You are on page 1of 31

Accounting For Depreciation

:
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.

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

g. strain. Causes of Depreciation: Learning Objectives: 1..g. although in proper working order.7. is known as internal depreciation. What are the causes of definition? The main causes of depreciation may be divided into two categories. leasehold property. quarry etc. etc. Total depreciation of an asset cannot exceed its depreciable value (cost less scrap value). Depletion: Some assets declines in value proportionate to the quantum of production. e. The amount of depreciation of an accounting year cannot be determined precisely . 8. The main external causes are as follows: Obsolescence: Some assets. however. With the raising of coal from coal mine the total deposit reduces gradually and after sometime it will be fully exhausted. machinery. may become obsolete. External Causes: Depreciation caused by some external reasons is called external depreciation. Physical deterioration of an asset is caused from movement. The wear and tear is general but primary cause of depreciation. 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 . In order to survive in the competitive market the manufacturers must must install new machines replacing the old ones. the greater would be the wear and tear.it has to be estimated. External Causes Internal Causes: Depreciation which occurs for certain inherent normal causes. 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. More and more use of an asset. copyright etc. plant. friction. Then its value will be reduced to nil. Other assets like this are building. mine. namely: 1. Again. For example. In certain cases. erasion etc. An obvious example of this is motor car which rapidly wears out. e. patent right. it may be ascertained exactly. Internal Cause and 2. The main causes of internal depreciation are: Wear and Tear: Some assets physically deteriorate due to wear and tear in use. furniture.

Need for Depreciation: Learning Objectives: 1. In such a case the destroyed asset must be written off as loss and a new one purchased. So Unless it is considered like all other expenses and losses. Accident: Assets may be destroyed by abnormal reasons such as fire. Efflux of Time: Some assets diminish in value on account of sheer passage of time. Ascertainment of True Cost of Production: Goods are produced with the help of plant and machinery which incurs depreciation in the process of production. although in good working condition. flood etc. if the cost of production is shown less by ignoring depreciation. true profit or loss cannot be ascertained. .000 (10. even though they are not used e. Its annual depreciation will be $1. the sale price will also be fixed at low level resulting in a loss to the business. leasehold property. Suppose we take a lease of a house for 10 years for $10.000/10). the house will go out of possession. This depreciation must be considered as a part of the cost of production of goods. The Need for depreciation arises for the following reasons: Ascertainment of True Profit or Loss: Depreciation is a loss. So. earthquake. if depreciation is not taken into account. irrespective of the the whether the house has been used or not. must be discarded and the new one purchased. In such a case the old machine. 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.. Otherwise. patent right. Sales price is fixed normally on the basis of cost of production.people. True Valuation of Assets: Value of assets gradually decreases on account of depreciation. depreciation must be considered in order to into out true profit or loss of a business. In other words.g. copyright etc. the cost f production would be shown less than the true cost.000. Because with the end of lease after 10 years. Why does the need for calculating and charging depreciation arise.

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

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

5. Depletion method. it is easy to access the rate of depreciation. 8. The following methods have therefore been evolved for depreciating various assets: 1. 2. 9. Depreciation Methods: Learning Objectives: 1. 10. Fixed installment or Straight line or Original cost method. The possibility of the asset becoming obsolete. After getting information on all these points. Usually engineers and experts give their opinion about these and they are accepted by businessmen. Depreciation fund method or Sinking fund amortization fund method. 4. higher depreciation should be written off such an asset. Diminishing Balance Method or Written down value method or Reducing Installment method. Insurance policy method. 5. 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. 6. Annuity Method. Sum of the year's digits method (SYD). The basis of use system. 7. . If there are great chances of improvements being made in a particular asset on account of inventions. 3. Revaluation method.

The cost of the asset less scrap value. The journal entries will be as under: 1. 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. it would be a straight line. The amount chargeable in respect of depreciation under this method remains constant from year to year. Define. Depreciation account . This method is also know as straight line method because if a graph of the amounts of annual depreciation is drawn. 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. explain and give example of fixed installment or straight line or original cost method. if any. Under this method the expected life of the asset or the period during which a particular asset will render service is the calculated. 2.Fixed Installment Method or Straight Line Method or Original Cost Method of Depreciation: Learning Objectives: 1.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 .

