Accounting For Depreciation

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Learning Objectives: 1. Define and explain the term "depreciation". 2. Why does depreciation calculated and charged? 3. What are the different methods for providing depreciation? Definition and Explanation of Depreciation: The value of assets gradually reduces on account of use. Such reduction in value is known as depreciation. Different authors have given different definitions of depreciation. Click here to read full article. Causes of Depreciation: The main causes of depreciation may be divided into two categories, namely:

1. Internal Cause and 2. External Causes Click here to read full article.
Need for Depreciation: Depreciation is a loss. So Unless it is considered like all other expenses and losses, true profit or loss cannot be ascertained. In other words, depreciation must be considered in order to find out true profit or loss of a business. Click here to read full article. Depreciation, Depletion and Amortization: The term depreciation is used with reference to tangible fixed assets because the permanent continuing and gradual fall in book value is possible only in the case of fixed asset. Click here to read full article. Difference Between Depreciation and Fluctuation: Depreciation of asset and fluctuation in its market value are not the same. For example, a businessman purchase a machine the life of which is estimated at 10 years and charges depreciation accordingly each year. If for certain reasons the market value of the machine decreases by say 20%, the businessman need not consider this decrease at all. Click here to read full article. Basic Factors of Determination of Depreciation: Read about the basic factors for the calculation of depreciation. Click here. Depreciation Methods / Methods for Providing Depreciation: Fixed assets differ from each other in their nature so widely that the same depreciation methods cannot be applied to each. Click here to read full article. Fixed Installment Method / Straight Line Method / Original Cost Method:

Fixed installment method is also know as straight line method or original cost method. Under this method the expected life of the asset or the period during which a particular asset will render service is the calculated. Click here to read full article. Diminishing balance/written Down Value/Reducing Installment Method of Depreciation: Diminishing balance method is also known as written down value method or reducing installment method. Under this method the asset is depreciated at fixed percentage calculated on the debit balance of the asset which is diminished year after year on account of depreciation. Click here to read full article. Annuity Method of Depreciation: According to this method, the purchase of the asset concerned is considered an investment of capital, earning interest at certain rate. The cost of the asset and also interest thereon are written down annually by equal installments until the book value of the asset is reduced to nil or its bread up value at the end of its effective life. Click here to read full article. Depreciation Fund Method or Sinking Fund Method: Depreciation fund method is also know as sinking fund method or amortization fund method. Under this method, a fund know as depreciation fund or sinking fund is created. Click here to read full article. Insurance Policy Method of Depreciation: Insurance policy method is a slight modification of the depreciation fund method or sinking fund method. Under this method the amount represented by the depreciation fund, instead of being used to buy securities, is paid to an insurance company as premium. The insurance company issues a policy promising to pay a lump sum at the end of the working life of the asset for its replacement. Click here to read full article. Revaluation Method of Depreciation: As the name implies under revaluation method, the assets are valued at the end of each period so that the difference between the old value and the new value, which represents the actual depreciation can be charged against the profit and loss account. Click here to read full article. Sum of the Years' Digits Method of Depreciation: Sum of the Years' Digits Method an accelerated method of depreciation which is also based on the assumption that the loss in the value of the fixed asset will be greater during the earlier years and will go on decreasing gradually with the decrease in the life of such asset. Click here to read full article. Double Declining Balance Method of Depreciation: Double declining balance method is another type of accelerated depreciation method followed generally in USA. The depreciation expense is computed by multiplying the asset cost less accumulated depreciation by twice the straight line rate expressed in percentage. Click here to read full article.

Depletion Method of Depreciation: Depletion method of depreciation is especially suited to mines, quarries, sand pits, etc. According to it the cost of the asset is divided by the total workable deposits. In this way, rate of depreciation per unit of output is ascertained. Depreciation in any particular year is charged on the basis of the output during that year. Click here to read full article. Basis of Use System of Depreciation: One of the chief factors causing depreciation is use. For example in case of plant and machinery, it is the total number of hours for which the machines work is the main factor and not their life. Click here to read full article. Depreciation Of Various Assets: We discuss the problem of depreciating some given assets. Click here to read full article Depreciation Accounting - General Questions and Answers: Find answers of some of the general questions about depreciation. Click here.

Depreciation causes perpetual. Such reduction in the value or utility of asset is called depreciation.such as stock. expired cost or utility of asset is depreciation.. Depreciation occurs till the last day of the estimated working life of the asset. obsolescence or similar causes. Depreciation is charged in case of fixed assets only.g. such as: "Depreciation may be defined as the permanent continuous diminution in the quality. e.g." (By Carter) "Depreciation may be defined as a measure of the exhaustion of the effective life of an asset from any cause during a given period. Explanation and Characteristics of "Depreciation" or "Accounting Depreciation": Learning Objectives: 1." (Northcott & Forsyth) "Depreciation is the diminution in the value of assets owing to wear and tear." (Cropper) From the above definitions. patent. . 6. effluscion of time. Different authors have given different definitions of depreciation." (By Pickles) "Depreciation is the gradual permanent decrease in the value of an asset from any cause. 5. quantity or value on an asset. property.. 3." (By Institute of Cost and Management Accountants.Definition. 4. There is no question of depreciation in case of current assets ." (By Spicer & Pegler) Depreciation is the diminution in intrinsic value of an asset due to use and/or the lapse of time. 2. Depreciation is a charge against revenue of an accounting period. plant and machinery. Define and explain the terms "depreciation" or "accounting depreciation". e. The value of assets gradually reduces on account of use. furniture etc. In certain cases. it follows that an asset gradually declines on account of use and passage of time and this causes permanent reduction in the value and utility of asset. Such reduction in value is known as depreciation. copyright etc. bills receivable etc. depreciation may occur even if the assets are not used. Characteristics of Depreciation: Depreciation has the following characteristics: 1. gradual and continual fall in the value of assets. debtors. Depreciation does not depend on fluctuations in market value of assets (see difference between depreciation and fluctuation page). In other words. building. leasehold. obsolescence or the passage of time. Depreciation occurs on account of use of asset. England) "Depreciation is the reduction in the value of a fixed asset occasioned by physical wear and tear. however.

