DEPRECIATION

Meaning: Depreciation means fall in the value of an asset because of usage or with efflux of time due to obsolescence or accident. Every fixed asset looses its value, once it is put to use.

According to the Institute of Chartered Accountants in England & Wales: Depreciation represents that part of the cost of a fixed asset to its owner which is not recoverable when the asset is finally out of use by him. Provision against this loss of capital is an integral cost of conducting the business during the effective commercial life of the asset and is not dependent on the amount of profit earned. Characteristics of Depreciation : 1) It is related to Depreciable fixed assets only. 2) It is a fall in the book value of Depreciable fixed asset. 3) The fall in the book value of an asset is due to the use of the asset in business operations, efflux ion (outward flow) of time, obsolescence, expiration of legal rights or any other cause. 4) It is a permanent decrease in the book value of an asset. 5) It is a continuous decrease in the book value of an asset. The term Depreciation covers Depletion , Amortization and obsolescence. Depletion means physical deterioration by the exhaustion of natural resources. Amortization refers to the economic deterioration by the intangible assets (Patent, goodwill, copyright etc.) Obsolescence refers to the economic deterioration by (a) invention of improved technique or equipment (b) market decline due to

change in taste and fashion etc. (c) inadequacy of existing plant to meet the increased business. Causes of Depreciation 1.Physical wear and Tear 2.With the passage of time 3.Changes in economics environment 4.Expiration of legal rights Need for charging Depreciation 1.To present true and fair view of the financial position 2.To ascertain true results of operations 3.T o ascertain the true cost of production 4.To comply with legal requirements 5.To accumulate funds for replacement of assets.

Methods of recording Depreciation

1. By charging to asset account. 2. By creating Provision for Depreciation/Accumulated Depreciation account.

1.Recording of Depreciation by charging to asset account. The various journal entries which are passed under this method are as follows: (a) To record purchases of asset Asset A/c Dr. To Cash/ Bank A/c (b) To Provide Depreciation Depreciation a/c Dr. To Asset A/c

(c) To close Depreciation a/c Profit & Loss A/c Dr. To Depreciation a/c (d) To record sale of asset Cash/ Bank A/C Dr. To Asset A/c (e) To record Profit/Loss on sale (i) in case of profit Asset A/c Dr. To Profit and Loss A/c (ii) in case of loss Profit and Loss A/c To Asset A/c

Dr.

Most commonly used methods for allocating depreciation over the useful lives of the assets employed in industrial and commercial enterprise are the Straight Line Method and the Written Down Value Method. Straight Line Method of Depreciation(SLM): Under SLM method a fixed and equal amount in the form of depreciation, according to a fixed percentage on the original cost ,is written off during each accounting period over the expected useful life of the asset. Calculation: Original cost less residual value Amount of depreciation = (Estimated scrap Value) Expected useful life of the asset (no. of years of Expected Life) Rate of depreciation = Amt. Of Depreciation Original Cost X 100

Problem1.Calculate the Rate of Depreciation under Straight Line Method(SLM) Purchase Price of a Machine=Rs.45000 Expenses to be capitalized =Rs.5000 Estimated residual Value = Rs.10,000 Expected useful Life = 10 yrs. Total cost of asset =45000 +5000 = Rs.50000 Amt of Depreciation =T. cost of Asset estimated Residual value Expected useful life = 50000- 10000 10 = Rs.4,000/Rate of Depreciation= Amt. Of depreciation X 100 Total cost of asset = 4000 X 100 50000 =8%

Problem: On 1st April 2001, Trehan Ltd. purchased a second-hand machine for Rs.80,000 and spent Rs. 20,000 on its cartage, repair and installation. The residual value at the end of its expected useful life of 4 years is estimated at Rs.40,000. On 30th September 2003,this machine is sold for rs.50,000. depreciation is to be provided according to Straight Line Method. Prepare Journal, Machinery account and Depreciation account for the first three rears assuming that the accounts are closed on 31st March each year.

Solution: Journal of Trehan Ltd. L.F DEBIT(Rs.) CR.(Rs.) . 01.04.2001 Machinery A/C Dr. 80,000 To Bank A/C 80,000 (Being the machinery purchased) 01.04.2001 Machinery A/C Dr. To Bank A/C (Being the cartage & installation charges paid) 31.03.2002 Depreciation A/C Dr. To Machinery A/C (Being the depreciation provided) 31.03.2002 Profit & Loss A/C Dr. To Depreciation A/C (Being the transfer of Depreciation A/C) 31.03.2003 Depreciation A/C Dr. To Machinery A/C (Being the depreciation provided) 31.03.2003 Profit & Loss A/C Dr. To Depreciation A/C (Being the transfer of Depreciation A/C) 30.9.2003 Depreciation A/C Dr. To Machinery A/C (Being the depreciation provided) 30.9.2003 Bank A/C Dr. To Machinery A/C (Being the Machinery sold) 20,000 20,000 DATE PARTICULARS

15,000 15,000 15,000 15,000

15,000 15,000 15,000 15,000

7,500 7,500 50,000 50,000

30.9.2003

31.3.2004

Profit & Loss A/C Dr. To Machinery A/C (Being the transfer of loss on sale of Machinery A/C) Profit & Loss A/C Dr. To Depreciation A/C (Being the transfer of Depreciation A/C)

12,500 12,500

7,500 7,500

DATE PARTICULARS 1.4.01 To Bank A/C To Bank A/C (Expenses)

1.4.02 To Bal. b/d

1.4.03 To Bal. b/d

Machinery A/C Rs. DATE PARTICULARS 80000 31.3.02 By Dep. A/C 20000 (100000x15 x 12 ) 100 12 By Bal. c/d 100000 85000 31.3.03 By Dep. A/C (100000x15 x 12 ) 100 12 By Bal. c/d 85000 70000 30.9.03 By Dep. A/C (100000x15 x 6 ) 100 12 By Bal. c/d By Profit & Loss A/C (loss) 70000

Rs. 15000

85000 100000 15000

70000 85000 7500

50000 12500 70000

DATE 31.3.02 31.3.03 30.9.04

PARTICULARS To Machinery A/C To Machinery A/C To Machinery A/C

Depreciation A/C AMT(Rs) DATE 15,000 31.3.02 15,000 31.3.03 7,500 31.3.04

PARTICULARS AMT(Rs.) By Profit & Loss A/c 15,000 By Profit & Loss A/c 15,000 By Profit & Loss A/c 7,500

Working Notes: (i) Calculation of Rate of Depreciation Step1: Calculation of total Cost of asset =Rs.80,000 +Rs.20,000 = Rs. 1,00,000 Step2: Calculation of Amt. Of Depreciation per year = Total cost of asset Estimated Residual Value Expected useful Life = 1,00,000 40,000 4 =Rs. 15,000 Step 3: Calculation of Rate of depreciation under SLM = Amount of Depreciation X 100 Total cost of Asset = 15,000 X 100 1,00,000 = 15% (ii) Calculation of Profit /Loss on sale of Machine =1,00,000 = 37,500

a) Total cost of Asset(80,000 +20,000) b) less: Depreciation from date of purchase to date of sale (100000 x15 x 30 100 12 c) Book Value as on date of sale(a-b) d) Less: Sale Proceeds e) Loss on sale of assets(c-d)

= = =

62,500 50,000 12,000