Depreciation

Depreciation is defined as the expensing of the cost of an asset involved in producing revenues
throughout its useful life.

Continuous decrease in the value of fixed assets due to its usage or wear and tear. Depreciation expense
also affects net income.

Wear and tear. Any asset will gradually break down over a certain usage period, as parts wear out and
need to be replaced. Eventually, the asset can no longer be repaired, and must be disposed of. This
cause is most common for production equipment, which typically has a manufacturer's recommended
life span that is based on a certain number of units produced. Other assets, such as buildings, can be
repaired and upgraded for long periods of time.

Method of Depreciation

Straight Line Depreciation/Original Cost Method/Fixed Installment Method

Straight line depreciation is the simplest way to calculate an asset’s loss of value (or depreciation) over
time. It is used for bookkeeping purposes to spread the cost of an asset evenly over multiple years. It
can also be used to calculate income tax deductions, but only for some assets, like nonresidential
property, patents and software.

The straight-line method of depreciation is the easiest to calculate, and consists of depreciating the
value of an asset in equal installments over the cost of its useful life. In this Straight Line method, each
year on every asset an equal amount of money is provided for depreciation until the asset is reduced to
nil or its scrap value at the end of the estimated life of the asset. This method is Not suitable for assets
like machinery where the benefits obtained from using the assets in each period are not of fixed
amounts.

Annual depreciation expense =

(Cost of fixed asset – Scrape value) / Estimated useful life

 Cost of the asset – The total cost of the item including taxes, shipping, installment etc.
 Estimated salvage/scrape value of the asset – How much you’ll sell it for once you’re done using
it
 Estimated useful life of the asset – The amount of time you’ll use it, typically in years

For example

Computer value is 1200 its salvage or scrape value is 200 and useful life 5 years.

Annual depreciation expense =

(Cost of fixed asset – Salvage/Scrape value) / Estimated useful life

Computer Annual Depreciation Expense Calculation:

(1200 – 200) / 5 = 200 per year

Practice question

A machine asset having a useful life of 3 years is purchased on 1 January 2013.Cost of the asset is
Rs.2,000 whereas its residual value/Scrape value is expected to be Rs500.Calculate depreciation up to 2
years . Accounts closed on every 31st December.

2.Declining balance depreciation/Diminishing balance method/written down

balance Method.
The Diminishing Balance Method is also known as Reducing Installment Method or Written Down Value
Method or Declining Balance Method. In this method, The depreciation is calculated at a certain
percentage each year on the value of the asset which is brought forward from the previous year.

The declining balance method calculates more depreciation expense initially, and uses a percentage of
the asset's current book value, as opposed to its initial cost. In this method, The depreciation charges in
the initial periods or at the beginning period is higher than those in the later period. i.e the depreciation
in the initial periods is higher when compared to that of the later periods like after 5 years or 10 years
although the depreciation rate is fixed over the years and don’t change.This method is usually adopted
for the assets of plant and machinery.
Practice Question

Q1. ABC purchased a machinery for Rs. 70,000 on 1 st July, 2001. They spend Rs. 10,000 on its installation.
Prepare the machinery Account for the four years under both
  Fixed / straight line Method
 Diminishing/Reducing/Decreasing Balance Method

Assumed that accounts closed every year 31 st December @ 10% P.a

Deprecation ( Machinery A/C)

Fixed /Straight Line

Date Details Rs Date Details Rs

1/7/2001 Bank/cash 80,000 31/12/2001 Depreciation 4000
(70,000+10000 (80,000*10%*6/12)
)
Balance C/d (80000- 76000
4000)
80,000 80,000
1/1/2002 Balance B/d 76000 31/12/2002 Dep(80,000*10%*12/12 8000
)
Bal C/d 68000
76000 76000
1/1/2003 Bal b/d 68000 31/12/2003 Dep(80,000*10%*12/12 8000
)
Bal C/d 60000
68000 68000
1/1/2004 Bal b/d 60000 31/12/2004 Dep 8000
(80,000*10%*12/12)
Bal C/d 52000
60000 60000

Deprecation ( Machinery A/C)

Reducing Balance Method

Date Details Rs Date Details Rs

1/7/2001 Bank/cash 80,000 31/12/2001 Depreciation 4000
(70,000+10000 (80,000*10%*6/12)
)
Balance C/d (80000- 76000
4000)
80,000 80,000
1/1/2002 Balance B/d 76000 31/12/2002 Dep(76,000*10%*12/12 7600
)
Bal C/d 68,400
76000 76000
1/1/2003 Bal b/d 68,400 31/12/2003 Dep(68400*10%*12/12) 6840
 Bal C/d 61,560
68000 68000
1/1/2004 Bal b/d 61,560 31/12/2004 Dep 6156
(61,560*10%*12/12)
Bal C/d 55404
61560 61560

Q2.X and Co purchased a machinery for Rs. 70,000 on 1 st jan, 2001. They spend Rs. 8000 on its
installation. In the same year Company purchased another machine on 1 st july, 2001 for Rs 30000 and
spent 2000 on its installation . Prepare the machinery Account for the three years under both

 Fixed / straight line Method

 Diminishing/Reducing/Decreasing Balance Method

Assumed that accounts closed every year 31 st December @ 10%

Q3.Ahmed purchased a machinery for Rs. 20,000 on 1st july, 2015. They spend Rs. 5000 on its
installation. Company purchased another machine on 1 st july, 2017 for Rs 40000 . Prepare the machinery
Account for the Four years under both

1. Fixed / straight line Method

2. Diminishing/Reducing/Decreasing Balance Method

Assumed that accounts closed every year 31st December @ 15%

Q.4 Yasir purchased a machinery for Rs. 25,000 on 1st july, 2016. They spend Rs. 5000 on its installation.
Company purchased another machine on 31 st Aug, 2018 for Rs 50000 and spent 2000 on its
transportation . Prepare the machinery Account for the Four years under both

1. Fixed / straight line Method

2. Diminishing/Reducing/Decreasing Balance Method

Assumed that accounts closed every year 31st December @ 10%