8. old machine becomes obsolete with the invention of more economical and sophisticated machine whose productive capacity is generally larger and cost of production is therefore less. friction. is known as internal depreciation. quarry etc. For example. erasion etc. External Causes: Depreciation caused by some external reasons is called external depreciation. In certain cases. Physical deterioration of an asset is caused from movement. More and more use of an asset. however. e. Depletion: Some assets declines in value proportionate to the quantum of production. In order to survive in the competitive market the manufacturers must must install new machines replacing the old ones.it has to be estimated. External Causes Internal Causes: Depreciation which occurs for certain inherent normal causes. Other assets like this are building. mine. it may happen that the articles produced by old machine are no longer saleable in the market on account of change of habit and taste of the . may become obsolete. e. it may be ascertained exactly. With the raising of coal from coal mine the total deposit reduces gradually and after sometime it will be fully exhausted. The amount of depreciation of an accounting year cannot be determined precisely . although in proper working order. The wear and tear is general but primary cause of depreciation. The main causes of internal depreciation are: Wear and Tear: Some assets physically deteriorate due to wear and tear in use. plant. Causes of Depreciation: Learning Objectives: 1. patent right. Again. What are the causes of definition? The main causes of depreciation may be divided into two categories. etc. Internal Cause and 2. namely: 1.7. The main external causes are as follows: Obsolescence: Some assets. copyright etc. machinery. strain. Total depreciation of an asset cannot exceed its depreciable value (cost less scrap value).. the greater would be the wear and tear.g. furniture. Then its value will be reduced to nil. leasehold property. An obvious example of this is motor car which rapidly wears out.g.

if depreciation is not taken into account. if the cost of production is shown less by ignoring depreciation. Accident: Assets may be destroyed by abnormal reasons such as fire. irrespective of the the whether the house has been used or not. In such a case the old machine. Need for Depreciation: Learning Objectives: 1. Efflux of Time: Some assets diminish in value on account of sheer passage of time. Its annual depreciation will be $1. the cost f production would be shown less than the true cost. even though they are not used e. The Need for depreciation arises for the following reasons: Ascertainment of True Profit or Loss: Depreciation is a loss. true profit or loss cannot be ascertained. So Unless it is considered like all other expenses and losses. Because with the end of lease after 10 years.000 (10. leasehold property. True Valuation of Assets: Value of assets gradually decreases on account of depreciation. flood etc. Why does the need for calculating and charging depreciation arise. although in good working condition.000/10). . Suppose we take a lease of a house for 10 years for $10. This depreciation must be considered as a part of the cost of production of goods. So. In other words.g. Sales price is fixed normally on the basis of cost of production. the value of asset will be shown in the books at a figure higher than its true value and hence the true financial position of the business will not be disclosed through balance sheet. the house will go out of possession. In such a case the destroyed asset must be written off as loss and a new one purchased. earthquake. Otherwise.000. the sale price will also be fixed at low level resulting in a loss to the business.. patent right. depreciation must be considered in order to into out true profit or loss of a business.people. copyright etc. must be discarded and the new one purchased. Ascertainment of True Cost of Production: Goods are produced with the help of plant and machinery which incurs depreciation in the process of production.

The process of their writing off is called amortization. Difference Between Depreciation and Fluctuation: Learning Objectives: 1. and amortization. the business will become weak and its profit earning capacity will also fall. profit will be shown more.Replacement of Assets: After sometime an asset will be completely exhausted on account of use. What is the difference among depreciation. This is contrary to sound commerce policy. If the whole amount of profit is withdrawal from business each year without considering the loss on account of depreciation. . If loss on account of depreciation is not considered in determining profit or loss at the year end. depletion. oil wells. copyrights. If the excess profit is withdrawal. Amortization The term amortization is used in respect of intangible assets like patents. gradually diminishes on account of depreciation. Keeping Capital Intact: Capital invested in buying an asset. written off. In such a case the required money is to be collected by introducing fresh capital or by obtaining loan or by selling some other assets. timber trees etc. Depletion and Amortization: Learning Objectives: 1. leasehold and goodwill which are recorded at cost. the working capital will gradually reduce. A new asset must then be purchased requiring a large sum of money. necessary sum may not be available for buying the new asset. What is the difference between depreciation and fluctuation?. Depreciation. Depreciation: The term depreciation is used with reference to tangible fixed assets because the permanent continuing and gradual fall in book value is possible only in the case of fixed asset. therefore. Depletion: The term depletion is used for the depreciation of wasting assets such as mines. Some intangible assets have limited useful life and are.

