Group- B

Rent account c Real account

Capital account d Artificial Personal account
Goodwill account a Nominal account
Harish Account e Representative personal Account
State Bank of India b Personal account

1.4 DEPRECIATION - METHODS (STRAIGHT LINE AND DIMINISHING BALANCE METHODS)

Depreciation is derived from the Latin word “Depretium”, where “De” – decline “Pretium” – Price. This decline in
price is due to constant use, wear and tear. “Depreciation is the gradual and permanent decrease in the value of
an asset from any cause.

Accounting Standard (AS 10) states that “Depreciation is allocated so as to charge a fair proportion of the
depreciable amount in each accounting period during the expected useful life of the asset.”

Amortization
 Intangible assets such as goodwill, trademarks and patents are written off over a number of accounting
periods covering their estimated useful lives.
 This periodic write off is known as Amortization and that is quite similar to depreciation of tangible assets.
 The term amortization is also used for writing off leasehold premises.
 Amortization is normally recorded as a credit to the asset account directly or to a distinct provision for
depreciation account.
 Though the write off of intangibles that have no limited life is not approved by some Accountants.
 Some concerns do amortize such assets on the ground of conservatism.

Depletion
 This method is specially suited to mines, oil wells, quarries, sandpits and similar assets of a wasting character.
 In this method, the cost of the asset is divided by the total workable deposits of the mine etc. And by following
the above manner rate of depreciation can be ascertained.
 Depletion can be distinguishable from depreciation in physical shrinkage or lessening of an estimated
available quantity and the latter implying a reduction in the service capacity of an asset.

Obsolescence
 The term ‘Obsolescence’ refers to loss of usefulness arising from such factors as technological changes,
improvement in production methods, change in market demand for the product output of the asset or
service or legal or medical or other restrictions.
 It is different from depreciation or exhaustion, wear and tear and deterioration in that these terms refer to
functional loss arising out of a change in physical condition.

Dilapidation
 In one sentence Dilapidation means a state of deterioration due to old age or long use. This term refers to
damage done to a building or other property during tenancy.

74 FUNDAMENTALS OF ACCOUNTING
 Causes of Depreciation

Internal Causes External Causes Time Element Abnormal Occurrence

Wear and Tear Depletion Obsolesce Inadequacy

A. Internal Causes

(i) Wear and tear: Plant & machinery, furniture, motor vehicles etc suffer from loss of utility due to vibration,
chemical reaction, negligent handling, rusting etc.
(ii) Depletion (or exhaustion): The utility or resources of wasting assets (like mines etc.) decreases with regular
extractions.

B. External or Economic Causes

(i) Obsolescence: Innovation of better substitutes, change in market demand, imposition of legal restrictions
may result into discarding an asset.
(ii) Inadequacy: Changes in the scale of production or volume of activities may lead to discarding an asset.

C. Time element: With the passage of time some intangible fixed assets like lease, patents. Copy- rights etc., lose
their value or effectiveness, whether used or not. The word “amortization” is a better term to speak for the
gradual fall in their values.

D. Abnormal occurrences: An accident, fire or natural calamity can damage the service potential of an asset
partly or fully. As a result the effectiveness of the asset is affected and reduced.

FUNDAMENTALS OF ACCOUNTING 75
 Fixed/Equal Installment OR Straight Line Method

Features:

(i) A fixed portion of the cost of a fixed asset is allocated and charged as periodic depreciation.
(ii) Such depreciation becomes an equal amount in each period.
(iii) The formula for calculation of depreciation is :
Depreciation = (V-S)/n
Where, V = Cost of the Asset
S = Residual value or the expected scrap value
n = estimated life of the asset

76 FUNDAMENTALS OF ACCOUNTING
Formula for calculation of rate of depreciation under Written Down Value Method:
Residual Value
1− n
Cost o
fof the Asset

Example:

If a plant costs ` 16,000 with an estimated salvage value of ` 2,000 at the end of third year of its useful life, compute
the rate of depreciation.

 2,000 
100 × 1- 3  = 50%
 1
6
16,
000 

Reducing / Diminishing Balance Method OR Written Down Value Method

Features

Depreciation is calculated at a fixed percentage on the original cost in the first year. But in subsequent years it is
calculated at the same percentage on the written down values gradually reducing during the expected working
life of the asset.

The rate of allocation is constant (usually a fixed percentage) but the amount allocated for every year gradually
decreases.

Methods of Recording Depreciation:

Depreciation can be recorded in the books of account by two different methods. They are discussed below:
1. When a provision for Depreciation Account is maintained:
In case of this method, the amount of depreciation to be charged in a particular year in debited to Depreciation
A/c and credited to Provision for Depreciation Account. The Asset Account appears in the books at original cost.
In case the asset is sold, the provision for Depreciation Account is transferred to the Asset Account. Any amount
released on account of sale of asset is also credited to Asset Account. The balance, if any, in the Asset Account is
transferred to the Profit and Loss Account.
2. When a provision for Depreciation Account is not maintained:
In case a Provision for Depreciation Account is not maintained, the amount of depreciation is debited to the
Depreciation Account and credited to the Asset Account. The Asset Account thus appears in the books at written
down value. The Depreciation Account is transferred to the Profit and Loss account like any other item of expense.

Accounting Treatment under different methods:

Sl. Transaction If Provision for If Provision for Depreciation A/c is maintained

No. Depreciation A/c If Asset Disposal A/c is NOT If Asset Disposal A/c is
is NOT maintained opened opened
(ordinary method)
1. For the purchase Asset A/c Dr. Asset A/c Dr. Asset A/c Dr.
of an asset To Cash/Bank A/c To Cash/Bank A/c To Cash/Bank A/c
(including exp.
Incurred till it is
brought into use)

FUNDAMENTALS OF ACCOUNTING 77