DEPRECIATION

Unit – 3
CA SHRUTI AGARWAL
DEPRECIATION
TOPICS TO BE COVERED
• Meaning
• Need for calculating depreciation
• Factors affecting depreciation
• Methods of calculating depreciation
DEPRECIATION
MEANING
• Reduction in the value of an asset over a period of time.
DEPRECIATION
NEED FOR CALCULATING DEPRECIATION
• Wear and tear of asset
• New technologies-old assets become obsolete
• Matching principle
DEPRECIATION
FACTORS AFFECTING DEPRECIATION
• Cost of asset
• Estimated salvage value/residual value
• Estimated useful life of asset
• Obsolescence
DEPRECIATION
METHODS OF CALCULATING DEPRECIATION
• Straight Line Method
• Written down value method/Diminishing Balance Method
• Annuity Method
• Depreciation Fund Method/ Sinking Fund Method
DEPRECIATION
METHODS OF CALCULATING DEPRECIATION
• Insurance Policy Method
• Revaluation or Appraisal Method
• Depletion Method
• Machine Hour Rate Method
STRAIGHT LINE METHOD/FIXED INSTALLMENT METHOD

• Depreciation calculated on original cost

• Depreciation remains uniform
• Value of asset becomes zero at the end of useful life
FORMULA
Depreciation = Original cost of asset-Scrap Value
Life of assets (in years)
DIMINISHING BALANCE METHOD/ WRITTEN DOWN VALUE
METHOD
• Depreciation calculated on decreasing value
• Rate of depreciation remains constant
• Cost of asset, scrap value and useful life of asset is used to
calculate depreciation
FORMULA
Depreciation
First year : (Original cost of asset-Scrap Value) * Depreciation Rate
Later years : (Written down value* Depreciation Rate)
DIFFERENCE BETWEEN SLM AND WDV METHOD
CRITERIA SLM WDV
MEANING A fixed amount is charged as A fixed rate of depreciation is
depreciation. charged on assets.
ASSET VALUE Becomes zero Does not become zero
DEPRECIATION Constant all years Decreases over a period of time
AMOUNT
WRITTEN OFF Completely Not completely
NATURE Easy to understand and calculate Little complicated as compared
to SLM
STRAIGHT LINE METHOD/FIXED INSTALLMENT METHOD

Q1. Cost of the machine:Rs.200000

Estimated life of machine: 5 years
Scrap value Nil
Calculate depreciation as per SLM
STRAIGHT LINE METHOD/FIXED INSTALLMENT METHOD

Solution 1:
Depreciation = Original cost of asset-Scrap Value
Life of assets (in years)
= (200000-0)
5
= 40000 Rs.
STRAIGHT LINE METHOD/FIXED INSTALLMENT METHOD

Year Value of asset at the Depreciation Value of asset at the

beginning of the year end of the year
1 200000 40000 160000
2 160000 40000 120000
3 120000 40000 80000
4 80000 40000 40000
5 40000 40000 -

Here, 40000 Rs. is charged every year to recover 200000 during its life of 5 years.
STRAIGHT LINE METHOD/FIXED INSTALLMENT METHOD

Q2. Cost of the machine:Rs.200000

Scrap Value :Rs.20000
Estimated life of machine: 5 years
Calculate depreciation as per SLM.
STRAIGHT LINE METHOD/FIXED INSTALLMENT METHOD

Solution 2:
Depreciation = Original cost of asset-Scrap Value
Life of assets (in years)
= (200000-20000)
5
= 36000 Rs.
STRAIGHT LINE METHOD/FIXED INSTALLMENT METHOD

Year Value of asset at the Depreciation Value of asset at the

beginning of the year end of the year
1 200000 36000 164000
2 164000 36000 128000
3 128000 36000 92000
4 92000 36000 56000
5 56000 36000 20000 (Scrap value)
STRAIGHT LINE METHOD/FIXED INSTALLMENT METHOD
WRITTEN DOWN VALUE METHOD
Q3. Cost of the machine:Rs.100000
Scrap Value :Rs.Nil
Depreciation rate 10%
Calculate depreciation as per WDV method for the first five
years.
WRITTEN DOWN VALUE METHOD

Year Value of asset at the Depreciation Value of asset at the

beginning of the year end of the year
1 100000 10000 (100000*10%) 90000(100000-10000)
2 90000 9000 (90000*10%) 81000(90000-9000)
3 81000 8100 (81000*10%) 72900(81000-8100)
4 72900 7290 (72900*10%) 65610(72900-7290)
5 65610 6561 (65610*10%) 59049(65610-6561)
WRITTEN DOWN VALUE METHOD
Q4. Cost of the machine:Rs.2500000
Scrap Value :Rs.Nil
Depreciation rate 20%
Calculate depreciation as per WDV method for the first five
years.
WRITTEN DOWN VALUE METHOD

Year Value of asset at the Depreciation Value of asset at the

beginning of the year end of the year
1 2500000 500000 (2500000*20%) 2000000
2 2000000 400000 (2000000*20%) 1600000
3 1600000 320000 (1600000*20%) 1280000
4 1280000 256000 (1280000*20%) 1024000
5 1024000 204800 (1024000*20%) 819200
WRITTEN DOWN VALUE METHOD/DIMINISHING VALUE METHOD
ANNUITY METHOD
• Also called as compound interest method of depreciation
• How asset depreciates by finding its rate of return
• Find the Internal Rate of Return (IRR) on assets cash inflows and
outflows- multiply it by initial book value of asset-then subtracted from
cash flow of the period of time being assessed-will give depreciation
• Used for assets having high cost, more life
• Considers the interest loss on cost of asset
• Difficult to understand
• May require frequent recalculations
DEPRECIATION FUND METHOD/SINKING FUND METHOD

• Depreciation amount put in a sinking fund

• Money is invested government or marketable securities-
interest earned-reinvested
• Proceeds used to replace asset when useful life expires
• Profit or loss on sale of securities is transferred to profit and
loss account
INSURANCE POLICY METHOD
• Similar to sinking fund method
• Insurance policy taken to replace the asset
• Premium based on depreciation
• Funds available of maturity of policy
• Funds are safe and liquid
REVALUATION/APPRAISAL METHOD
• Depreciation calculated based on revaluation of assets
• Revaluation done by experts
• Difference in valuation of two periods is depreciation or
appreciation
• Used for livestock,copyrights, patents etc.
DEPLETION METHOD/PRODUCTION METHOD
• Useful for natural assets like coal mines, oil wells ets.
• Depreciation based on production
• Depreciation = Total depreciable cost * Annual output
Total production
MACHINE HOUR RATE METHOD
• Used in textiles, jute mills etc
• Depreciation based on working hours of machine or plant
• Machine hour rate= Original cost of machine
Total wkg hours of machine production
• Depreciation = Machine hour rate * Total working hours of
plant in a year