CA.CS.CMA.MBA: Naveen.

Rohatgi NMIMS Pharmacy- FM 1

DEPRECIATION

1. MEANING
During the course of business we purchase many fixed assets. These assets have a long life and
generate revenue for the firm over the period of time. Though fixed assets have long life - they
are durable in nature - means have a limited number of years of useful life. They wear off after
certain years and they remain no longer useful to the firm. This wear off is not sudden - in fact
it is gradual - it happen all the time. It decreases year after year. The amount that can recovered
after selling this asset which is not equal to the amount it was purchased (Cost price). This
difference in value is known as depreciation. The realisable value decline as years passes by
due to deprecation.

2 DEFINITION :

To depreciate means to become less valuable. It can be defined as the reduction in the
value of fixed assets. Some other definitions are
1. Carter : “Depreciation is the gradual and permanent decrease in the value of an asset from
any cause whatsoever”.
2. ICAI : “Depreciation is a measure of the wearing out, consumption or other loss of value
of a depreciable asset arising from use, effluxion of time obsolescence through technology
and market changes."

3 FEATURES :

The above definition brings out the following features.

1. It is decrease in value of only Fixed assets.
2. The decline is gradual.
3. The decline is permanent.
4. There are many reasons for the decline in the value of assets.

4 CAUSES OF DEPRECIATION :

There are various causes due to which the value of fixed asset declines.
1. Physical deterioration: This is caused by the physical wear and tear of the fixed asset
through its use. It also arises due to factors like erosion, rust, rot, and decay due to its
exposure to wind, rain, sun and other natural elements.
2. Obsolescence: It refers to the process of becoming outdated or obsolete due to changing
fashions or new technological innovations. In such cases the machinery might have to be
disposed off, though it is still having useful life.

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CA.CS.CMA.MBA: Naveen. Rohatgi NMIMS Pharmacy- FM 1

3. Passage of time : This according to me is the most important reason for depreciation.
Even if the assets are not used, its value falls over the period of time. So, depreciation
should be charged even if the asset is idle. Some assets like patents, lease have a fixed life.
They have to be depreciated in such a manner that its book value becomes zero on the
expiry of such period.
4. Depletion : Some assets are of waste in character. This is due to extraction of materials
therefrom. Natural resources such as mines, quarries, oil wells are assets of this nature.

5 OBJECTIVES OF DEPRECIATION ACCOUNTING :

The following are objectives of providing for depreciation :

1. To spread the cost of fixed asset : The main objective of providing depreciation is to
spread the cost of fixed assets. Fixed assets as discussed before are useful for number of
years and hence their cost should be spread for the number of years.

2. Ascertainment of correct profits : Depreciation is the value of that portion of fixed asset
used for the given year. It is used for the production of goods and services. It is a charge
against profit and should be written off every year. Failure to do this will result in wrong
amounts of profit or loss. This is against one of the important objective of accounts - True
and fair profits.

3. Ascertainment of True and fair financial position : Another important objective of

accounting is true and fair financial position. Now if depreciation is not charged then
financial position will not reflect the correct position. Assets will continue to reflect on
historical values rather than actual values.

4. Replacement of assets : At the end of the useful life of the fixed asset, the used asset will
have to be replaced by a new asset. When depreciation is written off to profit and loss
account every year, it does result into the outflow of cash like rent, salary etc. It is known
as non cash expenditure. The funds will remain in business, which can be utilised for the
replacement of fixed assets.

5. Correct value of asset : As discussed earlier, asset cannot be shown at cost price all the
years. To ascertain the correct value of the asset - depreciation is a must.

6 METHODS OF CHARGING DEPRECIATION :

1. STRAIGHT LINE METHOD :

This method is also known as original cost method or straight line method. This method
takes into account :
(a) the original cost of the asset,
(b) the estimated useful life of the asset, and
(c) the estimated scrap value or the residual value of such asset.
In this method, the original cost of fixed asset less estimated scrap value thereof is spread
over the useful life of the asset.

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CA.CS.CMA.MBA: Naveen. Rohatgi NMIMS Pharmacy- FM 1