Depreciation of asset and fluctuation in its market value are not the same. So the business will ignore the fall in market price. But depreciation cannot be ignored . . Fluctuation 1. a businessman purchase a machine the life of which is estimated at 10 years and charges depreciation accordingly each year. The estimated residual or scrap value at the end of its life. Thus we see that there is no relationship between depreciation and fluctuation. while decrease means loss. The estimated working life of the asset or the number of years the asset is expected to last. The amount to be spent periodically for repairs and renewals. It is a regular loss . If the repairs necessary to keep the asset in a proper state of efficiency are regularly carried out. Generally it is not taken into account. Basic Factors of Determination of Depreciation: Learning Objectives: 1. 5. unless he sells the machine. It does not reduce productive capacity or utility of asset. It is generally irregular.it will be used permanently in the business. It is the value which the asset will fetch when discarded as useless. It reduces value of asset gradually. It may not occur 3.it must be considered. Increase in market value means profit. But the machine is not intended for sale . in case of current assets permanent fall in price is considered. 4. 2. What are the basic factors of depreciation determination? For calculation depreciation the basic factors are: 1. 4.it must be charged throughout the working life of asset. 6. It always indicates loss 6. It may indicate either profit or loss. The value of asset may arise or fall on account of fluctuation. It reduces productive capacity or utility of asset. the businessman need not consider this decrease at all. 4. 2. 5. However. Loss by way of depreciation must be considered. It must occur 3. 3. The points of difference between depreciation and fluctuation are stated below in a tabular form: Depreciation 1. 2. The original cost of the asset. For example. Because the productive capacity or the utility of the machine to the businessman has not been reduced on account of fall in its market value. So he will not have to suffer any loss. the life of the asset is prolonged and the amount of annual depreciation is proportionately lowered. If for certain reasons the market value of the machine decreases by say 20%.

8. Insurance policy method. 6. . 9. it is easy to access the rate of depreciation. The basis of use system. 5. higher depreciation should be written off such an asset. 7. The following methods have therefore been evolved for depreciating various assets: 1. 3. Diminishing Balance Method or Written down value method or Reducing Installment method. 10. Sum of the year's digits method (SYD). Revaluation method. Annuity Method. 2. Depreciation Methods: Learning Objectives: 1. If there are great chances of improvements being made in a particular asset on account of inventions. Usually engineers and experts give their opinion about these and they are accepted by businessmen. Depreciation fund method or Sinking fund amortization fund method. After getting information on all these points. Depletion method.5. The possibility of the asset becoming obsolete. Fixed installment or Straight line or Original cost method. 4. Double declining balance method. What are the various methods for depreciation? Fixed assets differ from each other in their nature so widely that the same depreciation methods cannot be applied to each.

Scrap Value)/Estimated Life of Machinery] Journal Entries: The journal entries that will have to be made under this method are very simple. Formula: The following formula or equation is used to calculate depreciation under this method: Annual Depreciation = [(Cost of Assets . What are the advantages and disadvantages of of using this method? Fixed installment method is also know as straight line method or original cost method. Define. The cost of the asset less scrap value. Under this method the expected life of the asset or the period during which a particular asset will render service is the calculated. it would be a straight line. if any. The amount chargeable in respect of depreciation under this method remains constant from year to year. The journal entries will be as under: 1. 2. Depreciation account .Fixed Installment Method or Straight Line Method or Original Cost Method of Depreciation: Learning Objectives: 1. This method is also know as straight line method because if a graph of the amounts of annual depreciation is drawn. explain and give example of fixed installment or straight line or original cost method. at the end f its expected life is divided by the number of years of its expected life and each year a fixed amount is charged in accounts as depreciation.

000. After it its break up value will be $1. The book value of the asset can be reduced to zero. 2. patents. the scrap will be sold and with the amount that realised by the sale the following entry will be passed: 3. short leases etc. Example: On 1st January 1991 X purchased a machinery for $21. it is generally applied in case of those assets which have small value or which do not require many repairs and renewals for example copyright. The result is that the profit and loss account has to bear a light burden in the initial years of the asset but later on this burden becomes heavier. Disadvantages: 1. Calculate the amount of annual depreciation according to fixed installment method (straight line method or original cost method) and prepare the machinery account for the first three years. 3. No provision for the replacement of the asset is made. This method. Scope of Application: On account of the above mentioned advantages and disadvantages of fixed installment method. Difficulty is faced in calculation of depreciation on additions made during the year.) Advantages: 1. in spit of its being simplest is not very popular because of the fact that whereas each year's depreciation charge is equal. Fixed installment method of depreciation is simple and easy to work out 2. 4. Interest on money is locked up in the asset is not taken into account as is done in some other methods. The estimated life of the machine is 10 years. the charge for repairs and renewals goes on increasing as the asset becomes older.To Asset account (Being the depreciation of the asset) 2. In the last year. Cash account To Asset account (Being the sale price of scrap realised. Machinery Account Debit Side $ Credit Side $ . Profit and loss account To Depreciation account (Being the amount of depreciation charged to Profit and Loss account) These entries will be passed at the end of each year so long as the asset lasts.000 only.

000 15.000 17. Advantages of Diminishing Balance Method: 1.000 17. Journal Entries: The entries in this case will be identical to those discussed in the case of the fixed installment method.000 1991 Dec. 31 By Depreciation account By Balance c/d 2. Define. 1 To Bank account 21. 31 By Depreciation account 2.000 15. 31 1991 Dec.000 21.000 19.000 17. Under this method the asset is depreciated at fixed percentage calculated on the debit balance of the asset which is diminished year after year on account of depreciation.000 21. 31 By Depreciation account By Balance c/d 2. Only the amount will be differently calculated.000 1992 Jan. The strongest point in favor of this method is that under it the total burden imposed on profit an loss account due to depreciation and repairs remains more or less equal year after year since the amount after depreciation goes on diminishing with the passage of time whereas the amount of repairs goes on increasing an asset grow older.1991 Jan. 31 1991 Dec.000 1991 Dec. explain and give example of the diminishing balance method/written down value method/reducing installment method? 2. 31 1991 Dec. 1 To Balance b/d 19. What are advantages and disadvantages of diminishing balance method? Definition and Explanation: Diminishing balance method is also known as written down value method or reducing installment method.000 Diminishing Balance Method of Depreciation: Learning Objectives: 1. 1 To Balance b/d 17.000 15.000 1993 Jan. .000 1991 Dec.