This method.000. The estimated life of the machine is 10 years. 4.) Advantages: 1. the charge for repairs and renewals goes on increasing as the asset becomes older. in spit of its being simplest is not very popular because of the fact that whereas each year's depreciation charge is equal. the scrap will be sold and with the amount that realised by the sale the following entry will be passed: 3. 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. Example: On 1st January 1991 X purchased a machinery for $21. 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. Fixed installment method of depreciation is simple and easy to work out 2. short leases etc. Machinery Account Debit Side $ Credit Side $ . The book value of the asset can be reduced to zero. Scope of Application: On account of the above mentioned advantages and disadvantages of fixed installment method. Interest on money is locked up in the asset is not taken into account as is done in some other methods. Disadvantages: 1. 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. 2. Cash account To Asset account (Being the sale price of scrap realised.To Asset account (Being the depreciation of the asset) 2. In the last year. Difficulty is faced in calculation of depreciation on additions made during the year.000 only. After it its break up value will be $1. No provision for the replacement of the asset is made. 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. 3. patents.

31 1991 Dec.000 17.000 1993 Jan.000 1992 Jan.000 1991 Dec.000 15. 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. 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. 31 By Depreciation account By Balance c/d 2. 31 1991 Dec.000 15.000 21. 1 To Balance b/d 17.000 19.000 1991 Dec.000 1991 Dec.1991 Jan.000 17.000 15. Journal Entries: The entries in this case will be identical to those discussed in the case of the fixed installment method. .000 17. 1 To Balance b/d 19. 31 By Depreciation account By Balance c/d 2. explain and give example of the diminishing balance method/written down value method/reducing installment method? 2. Advantages of Diminishing Balance Method: 1. 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. Only the amount will be differently calculated.000 Diminishing Balance Method of Depreciation: Learning Objectives: 1. 31 By Depreciation account 2. Define. 31 1991 Dec. 1 To Bank account 21.000 21.

Separate calculations are unnecessary for additions and extensions. 1 Credit Side $ Date 1994 Dec.000 By Balance c/d 16.000 25. This method cannot reduce the book value of an asset to zero if it is desired.000 1995 Dec. Plant and Machinery Account Debit Side Date 1994 Jan. 3. 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. 1 To Balance b/d 16. 1 To Balance b/d 20. 31 " $ By Depreciation By Balance c/d 5. the asset. Disadvantages of Diminishing Balance method: 1.000 1995 Jan.800 16. a merchant purchased plant and machinery costing $25.000** 16. This method ignores the question of interest on capital invested in the asset and the replacement of 2. 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.000. Example: On 1st January.000 1996 Dec.000 To Cash 25. 1994. Written down value method or reducing installment method does not suit the case of lease. It has been decided to depreciate it at the rate if 20 percent p.2.000 20.000 .000* 20.000 1996 Jan.200*** 12. on the diminishing balance method (written down value method). 31 " By Depreciation By Balance c/d 4.000 20.000 25. whose value has to be reduced to zero.a. 31 By Depreciation 3. Show the plant and machinery account in the first three years.

(5. journal entries have to be made in respect of interest and depreciation. What is annuity method of depreciation? Where is it adopted? According to this method.000)] × 20% = 3. The annual charge to be made by way of depreciation is found out from annuity tables. at the given rate. The entry that is passed: 1. 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 . it has to be calculated on the debit balance of the asset account at the commencement of the period. the purchase of the asset concerned is considered an investment of capital. 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.000 ***Third Year: [25000 .Formula or equation for the depreciation calculation may be written as follows: *First year: 25. As regards interest. while the interest will be debited to asset account and credited to interest account. The annual charge for depreciation will be credited to asset account and debited to depreciation account. Journal Entries: Under annuity method.200 Annuity Method of Depreciation: Learning Objectives: 1.000 + 4. earning interest at certain rate.5000) × 20% = 4. the following entry is passed: .

