Accounting Standard 6: Depreciation

Depreciation can be defined as a continuing, permanent and gradual decrease

in the book value of fixed assets. This type of shrinkage is based on the cost of
assets utilised in a firm and not on its market value.

Depletion  The term ‘Depletion’ is used with regard to the ‘Natural Resources’ like oil wells,
Mines etc.
 When natural resources are extracted and their stock value is reduced. This reduction
is termed as depletion.
Amortisation  The term ‘Amortisation’ is used with regard to ‘Intangible Assets’.
 Amortisation refers to writing off the cost of intangible assets like patents, copyright,
trademarks, franchises, etc.
Obsolescence  It refers to a decline in the value of assets due to innovation or improved techniques,
changes in the taste or fashion of the existing asset.

Features of Depreciation

- Depreciation is a decrease in the book value of fixed assets.

- Depreciation involves loss of value of assets due to the passage of time and
obsolescence.
- Depreciation is an ongoing process until the end of the life of assets.

Causes of Depreciation
- Wear and Tear due to Use or Passage of Time: Wear and tear is nothing
but deterioration and the following decrease in the value of an asset,
resulting from its use in business operations for earning revenue.
- Expiration of Legal Rights: Some categories of assets lose their value after
the agreement directing their use in business comes to an end after the
expiry of the predetermined period.
- Obsolescence: Obsolescence is another factor driving to the depreciation
of fixed assets. In common language, obsolescence means being “out-of-
date”. Obsolescence refers to an actual asset becoming outdated on account
of the availability of a better type of asset.
- Abnormal Factors: Drop in the use of the asset may be caused by abnormal
factors. Namely, accidents due to the earthquake, fire, floods, etc.,
Accidental loss is permanent but not continuing.
Methods of recording depreciation
1. By charging to asset A/C
- depreciation is directly credited to the respective asset A/C
- Respective asset account appears at its BOOK VALUE (ORIGINAL COST –
DEPRECIATION TILL DATE); PROFIT = SALES PROCEEDS – BV AS ON
DATE OF SALE; LOSS= BV AS ON DATE OF SALE – SALES PROCEEDS
- In exchange of an asset sale, sales proceeds imply the trade in allowance
- In case of an damage of an unsecured asset by fire/ accident, sales proceed imply
claim admitted by insurance co. together with salvage value (if any).
2. By creating a provision for depreciation/ accumulated depreciation A/C

Asset value includes freight & In transit insurance, import duties and other non-
refundable taxes, cartage and carriage expenses, site preparation costs,
installation costs, professional fees of architect & designs, expenses on tests runs
and experimental production.
Methods of calculating depreciation charge
1. Straight Line Method (SLM) equal amount of depreciation every year.
Depreciation = (Asset Cost- estimated disposal value)/ Number of expected
years of use
Asset Cost = 30000, Estimated disposal/ residual/ salvage value = 5000, n= 5
year
MV = (30000-5000)/5
Depreciation = ₹5000 each year
Cost = 30000, Estimated disposal value = 0, n= 5 year
MV = (30000- 0)/5
Depreciation = ₹6000
2. Reducing value method/ Written down value method: Depreciation rate @
10%p.a., n= 3years, Cost = 30000, residual value = 5000
Year 1 30000
(-)Depr@10% 3000
Year 2 27000
(-) Depr @10% 2700
Year 3 24300
(-) depr@10% 2430
21870
Residual value 21870- 5000= ₹16870

Rate of depreciation = 𝒏𝑺𝒒 𝑹𝒕(S/C)

Example 1. A business has just bought a machine for £8,000. It will be kept in
use for four years, when it will be disposed of for an estimated amount of £500.
The accountant has asked you to prepare a comparison of the amounts charged as
depreciation using both methods.
4sq rt(500/8000)

R= 60%

Other methods of depreciation

Revaluation Method

When there are a few expensive non-current assets, it is not difficult to draw up
the necessary accounts for depreciation. For each item we:
a) Find its cost.
b) Estimate its years of use to the business.
c) Calculate and provide depreciation.
d) Make the adjustments when the asset is disposed of.
e) Calculate profit or loss on disposal.

Depreciation to fixed Assets

1. Rate of depreciation p.a. DOA given then according to the beginning of

DOA till ending for the accounting period.
DOA is NOT given than charge half year depreciation

2. When flat rate of depreciation is given without p.a. then charge full
accounting period depreciation irrespective of DOA.
Example

Illustration 2
Asset cost: ₹600000
Sales proceeds: ₹450000
(in ₹)
Particula Case A DOS B DOS 30.9.14 C DOS 31.3.15 D DOS30.9.14
rs 31.3.15
DOP 1.4.12 1.4.12 1.7.12 1.7.12
Total 600000 600000 600000 600000
Machine
cost
Less: (600000*10/10 (600000*10/100*3 (600000*10/100*33/ (600000*10/100*2
Depreciati 0*3) = 180000 0/12) = 150000 12)= 165000 7/12) = 135000
on
Book 420000 450000 435000 465000
value as
on date of
sale
Less: 450000 450000 450000 450000
Sales
proceeds
Profit/ 30000 0 15000 (15000)
loss on
sale

Illustration 5
Machinery A/C (In ₹)
Date Particular Amount Date Particular Amount
2011 To Bank (Machine 128,000 2012 By Depreciation A/C 24000
Oct 1 1) March (240000*20/100*6/12)
To Bank 64000 31 By Bal c/d 216000
(expenses)
To bank 48000
(Expenses)
240000 216000
2012 To Bal b/d 216000 2013 By Depreciation
April 1 To Bank (Machine 80000 March Machine 1 48000
2) 31 (240000*20/100)
Machine 2 (80000*20/100) 16000

By Bal c/d
Machine 1 (216000-48000) 168000
Machine 2 (80000-16000) 64000
296000 296000
2013 To Bal b/d 2013 By Bank 27840
April 1 Machine 1 168000 Oct 1 By depreciation
Machine 2 64000 Machine sold
(240000*20/100*1/3*6/12) 8000
October 1 To Bank (Machine 40000 By P/L A/C (loss on sale) 20160
3) By depreciation
Machine 1 32000
Machine2 16000
Machine 3 4000

By Bal c/d
Machine 1 80000
Machine 2 48000
Machine 3 36000

272000 272000

Working notes:
₹
A. Original cost 240000*1/3 80000
B. Less: depreciation till DOS from DOP 32000
(240000*20/100*1/3*2)
C. Book value as on DOS (A-B) 48000
D. Less: sales proceeds 27840
E. Profit/ loss on sale (20160)