000 20.000* 20. a merchant purchased plant and machinery costing $25. Example: On 1st January. 1 To Balance b/d 16. 31 " By Depreciation By Balance c/d 4. Written down value method or reducing installment method does not suit the case of lease.200*** 12. 1994.000 .000 1996 Dec. 1 To Balance b/d 20.000 To Cash 25. Separate calculations are unnecessary for additions and extensions. Plant and Machinery Account Debit Side Date 1994 Jan. This method cannot reduce the book value of an asset to zero if it is desired.000 25. on the diminishing balance method (written down value method).a. whose value has to be reduced to zero.000** 16.000 1995 Jan.000 By Balance c/d 16. 1 Credit Side $ Date 1994 Dec.2. It has been decided to depreciate it at the rate if 20 percent p. Disadvantages of Diminishing Balance method: 1. 31 " $ By Depreciation By Balance c/d 5. 3.000.000 1995 Dec. the asset. Very high rate of depreciation would have to be adopted other wise it will take a very long time to write an asset down to its residual value Scope of Application: Diminishing balance method of depreciation is most suited to plant and machinery where additions and extensions take place so often and where the question of repairs is also very important.000 20. 31 By Depreciation 3.000 1996 Jan. This method ignores the question of interest on capital invested in the asset and the replacement of 2.000 25. though in the first year some complications usually arise on account of the fact that additions are generally made in the middle of the year.800 16. Show the plant and machinery account in the first three years.

The annual charge for depreciation will be credited to asset account and debited to depreciation account.5000) × 20% = 4. The annual charge to be made by way of depreciation is found out from annuity tables. Journal Entries: Under annuity method. What is annuity method of depreciation? Where is it adopted? According to this method. The entry that is passed: 1.000 ***Third Year: [25000 . at the given rate. while the interest will be debited to asset account and credited to interest account. the purchase of the asset concerned is considered an investment of capital.000)] × 20% = 3. The cost of the asset and also interest thereon are written down annually by equal installments until the book value of the asset is reduced to nil or its bread up value at the end of its effective life.000 × 20% = 5000 **Second Year: (25000 .000 + 4. journal entries have to be made in respect of interest and depreciation. the following entry is passed: . Asset account To Interest account (Being interest on capital sunk in asset) With regard to depreciation the amount found out from the depreciation annuity table.(5. it has to be calculated on the debit balance of the asset account at the commencement of the period.200 Annuity Method of Depreciation: Learning Objectives: 1. As regards interest. earning interest at certain rate.Formula or equation for the depreciation calculation may be written as follows: *First year: 25.

1 Dec.142456 3.000 Credit Side $ . Example: A firm purchased a 5 years' lease for $40.148528 4. the annual charge for depreciation reckoning interest at 5 percent p. Presuming the rate of interest to be 5% per annum. would be: 230975 × 40.193878 0.359634 0.218355 0.000 on first January. Annuity Table Amount required to write off $1 by the annuity method. 31 To Cash To Interest 40.239 Lease Account Debit Side Date 1st Year Jan.278744 0.000 = $9.160 34.363773 0. 31 By Depreciation By Balance c/d 9.269027 0.163544 0.172820 0. 1 Dec.367209 0.224627 0.5% 0.399 $ Date 1st Year Dec.169701 0.230975 0.239 32. Years 3 4 5 6 7 8 3% 0.2. But the amount of depreciation remains the same during the life time of the asset. 31 To Balance b/d To Interest 32.761 42.197017 0.638 34. Calculations are to be made to the nearest dollar.353530 0.221418 0.761 1.282012 0.187668 0.a.000 2nd Year Jan.190762 0.272251 0.184598 0.360349 0. Depreciation account To Asset account (Being the depreciation of asset) It should be remembered that the interest is charged on the diminishing balance of the asset account.166610 0.227792 0.154722 Solution: According to the annuity table given above.000 42.160506 0.5% 0.275490 0.399 2nd Year Dec. the amount of interest goes on declining year after year.239 25.145477 4% 0. 31 By Depreciation By Balance c/d 9. Show the lease account for the first 3 years.000 2. It decides to write off depreciation on the annuity method.151610 5% 0.

2.170 Dec.239 17.3rd Year Jan. Disadvantages: 1. 31 To Balance b/d To Interest 25. This method takes interest on capital invested in the asset into account. which is very inconvenient.160 1. the calculation have to be changed frequently. When the asset requires frequent additions and extensions.418 Advantages: 1. It is regarded as most exact and precise from the point of view of calculations. Scope of Application: This method is best suited to those assets which require considerable investment and which do not call for frequent additions e.g. The amount of interest credited goes on diminishing as years pass by.179 26. a fund know as depreciation fund or sinking fund is created. What are its advantages and disadvantages? Definition and Explanation: Depreciation fund method is also know as sinking fund method or amortization fund method. 3. Under this method. The system is complicated. and is therefore most scientific. long lease. 1 Dec. Depreciation Fund Method or Sinking Fund Method of Depreciation: Learning Objectives: 1. 2. What is depreciation fund method or sinking fund method of depreciation? 2. 1 To Balance b/d 17.418 3rd Year Jan. The burden on profit and loss account goes on increasing with the passage of time whereas the amount of depreciation charged each year remains constant. Each year the profit and loss account is debited and the fund account credited with a sum. 31 By Depreciation By Balance c/d 9.258 26. which is so calculated that the annual sum . the ultimate consequence being that the net burden on profit and loss account grows heavier each year..