353530 0.230975 0. 31 To Cash To Interest 40.148528 4. Show the lease account for the first 3 years.166610 0.761 1.000 on first January.145477 4% 0.169701 0. would be: 230975 × 40.193878 0.154722 Solution: According to the annuity table given above.227792 0.221418 0.363773 0.5% 0. But the amount of depreciation remains the same during the life time of the asset. 1 Dec. Calculations are to be made to the nearest dollar.a. It decides to write off depreciation on the annuity method.163544 0.239 Lease Account Debit Side Date 1st Year Jan.399 $ Date 1st Year Dec.360349 0. Years 3 4 5 6 7 8 3% 0.239 25.172820 0.000 Credit Side $ . the annual charge for depreciation reckoning interest at 5 percent p.190762 0.160506 0.399 2nd Year Dec.239 32. 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.142456 3.224627 0.272251 0. 31 To Balance b/d To Interest 32.218355 0.359634 0.282012 0.151610 5% 0.184598 0. Presuming the rate of interest to be 5% per annum. Example: A firm purchased a 5 years' lease for $40.275490 0.2.160 34. 1 Dec.761 42. Annuity Table Amount required to write off $1 by the annuity method.638 34.187668 0.269027 0. the amount of interest goes on declining year after year. 31 By Depreciation By Balance c/d 9.000 = $9.000 2nd Year Jan. 31 By Depreciation By Balance c/d 9.5% 0.197017 0.000 2.278744 0.000 42.367209 0.

31 By Depreciation By Balance c/d 9. the calculation have to be changed frequently. Scope of Application: This method is best suited to those assets which require considerable investment and which do not call for frequent additions e.170 Dec. and is therefore most scientific. 31 To Balance b/d To Interest 25.239 17. 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.179 26. What are its advantages and disadvantages? Definition and Explanation: Depreciation fund method is also know as sinking fund method or amortization fund method. long lease. a fund know as depreciation fund or sinking fund is created. the ultimate consequence being that the net burden on profit and loss account grows heavier each year.160 1. The amount of interest credited goes on diminishing as years pass by.418 Advantages: 1. 1 To Balance b/d 17.258 26. 2. which is so calculated that the annual sum . 3. Depreciation Fund Method or Sinking Fund Method of Depreciation: Learning Objectives: 1. When the asset requires frequent additions and extensions.418 3rd Year Jan. 2.g. The system is complicated. What is depreciation fund method or sinking fund method of depreciation? 2. which is very inconvenient. It is regarded as most exact and precise from the point of view of calculations. This method takes interest on capital invested in the asset into account. 1 Dec. Under this method.. Disadvantages: 1.3rd Year Jan. Each year the profit and loss account is debited and the fund account credited with a sum.

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.152668 0.154598 0.232012 0.235490 0.5% 0.237251 0.104722 . Debit profit and loss account and credit depreciation fund account with the annual depreciation installment.108528 4.122820 0.239027 0. Also debit depreciation fund investment account and credit cash account with an equal amount. Debit depreciation fund investment account and credit depreciation fund account with the amount of interest earned and reinvested. The asset appears in the balance sheet year after year at its original cost while depreciation fund account appears on the liability side.124701 0.150762 0. Sinking Fund Table Annual sinking fund installment to provide $1.188350 0. On replacement of asset.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.320349 0.112446 3. The amount of annual depreciation to be provided for by the depreciation fund method will be ascertained from sinking fund table. (2).147017 0.182792 0. (1).126610 0. (b). In subsequent years. (c). (a).106610 5% 0.186481 0. generally in gilt-edged securities. (3). (2). Debit depreciation fund account and credit the account of the old asset which has become useless.323540 0. Debit cash account and credit depreciation fund investment account with the amount realized by the sale of investment. (3). Debit profit and loss account and credit depreciation fund account with the amount of the annual depreciation charge.318773 0. Years 3 4 5 6 7 8 3% 0. Debit depreciation fund investment account and credit cash account with an equal amount. Journal Entries: The following entries are necessary to record the depreciation and replacement of an asset by this method.317208 0.180975 0.148878 0.130506 0.5% 0. (2). (1). First year (at the end) (1). (4).184627 0. Transfer any profit or loss on sale of investment to profit and loss account.110477 4% 0.321934 0.233741 0.128544 0. Debit the new asset purchased and credit cash account.

