation

a\c Dr To Fixed Asset (when Depreciation is Charged) P & L Account Dr. To Depreciation a\c (When Depreciation a\c is closed and transferred to P&L a\c)

Depletion Method/Productive output Method

Dep is based on the use of the asset ie Total Amount Paid Total Estimated Quantities of the Output Available Actual quantity taken during the accounting period Eg. More suitable for Mines and Quarries

Merits
Dep

is based on effective utilization Exact cost can be calculated Demerits Correct estimation of the output may not be practical

Machine Hour Rate Method/Service Hours Method

Based

on the use (in hours) of the machine and total running time available

Dep

(per hour) = Cost of the Asset Scrap value Life of the Asset in Hours Dep = Dep per hour X No. of hrs

Declining or accelerated Methods

Amount of depreciation goes on declining every year Methods Diminishing Balance Method Sum of Years Digit Method Double Declining Method

Diminishing Balance Method/WDV

Dep

is based on the book value of the asset The amount of depreciation decreases every year
Eg.

Merits and Demerits

Total

charge for the use of the asset may be same throughout the year Dep is based on the book value Demerits Value of the asset cannot be brought down to zero Determining suitable rate of depreciation is not easy

Sum of Years Digit method(SYD)

Depreciation

goes on decreasing Dep = Remaining Life of the Asset (including current Year) Sum of all the Digits of the Life of the Asset in Years Eg.

Double Declining Method

Similar

to declining Depreciation is charged at a rate which is twice the straight-line rate