180975 0.130506 0.186481 0. In subsequent years. (2).323540 0. Years 3 4 5 6 7 8 3% 0. (c).233741 0. Also debit depreciation fund investment account and credit cash account with an equal amount.104722 .318773 0. (a).152668 0.182792 0.112446 3. Transfer any profit or loss on sale of investment to profit and loss account. The amount of annual depreciation to be provided for by the depreciation fund method will be ascertained from sinking fund table.239027 0.320349 0. Debit cash account and credit depreciation fund investment account with the amount realized by the sale of investment. Debit depreciation fund investment account and credit depreciation fund account with the amount of interest earned and reinvested. On replacement of asset. Debit depreciation fund account and credit the account of the old asset which has become useless.5% 0.5% 0. (1).credited to the fund account and accumulating throughout the life of the asset may be equal to the amount which would be required to replace the old asset.128544 0. (b).154598 0.235490 0. Sinking Fund Table Annual sinking fund installment to provide $1. (2).108528 4. (1).147017 0.232012 0.126610 0. (2).106610 5% 0.124701 0.321934 0.110477 4% 0. Debit the new asset purchased and credit cash account. (3).184627 0. First year (at the end) (1).122820 0. (3). The asset appears in the balance sheet year after year at its original cost while depreciation fund account appears on the liability side. Journal Entries: The following entries are necessary to record the depreciation and replacement of an asset by this method. In order that ready funds may be available at the time of replacement of the asset an amount equal to that credited to the fund account is invested outside the business.317208 0. Debit profit and loss account and credit depreciation fund account with the amount of the annual depreciation charge.150762 0. generally in gilt-edged securities.237251 0. Debit profit and loss account and credit depreciation fund account with the annual depreciation installment.148878 0. Debit depreciation fund investment account and credit cash account with an equal amount. (4).188350 0.

35. 1 Dec.80 i.000 14702. 1 Dec.99 384.80 14702. for $20.709.80 188.709.490 × 20.000 and it is decided to make provision for the replacement of the lease by means of a depreciation fund. the investment yielding 4 percent per annum interest. 31 " 9607.000 will be necessary.11 1992 Jan.1 To Cash 20.99 4.80 20.99 By P & L account 4.000 an annual investment of $4.80 9607.99 1992 Dec.490 is necessary. 31 By Balance b/d By Depreciation fund investment By P & L 20. 31 To Balance c/d 9607.Example: On 1st January. 2. 31 To Lease account 20. 31 To Balance c/d 1991 Dec. 31 To Balance c/d 14702.e. Therefore.000 By Balance b/d By Depreciation fund investment By P & L account 9607. Solution: To get $1 at the end of 4 years at 4 percent an annual investment of $2.11 588.80 1990 Dec.000 1990 Dec.11 By Balance c/d By Depreciation fund investment By P&L account 4709.709. 1990 a four years lease was purchased for $20.709.35. 31 1991 Jan..000 Depreciation Fund Account 1990 Dec.11 1993 Dec. 1 Dec. Lease Account 1990 Jan.000 1993 Jan. Show the necessary ledger account. 31 " 14702.39 4709. 31 By Depreciation fund 20.80 Depreciation Fund Account .9 4.32 4709.

000. Advantages of Depreciation Fund Method Or Sinking Fund Method: The most important advantages of this method is that it makes available a sum of money for the replacement of the asset.702. 3.80 20. 2.000 Note: The cash installment at the end of the last year will not be invested because there is no point in buying the investment and selling them on the same date.80 1991 Dec.80 9.702. Disadvantages of the Depreciation Fund Method Or Sinking Fund Method: 1. The burden on profit and loss account goes on increasing as years pass by since the amount of depreciation every year remains same but the amount spent on repairs goes on increasing as the asset becomes old. 31 Dec. If separate provision was not made. 1 Dec. 31 By Cash 20.99 384. 31 14.9 4709. 31 By Balance c/d 4709. Scope of Application: This method is found suitable wherever it is desired not only to charge depreciation but also to replace the asset as happens in the case of plant and machinery and other wasting assets.80 188.607.11 588.99 1992 Jan.607. 31 Dec.11 1993 Jan. 1 Dec. 31 To Balance b/d To Depreciation fund To Cash 9. . 31 Dec.00 20.80 1991 Jan.32 4709. 31 To Cash 4709. 31 By Balance c/d 9. 31 By Balance c/d 14.99 1992 Dec. 31 To Balance b/d To Depreciation fund To Cash 4709. which has become useless. 1 Dec.000 1993 Dec. the sum required to purchase the new asset will have to be drawn from the business which might effect the financial position of the concern adversely.80 1990 Dec.607.709.607. Prices of securities may fall at the time when they are to be realized as a result of which loss may have to be suffered.1990 Dec. It can also be said that the work of investing money is complicated.99 9.39 4.