31 To Lease account 20. 1 Dec. 31 " 9607.709.80 14702.11 1992 Jan.000 and it is decided to make provision for the replacement of the lease by means of a depreciation fund. Lease Account 1990 Jan. 1 Dec.000 By Balance b/d By Depreciation fund investment By P & L account 9607.000 1993 Jan.000 an annual investment of $4.709.9 4.000 14702.80 20.99 1992 Dec.e.11 By Balance c/d By Depreciation fund investment By P&L account 4709. 31 To Balance c/d 1991 Dec.000 will be necessary. Solution: To get $1 at the end of 4 years at 4 percent an annual investment of $2.80 188..Example: On 1st January.11 1993 Dec.39 4709.490 is necessary. 1 Dec. 31 To Balance c/d 9607.709. the investment yielding 4 percent per annum interest. 31 " 14702.32 4709. 2.99 By P & L account 4.99 4.35. Therefore. Show the necessary ledger account. 31 By Depreciation fund 20.80 1990 Dec.490 × 20. 1990 a four years lease was purchased for $20.000 Depreciation Fund Account 1990 Dec.1 To Cash 20. for $20. 31 1991 Jan.99 384.000 1990 Dec.80 Depreciation Fund Account . 31 To Balance c/d 14702.80 i.709. 31 By Balance b/d By Depreciation fund investment By P & L 20.11 588.35.80 9607.

31 To Cash 4709. It can also be said that the work of investing money is complicated.80 9.80 1991 Jan.11 588. 3.80 20.702.99 1992 Dec.000 1993 Dec. 2. 1 Dec. 1 Dec.702.80 188.80 1991 Dec. If separate provision was not made. Disadvantages of the Depreciation Fund Method Or Sinking Fund Method: 1.00 20. 31 Dec.000.11 1993 Jan.99 384. 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.607.607.32 4709.39 4.709.9 4709.000 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. 31 To Balance b/d To Depreciation fund To Cash 9.607.607. 1 Dec. 31 14. 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. 31 By Balance c/d 9. 31 To Balance b/d To Depreciation fund To Cash 4709. 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.99 1992 Jan. 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. 31 By Cash 20.1990 Dec. 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. .80 1990 Dec. 31 Dec. 31 By Balance c/d 4709. 31 Dec. 31 By Balance c/d 14.99 9. which has become useless.

while disadvantage lies that the interest received on the premiums paid is comparatively very low. Depreciation insurance policy account 4. instead of being used to buy securities. is paid to an insurance company as premium. Under this method the amount represented by the depreciation fund. In the beginning: Depreciation insurance policy account To Cash account (Being the payment of premium on depreciation policy) 2.Insurance Policy Method of Depreciation: Learning Objectives: 1. Define and explain the insurance policy method of depreciation. 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.e. 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. 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.. to say the amount of the policy will be received. Entries: Every years two entries will be made: 1. The entry is: Cash account 3. It now be written off by transfer to . 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. This will be transferred to depreciation fund account. but the total interest on the premiums will be received when the policy matures. the entry being. To Depreciation fund account (Being the policy amount realized) The asset account will have been shown throughout at its original cost. To Depreciation insurance policy account (Being the policy amount realized) The depreciation insurance policy account will show some profit.

400 1990 Dec. 31 To Cash 6.800 By Balance b/d By Profit and Dec. The entry is: Depreciation fund account 5. 31 By Depreciation fund 20. Side . Side 1990 Dec. 1990 a business purchases a three year lease of premises for $20.000 1990 Dec.400 Cr. 1 6.800 12.000 Leasehold Policy Account Dr. Side 1990 Jan. 31 loss a/c Jan.000 Cr.800 1992 Dec.400 Cr.000 1992 By Balance b/d By Profit and Dec.400 1990 Dec. Side 1991 Dec. Solution: Leasehold Account Dr.400 800 20.000 and it is decided to make a provision for replacement of the lease by means o an insurance policy purchased for annual premium.800 6.400 12. Show the ledger accounts dealing with this matter. 31 To Balance c/d 12.000 By Leasehold 12. 31 To Leasehold Property 20. Side 1990 Dec.depreciation fund account. 31 By Profit and loss a/c 6. 1 " 20. 1 To Cash 20. 31 By Balance c/d 6. 31 To Balance c/d 6. Side Depreciation Fund Account Dr. To Asset account Insurance Policy Method Example: On 1st January. 31 loss a/c Jan.400 6.