A fixed percentage on original cost of a particular asset is calculated and is written off as
depreciation every year.
Thus a fixed amount is charged every year as depreciation. Therefore, it is called as Fixed
Instalment method.
For example, An asset was purchased for ` 50,000 on 1/1/2001 and was decided to be
depreciated at 10% on S.L.M basis
01-01-2001 50,000
Dep 10%, 12m, SLM 5,000
01-01-2002 45,000
Dep 10%, 12m, SLM 5,000
01-01-2003 40,000
Advantages :
(a) It is very simple.
(b) Calculations of depreciation is easy and not complicated.
(c) Same amount is to be charged year after year.
(d) This method is one of the methods recognised in Section 205(2) of Companies Act.
Disadvantages :
(a) It is difficult to find out the estimated life of all kinds of assets.
(b) If a new asset of the same type is introduced during the year, it creates difficulty in
calculation of depreciation.
(c) Under this method, repair and renewal expenses grow more and more by the passing of
time, while the depreciation charges remain fixed.
2. DIMINISHING BALANCE METHOD :
This method is also known as `Reducing Balance Method' or `Written Down Value
Method'.
Under this method a fixed percentage is written off every year on reduced balance of the
asset.
Thus, the percentage of depreciation is not applied to the original cost but to the BOOK
VALUE (i.e. the balance which remains after charging depreciation) in the beginning of the
year.
The percentage of depreciation remains fixed for all the years of the working life of an
asset but the actual amount of depreciation is reduced year after year with the reduction in the
value of the asset till the expiry of the working life and the value of the asset brought down to
its scrap value.
For example, An asset was purchased for ` 50,000 on 1/1/2001 and was decided to be
depreciated at 10% on W.D.V method.
01-01-2001 50,000
Dep 10%, 12m, SLM 5,000
01-01-2002 45,000
Dep 10%, 12m, SLM 5,000

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CA.CS.CMA.MBA: Naveen. Rohatgi NMIMS Pharmacy- FM 1

01-01-2003 40,000
Advantages :
(a) This method considers the charge for repairs and renewals. Under this method,
depreciation decreases year by year, while repairs and renewals charges go on increasing.
Thus, the total expenditure remains more or less constant. More or less equal amount is
charged to each year's profit and loss account for the same amount for service provided
each year by the asset.
(b) It is admitted and accepted by income tax authorities.
(c) There is no need for separate calculations for any addition during the year as the
percentage is calculated on the total book value of an asset at the end of the year
irrespective of the fact whether there are additions or not during the year.
Disadvantages :
(a) It takes a very long time to reduce the value of assets to its scrap value, unless the initial
rate of depreciation is kept very high.
(b) By the passing of time depreciation charges go on decreasing as the calculation of
depreciation is made on diminishing value of the asset.
The Diminishing Balance method is followed for those assets which have a long life and
also requires plenty of repairs and renewals e.g. Buildings, Plant and Machinery,
Furniture.

NUMERCIALS

Q1) On 1/1/2012 Lakshmi and company purchased a imported Machine from the cost of the
machine is ` 12, 00, 000 and import duty of ` 2, 50,000 and installation charges ` 25,000.
On 1/6/2013 purchased a machine for Rs 1, 00,000 and incurred installation cost of `
25,000.
On 1/8/2014 the company purchased another machine for ` 3, 00,000 and the machinery
purchased on 1/1/2012 was sold for ` 5, 00,000.
Prepare machinery account for 2012, 2013, 2014 assuming that depreciation is charged
on original cost method at 15%.Assume the year as calendar year.

Q2) On 1/7/2013 Suraj and company purchased a imported Machine from USA the cost of
the machine is Rs 22,00,000 and import duty of Rs 3,50,000 and installation charges
45,000.

On 1/6/2014 purchased a machine for Rs 1, 00,000 and incurred installation cost of Rs

45,000.

On 1/9/2015 the company purchased another machine for Rs 3, 00,000 and the
machinery purchased on 1/7/2013 was sold for Rs 6,00,000.

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CA.CS.CMA.MBA: Naveen. Rohatgi NMIMS Pharmacy- FM 1

Prepare machinery account for 2013-14, 2014-15, 2015-16 assuming that depreciation
is charged on straight line method at 10% and the year is a financial year.

Q3) On 1/4/2013 Reliance and company purchased a imported Machine from Spain, the cost
of the machine is ` 18,50,000 and import duty of
` 3,50,000 and installation charges 45,000.

On 1/7/2014 purchased a machine for ` 1,00,000 and incurred installation cost of `

45,000.

On 1/5/2015 the company purchased another machine for ` 3,00,000 and the machinery
purchased on 1/4/2013 was sold for ` 7,00,000.

Prepare machinery account and depreciation account for 2013-14, 2014-15, 2015-16
assuming that depreciation is charged on WDV at 10%. The year is a financial year.

Q4) On 1/5/2013 and company purchased a imported Machine from France the cost of the
machine is ` 25,00,000 and import duty of ` 1,50,000 and installation charges 35,000.

On 1/6/2014 the imported Machine was sold for ` 6,00,000. On the same date it
purchased another machine for ` 50,000. and installation charges 5,000.

On 1/9/2015 the company purchased another machine for ` 5,00,000

Prepare machinery account and depreciation account for 2013,2014, 2015

Assume year to be a calendar year.Rate of depreciation is 15% on WDV Method