the entry being. while disadvantage lies that the interest received on the premiums paid is comparatively very low. is paid to an insurance company as premium. The advantage of insurance policy method is that risk of loss on the sale of investment and the trouble and expense of buying investment are avoided. To Depreciation fund account (Being the policy amount realized) The asset account will have been shown throughout at its original cost. The insurance company issues a policy promising to pay a lump sum at the end of the working life of the asset for its replacement. Definition and Explanation: Insurance policy method is a slight modification of the depreciation fund method or sinking fund method. When insurance policy method is employed the policy account will take the place of the depreciation fund investment account and no interest will be received at the end of each year. In the beginning: Depreciation insurance policy account To Cash account (Being the payment of premium on depreciation policy) 2. The entry is: Cash account 3.Insurance Policy Method of Depreciation: Learning Objectives: 1.e. To Depreciation insurance policy account (Being the policy amount realized) The depreciation insurance policy account will show some profit.. to say the amount of the policy will be received. Define and explain the insurance policy method of depreciation. This will be transferred to depreciation fund account. instead of being used to buy securities. Depreciation insurance policy account 4. but the total interest on the premiums will be received when the policy matures. Entries: Every years two entries will be made: 1. It now be written off by transfer to . At the end of the year: Profit and loss account To Depreciation fund account (Being the amount of depreciation charged to profit and loss account) When the policy will mature i. Under this method the amount represented by the depreciation fund.

400 Cr. To Asset account Insurance Policy Method Example: On 1st January.400 6. Side 1991 Dec.400 800 20.000 By Leasehold 12. Side 1990 Jan. 31 To Balance c/d 12.400 Cr. 31 loss a/c Jan. Side . 31 By Profit and loss a/c 6.000 1992 By Balance b/d By Profit and Dec.400 1990 Dec.400 1990 Dec.400 12. Solution: Leasehold Account Dr.000 1990 Dec. 31 To Balance c/d 6. 1 " 20. 31 By Depreciation fund 20.800 12.000 Cr. Show the ledger accounts dealing with this matter.800 1992 Dec. Side 1990 Dec.800 6. 31 To Cash 6. 31 By Balance c/d 6. Side Depreciation Fund Account Dr. 1 To Cash 20.800 By Balance b/d By Profit and Dec.000 and it is decided to make a provision for replacement of the lease by means o an insurance policy purchased for annual premium.depreciation fund account. 31 To Leasehold Property 20. 1990 a business purchases a three year lease of premises for $20. Side 1990 Dec. 31 loss a/c Jan. 1 6.000 Leasehold Policy Account Dr. The entry is: Depreciation fund account 5.

Firstly.1991 Jan. 31 To Cash 6. packages.400 6. 1 To Balance b/d Dec. which represents the actual depreciation can be charged against the profit and loss account.400 800 20. This method is mostly used in case of assets like bottles. casks etc. the method do not specify as to which is the value that the experts are to estimate at the end of each year. the assets are valued at the end of each period so that the difference between the old value and the new value. .400 12. It however appears that this is the market value.800 6. 2. Revaluation method is open to various objections. When and where this method is used? As the name implies under revaluation method. On rare occasions when on revaluation the value of an asset is found to have increased. If so.800 To Balance b/d To Cash 12.000 1991 Dec. because there are great chance of manipulations. Define and explain the revaluation method of depreciation. loose tools. 31 By Balance c/d 12.000 Revaluation Method of Depreciation: Learning Objectives: 1. A fixed asset has nothing to do with market value.000 20. the charge against profit and loss account on account of depreciation will vary year to year through the asset renders the same service throughout of its life time. to assess depreciation with reference to market value is against the basic principles and theory of depreciation. this method is unscientific. Thirdly. it being of temporary nature not taken into account.800 By Cash 20. horses. Secondly.800 12.

+ n For example if the useful life of an asset is 5 years. we have: 5(5 + 1) = 2 2 30 = 15 The yearly depreciation is then calculated by multiplying the total depreciable amount for the life of the asset by a fraction whose numerator is the remaining useful life and whose denominator is the SYD. purchased a truck for $65.. . and totaling these numbers. Calculate the annual depreciation expense by applying sum-of-the-years' digits (SYD) method. For n years: SYD = 1 + 2 + 3 + 4 + . Thus in our example the calculation would: First year depreciation Second year depreciation Third year depreciation Fourth year depreciation Fifth year depreciation = = = = = 5/15 4/15 3/15 2/15 1/15 × × × × × Depreciation Depreciation Depreciation Depreciation Depreciation cost cost cost cost cost The formula for depreciation for this method is: Depreciation = Depreciation cost × (Remaining useful life/SYD) Example: ABC Ltd.000 on 1st January 1991. For these assets the formula n (n + 1) / 2 where n = the number of periods in the asset's useful life can be applied to derive the SYD..000...Sum of the Years' Digits Method of Depreciation: Learning Objectives: 1.. The SYD is found by estimating an asset's useful life in years. the SYD would be 1 + 2 + 3 + 4 + 5 = 15. Definition and Explanation: Sum of the Years' Digits Method an accelerated method of depreciation which is also based on the assumption that the loss in the value of the fixed asset will be greater during the earlier years and will go on decreasing gradually with the decrease in the life of such asset. then assessing consecutive numbers to each year. Determining the SYD factor by simple addition can be somewhat laborious for long-lived assets. Explain the sum of the years' digits method of depreciation. In our example. The expected life was 5 years and salvage value $5.