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.1991 Jan. . casks etc. 2. Revaluation method is open to various objections. because there are great chance of manipulations. packages. 1 To Balance b/d Dec.400 6.000 20.800 By Cash 20. loose tools. it being of temporary nature not taken into account.800 To Balance b/d To Cash 12.400 800 20. 31 To Cash 6.400 12. A fixed asset has nothing to do with market value. the method do not specify as to which is the value that the experts are to estimate at the end of each year. It however appears that this is the market value. which represents the actual depreciation can be charged against the profit and loss account. to assess depreciation with reference to market value is against the basic principles and theory of depreciation. Firstly. If so. Define and explain the revaluation method of depreciation. the assets are valued at the end of each period so that the difference between the old value and the new value. horses. This method is mostly used in case of assets like bottles. Secondly.000 Revaluation Method of Depreciation: Learning Objectives: 1.800 12. On rare occasions when on revaluation the value of an asset is found to have increased. Thirdly. 31 By Balance c/d 12. When and where this method is used? As the name implies under revaluation method.800 6. this method is unscientific.000 1991 Dec.

Calculate the annual depreciation expense by applying sum-of-the-years' digits (SYD) method. .. and totaling these numbers.000. the SYD would be 1 + 2 + 3 + 4 + 5 = 15. Determining the SYD factor by simple addition can be somewhat laborious for long-lived assets.. 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. 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. In our example. The expected life was 5 years and salvage value $5. 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. Explain the sum of the years' digits method of depreciation.. For n years: SYD = 1 + 2 + 3 + 4 + .Sum of the Years' Digits Method of Depreciation: Learning Objectives: 1... + n For example if the useful life of an asset is 5 years. purchased a truck for $65. The SYD is found by estimating an asset's useful life in years.000 on 1st January 1991. 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. then assessing consecutive numbers to each year.

000 60.000 60. Define and explain the double declining balance method of depreciation.000 60. .Solution: Amount to be written of = $65.000 60.000 23.000 Years' fraction 5/15 (1/2) Years' depreciation 10.000 65.000 37.000 10.000 60. 5.000 65.5.000 4.000 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 When the asset is acquired during the year.000 58.000 4.000 2.000 60. the depreciation expense may be determined by dividing the fractional multipliers between the current and succeeding year.000 60. 2.000 60.000 5. 4.000 60.000 6.000 Book value 55.000 = = = = = 20. the depreciation is computed as follows: End of the year 1.000 = 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 2.000 8.000 8.000 65.000 60. Double Declining Balance Method of Depreciation: Learning Objectives: 1. 3.000 Cost 65. Double declining balance method is another type of accelerated depreciation method followed generally in USA.000 12. Depreciable cost 60.000 60.000 65.000 13.000 7.000 4.000 8. 6.000 42. The depreciation expense is computed by multiplying the asset cost less accumulated depreciation by twice the straight line rate expressed in percentage.000 60.000 60.000 Accumulated depreciation 1. Using the data in the above example suppose the truck is purchased on 30thJune 1991. 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. No provision is made for salvage value of the asset.000 .000 16.000 60.000 6.000 28.000 65.000 60.000 52.