000 65.000 65.000 60.000 Accumulated depreciation 1. 2.000 60.000 6.000 58.000 .000 4.000 60.000 65.000 60.5. Double declining balance method is another type of accelerated depreciation method followed generally in USA.000 SYD = 1 + 2 + 3 + 4 + 5 = 15 The annual depreciation is: First year depreciation Second year depreciation Third year depreciation Fourth year depreciation Fifth year depreciation Total = = = = = 5/15 4/15 3/15 2/15 1/15 × × × × × 60.000 4.000 8. . No provision is made for salvage value of the asset.000 4.000 8.000 60.Solution: Amount to be written of = $65. 6.000 42.000 = = = = = 20.000 60.000 13.000 Book value 55.000 60.000 5.000 8. Using the data in the above example suppose the truck is purchased on 30thJune 1991.000 16. The depreciation expense is computed by multiplying the asset cost less accumulated depreciation by twice the straight line rate expressed in percentage.000 37.000 2.000 60.000 = 60.000 28.000 65.000 23.000 60.000 Years' fraction 5/15 (1/2) Years' depreciation 10. the depreciation expense may be determined by dividing the fractional multipliers between the current and succeeding year.000 60.000 6.000 60. the SYD approach is most appropriate for those situations in which the asset is judged to render greater utility during its earlier life and less in its later life.000 7. 3. Double Declining Balance Method of Depreciation: Learning Objectives: 1.000 60.000 52.000 12.000 65.000 When the asset is acquired during the year. Define and explain the double declining balance method of depreciation. Depreciable cost 60.000 10.000 Cost 65.000 60.000 60.000 ] ] ] 5/15 (1/2) 4/15 (1/2) 4/15 3/15 3/15 2/15 2/15 1/15 (1/2) (1/2) (1/2) (1/2) (1/2) (1/2) 1/15 (1/2) Scope of the Sum of Years' Digits Method (SYD): As an accelerated depreciation method.000 2. 4.000 60. the depreciation is computed as follows: End of the year 1. 5.

Double declining balance rate is found by using the following formula: Double Declining Balance Rate = (100%/Years of Useful Life) × 2 Example: A printing machine is purchased for $20. a salvage value of $1. What is depletion method of depreciation? Explain with example.037.00.00. There is bound to be some balance though only a small one. the rate of depreciation per unit will be $4 i. The scrap value is estimated at $2.00.000 12.000 at the end of 5 years useful life of the asset. etc.800 2.00. .000 tons. In this example.680 17.880 1.000 20.000 tons minerals is extracted. (20.000 7. Depletion method of depreciation is especially suited to mines.000 20.00.037 accumulated depreciation 8.000). rate of depreciation per unit of output is ascertained. In this way. Depletion Method of Depreciation: Learning Objectives: 1.000 Rate depreciation 40% 40% 40% 40% 40% Amount depreciation 8.800 15..000 4.728 1.320 2. If during the year 25.408 18. Therefore the depreciation expenses at the end of fifty year should be $592 and not $1.000 / 5.445 Book Value 12.000. Example: A mine was acquired at a cost of $20. Required: Calculate the annual depreciation charge by applying double declining balance method Solution: Depreciation rate (100%/5) × 2 = 40% The following table shows the depreciation for the five year period: End of Year 1 2 3 4 5 Asset Cost 20.555 is automatically provided for. the amount of depreciation will be 25.555 In applying this method the entire original cost can never be depreciated.e.000 20. quarries.000 × 4 = $1. Depreciation in any particular year is charged on the basis of the output during that year.200 4. sand pits. However.000.592 1. According to it the cost of the asset is divided by the total workable deposits. an asset should not be depreciated below it salvage value of $2.000 20.000 the quantity of minerals expected to be mined is 5.000 on January 1991.

The net cost of the asset is divided by the number of hours estimated and the result would give the amount of depreciation per hour. Freehold Land and Building: It means that land and building which has been purchased out right and not on lease. In order to calculate. Depreciation of Various Assets: Learning Objectives: 1. depreciation should be charged on the basis of use. If in a year machine is used for 1. How should the depreciation on various assets be calculated?. few repairs will be needed. Thus either of the straight line method or reducing installment method may be adopted to depreciate this asset. its book value also disappears from the books of accounts. Efficient repairs. According to modern opinion the idea of the depreciation with regard to land cannot be ruled out entirely. so that by the time it falls down. Each year depreciation would be written off at this rate on the number of hours worked during the year.000 × 2).000 and its life is estimated at 20.000 (1.000 hours. Agricultural land may loss its fertility. Example: A machine is bought for $40.000 hours. After some considerable time the building will practically fall in spite of all the repairs. but they cannot make it everlasting. One of the chief factors causing depreciation is use. Therefore. Define and explain the basis of use system of depreciation. One of the peculiarly of the land is that it does not generally depreciate. add to the life of the building. in some cases at least land must be depreciated. Hence it is absolutely necessary to charge depreciation on such building. the total number of hours for which the machine is estimated to work is ascertained. These repairs will keep the building in proper order. . depreciation will be $2. Brick land may depreciate. it is the total number of hours for which the machines work is the main factor and not their life. no doubt. Its value may and does fluctuate from time to time. as such.Basis of Use System of Depreciation of Depreciation: Learning Objectives: 1. but such fluctuations do not influence depreciation in any way. the method of depreciation employed should be such as it provides a fund for its reconstruction on its dilapidation. Consequently older accountants were of the opinion that land should be left at the cost price in the books. We discuss below the problem of depreciating some given assets. The hourly rate of depreciation will be $2. As this asset possesses a long life. But after sometime the building will begin to decay and even the repairs will not succeed in keeping it in proper working order. In the case of building it will be seen that in its early life. For example in the case of plant and machinery.

but may of course be less or much more. it is not necessary to depreciate it. The name under which the business is carried on acquires a reputation and consequently a saleable value. it is advisable to create a reserve from the profit and loss account in prosperous years because when profits fall and goodwill depreciates it may be difficult to write it off. the diminishing balance method is generally employed to depreciate this asset. The most general duration is 99 years. howsoever well established. . It is an intangible asset. The assets should be depreciated by the straight line method so that it is written off within the legal or commercial life whichever is shorter. As the working life of each one of them is different. fixed plant. But as no business. The value of the leasehold property should be written off during the term of the lease and the rate of depreciation should be fixed accordingly. Loose Tools: As this asset is liable to breakage and pilferage.Leasehold Land and Building: By leasehold is meant the land that is taken on lease for a certain number of years. Etc: The depreciation should be estimated by the depletion method. It can be sold only when entire business is sold off. Goodwill: Goodwill has been defined as the benefit or advantage arising from regular public patronage on account of facilities offered. boilers. running machinery. As goodwill is not consumed in the process of earning income. Mines. Though goodwill is a fixed asset it does not depreciate on account of wear and tear like plant and machinery etc. If the lease under which the property is acquired is short. engines. etc. the fixed installment method or straight line method of depreciation can be applied conveniently. If on the other hand. Though fixed installment method or straight line method can be suitably applied to depreciating plant and machinery but owing to the difficulty of calculating depreciation on additions made during the year. Furniture and Fixture: The diminishing balance method is usually employed to depreciate this asset. Plant and Machinery: This term includes machinery of different kinds e.. can have perpetual life. Oil Well. the rate of depreciation should also be different. Quarries. it be a long lease. The difference between the present value and the value as per last balance sheet should be treated as depreciation. the annuity method of depreciation would be more suitable.g. The rate of depreciation should be high enough to reduce it to its residual value at the end of its working life. Patents and Copyrights: There is a maximum legal life of such assets but the commercial life (during which such assets can be effectively exploited) may even be shorter. it should be annually valued.

Explain the difference between (i) depreciation and fluctuation (ii) depreciation and obsolescence.Depreciation Accounting . How should obsolescence be provided for. motor vehicles. What are the objects of making provision for depreciation of the fixed assets of a business. 6. 7. . 4. live stock. 5. and discuss any one of them in detail? 3. Name the different methods of providing for depreciation. Answers of some of the general questions about depreciation accounting. Which is the best method of providing for depreciation of the following assets: Loose tools. What is depreciation? Does it depend on the market value of the asset? Why is it necessary to provide for depreciation of assets while preparing the balance sheet. What is depreciation and how is it brought about? 2. 8.General Questions and Answers: Learning Objectives: 1. lease. Why should depreciation on fixed assets be brought into account. Discuss in detail the several methods of providing for depreciation. Theoretical: 1. machinery. Explain briefly the nature and use of the "revaluation process" of depreciation.

Valuation. iii. To show the true financial position in the balance sheet. The amount of depreciation is credited to depreciation fund account in case of annuity method. The main objective of providing depreciation is: i. ii. . ii. 9. Physical wear and tear. State whether each of the following statements are true or false: 1. The charge for use of the asset remains uniform each year in case of straight line method. The objective of charging profit and loss account with the amount of depreciation is to spread the cost 2. Objectives: A. Answers: 1 True 2 False 3 False 4 True 5 False 6 True 7 True 8 True 9 False B. Depreciation arises because of: i. 4. Depletion method is suitable for charging depreciation in case of stock or loose tools. Fall in the market value of an asset. iii. Depreciation is a process of: i. iv. To reduce tax burden. Allocation. 6. 2. iv. of an asset over its useful life for the purpose of income determination. 8. ii. Non of these. To provide funds for replacement of fixed assets. Click here to start now. Depreciation is charged on the book value of the asset each year in case of diminishing balance method. Net charge to the profit and loss account is the same under both annuity method and depreciation fund method. 3. 1. Both valuation and allocation. In case of insurance policy method. Indicate the alternative which you consider to be correct. please read our accounting for depreciation chapter in detail. To allocate true profit. 7. 3. the depreciation is credited to the asset account.Answers: To find the answers of all the questions above. 5. The asset appears always at original cost in case depreciation is credited to provision for depreciation account. The amount of depreciation is credited to the depreciation fund account in the depreciation fund method.

4. Fall in the market value of money.iii. it: i. 8. The amount of depreciation charged on a machinery will be debited to: i. Is constant every year. iii. ii. Original cost. The total amount of depreciation to be written off over the life of an asset is equal to the cost of the asset less its ________. Depreciation on diminishing balance method of $2.400 ii. Depreciation fund account Answers: 1 ii 2 i 3 ii 4 iii 5 ii 6 i 7 iv 8 ii 9 iii C. Under the diminishing balance method. 7. Obsolescence and inadequacy are called the ________ factors causing depreciation. 5. Decreases every year. Non of the above. Machinery a/c. Sales account iii. Depreciation account. Loss on the sale of machinery should be written off against: i. iii. . The rate percent of depreciation declines from year to year. the depreciation is calculated on: i. Share premium account. iii. $542 iv. 2. $1. $1. The scrap value 6. A diminishing balance method of providing depreciation is one according to which: i. ii. The rate percent as well as the amount reduces every year.000 at the rate of 10% p. Written down value. ii. Under the straight line method of charging depreciation. Cash account.458 iii. Increases every year. iii. Fill in the blanks 1. ii. ii.a after three years will be: i. 9. The amount of depreciation is reduced year to year.

4. depreciation inadequacy 3 5 depletion . Answers: 1 scrape value 2 economic 4 shorter. 5. This is usually because of such factors as _________ and ________. obsolescence. The useful life of depreciable asset for an enterprise may be ________ than its physical life.3. In the case of wasting assets the amount of charge determined on the basis of exhaustion of the asset is known as ________. Over or under provision of ________ is taken to profit and loss account as profit or loss at the time of termination or sale of assets.

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