000 tons.592 1.800 15.000 on January 1991. (20.00. rate of depreciation per unit of output is ascertained. 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 20.000 20.00.00.000 20.037.555 In applying this method the entire original cost can never be depreciated.000 at the end of 5 years useful life of the asset.000. the rate of depreciation per unit will be $4 i. etc. Therefore the depreciation expenses at the end of fifty year should be $592 and not $1.000).800 2. In this example. If during the year 25.000 the quantity of minerals expected to be mined is 5.555 is automatically provided for.680 17. According to it the cost of the asset is divided by the total workable deposits.00.728 1. Depletion method of depreciation is especially suited to mines. Depreciation in any particular year is charged on the basis of the output during that year. However.320 2.000 20.e. quarries.445 Book Value 12. sand pits.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 $20.000 4.408 18. Example: A mine was acquired at a cost of $20. an asset should not be depreciated below it salvage value of $2.000 12..037 accumulated depreciation 8.200 4.000 tons minerals is extracted.000 × 4 = $1.00.000 7.000 Rate depreciation 40% 40% 40% 40% 40% Amount depreciation 8.000 20. In this way. There is bound to be some balance though only a small one. .880 1.000 / 5. a salvage value of $1. The scrap value is estimated at $2.000. What is depletion method of depreciation? Explain with example. Depletion Method of Depreciation: Learning Objectives: 1. the amount of depreciation will be 25.

000 × 2). but such fluctuations do not influence depreciation in any way. Consequently older accountants were of the opinion that land should be left at the cost price in the books. As this asset possesses a long life. in some cases at least land must be depreciated. Example: A machine is bought for $40. but they cannot make it everlasting. . depreciation will be $2. Thus either of the straight line method or reducing installment method may be adopted to depreciate this asset. In the case of building it will be seen that in its early life. Depreciation of Various Assets: Learning Objectives: 1.000 (1. Each year depreciation would be written off at this rate on the number of hours worked during the year. These repairs will keep the building in proper order. it is the total number of hours for which the machines work is the main factor and not their life. Freehold Land and Building: It means that land and building which has been purchased out right and not on lease.000 and its life is estimated at 20. the method of depreciation employed should be such as it provides a fund for its reconstruction on its dilapidation. If in a year machine is used for 1. One of the chief factors causing depreciation is use. In order to calculate. For example in the case of plant and machinery. Brick land may depreciate. Agricultural land may loss its fertility. We discuss below the problem of depreciating some given assets. But after sometime the building will begin to decay and even the repairs will not succeed in keeping it in proper working order. Hence it is absolutely necessary to charge depreciation on such building. its book value also disappears from the books of accounts. depreciation should be charged on the basis of use.000 hours. no doubt. add to the life of the building. as such. According to modern opinion the idea of the depreciation with regard to land cannot be ruled out entirely. The hourly rate of depreciation will be $2. How should the depreciation on various assets be calculated?. One of the peculiarly of the land is that it does not generally depreciate. Therefore. Its value may and does fluctuate from time to time. few repairs will be needed. After some considerable time the building will practically fall in spite of all the repairs. 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.Basis of Use System of Depreciation of Depreciation: Learning Objectives: 1. Define and explain the basis of use system of depreciation.000 hours. so that by the time it falls down. the total number of hours for which the machine is estimated to work is ascertained. Efficient repairs.

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

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

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

Fall in the market value of money. Sales account iii. Original cost. 9. Is constant every year. The rate percent of depreciation declines from year to year.458 iii. ii. The amount of depreciation is reduced year to year. Under the diminishing balance method. Loss on the sale of machinery should be written off against: i. A diminishing balance method of providing depreciation is one according to which: i. Increases every year. The scrap value 6. $1. 2. ii. iii. Depreciation fund account Answers: 1 ii 2 i 3 ii 4 iii 5 ii 6 i 7 iv 8 ii 9 iii C.a after three years will be: i. 4.iii. iii. Obsolescence and inadequacy are called the ________ factors causing depreciation. 7. The rate percent as well as the amount reduces every year. ii. Non of the above. Machinery a/c. 5. Under the straight line method of charging depreciation. 8. Share premium account. Depreciation on diminishing balance method of $2. iii. Written down value. iii. ii. The amount of depreciation charged on a machinery will be debited to: i. Cash account. it: i. $542 iv. Fill in the blanks 1. $1. Depreciation account.000 at the rate of 10% p. Decreases every year.400 ii. 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 ________. . ii. the depreciation is calculated on: i.

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