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Meaning of Depreciation

 Depreciation can be defined as a continuing, permanent and

gradual decrease in the book value of fixed assets.
 This type of shrinkage is based on the cost of assets utilised in a
What is Depreciation? Straight Line Method
Type equation here.

firm and not on its market value.

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Features of Depreciation Causes of Depreciation

1. Wear and Tear due to Use or Passage of Time: Wear and tear is
 Following are the 3 principal features of depreciation:
nothing but deterioration and the following decrease in the value
 Depreciation is a decrease in the book value of fixed assets.
of an asset, resulting from its use in business operations for
 Depreciation involves loss of value of assets due to the passage
earning revenue.
of time and obsolescence.
2. Expiration of Legal Rights: Some categories of assets lose their
 Depreciation is an ongoing process until the end of the life of
value after the agreement directing their use in business comes to
assets.
an end after the expiry of the predetermined period.

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Depreciation Formula:

3. Obsolescence: Obsolescence is another factor driving to the 1. Annual amount of depreciation under
depreciation of fixed assets. In common language, obsolescence Annual Depreciation =
means being “out-of-date”. Obsolescence refers to an actual asset
becoming outdated on account of the availability of a better type
of asset.
4. Abnormal Factors: Drop in the use of the asset may be caused
by abnormal factors. Namely, accidents due to the earthquake,
fire, floods, etc., Accidental loss is permanent but not continuing.

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Advantages and Disadvantages of
Straight Line Method:
2. Rate of depreciation on original cost
Rate of depreciation = Advantages Disadvantages

It is a very simple method of calculating Under this method book value of the asset will
depreciation. be charged more for maintenance and repair
in the final years as compared to initial years.

Under this method, Asset can be depreciated It is difficult to ascertain a suitable rate of
up to the net scrap value or zero value. depreciation.

Under this method, the same amount is It is not suitable for assets having long life and
charged as depreciation in Profit & Loss high value.
Account.

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Methods of Calculating
Depreciation
 Written Down Value Method (WDV)
 Straight Line Method (SLM)  Under the Written Down Value method, depreciation is charged
 Under the depreciation Straight Line Method, a fixed on the book value (cost –depreciation) of the asset every year.
depreciation amount is charged annually, during the lifetime of Under the WDV method, book value keeps on reducing so,
an asset. annual depreciation also keeps on decreasing.
 The amount of annual depreciation is computed on Original  This method is also known as ‘Diminishing Balance Method’ or
Cost and it remains fixed from year to year. ‘Reducing Instalment Method’.
 This method is also known as the ‘Original Cost method’ or
‘Fixed Instalment method’.

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Straight Line Method vs Written Down Value Method Theory Questions:
Straight Line Method Written Down Value Method Q.1- What are the other concepts similar to depreciation?

Basis of Charging Depreciation

Depreciation is calculated on the original cost of Depreciation is calculated on the book value of Answer:
fixed assets. fixed assets.
Depletion The term ‘Depletion’ is used with regard to the ‘Natural Resources’
Amount of Annual Depreciation like oil wells, Mines etc.
The amount of annual depreciation is fixed for all The amount of depreciation declines year after When natural resources are extracted and their stock value is
years of useful life. year. reduced. This reduction is termed as depletion.
Recognition by Income Tax
The Straight Line Method is not recognized by the The Written Down Value method is recognized by Amortisation The term ‘Amortisation’ is used with regard to ‘Intangible Assets’.
Income Tax Department. the Income Tax Department. Amortisation refers to writing off the cost of intangible assets like
patents, copyright, trademarks, franchises, etc.
Cost of Depreciation and Repairs
The combined cost on account of depreciation The combined cost on account of depreciation
Obsolescence It refers to a decline in the value of assets due to innovation or
and repairs is lower in the initial years and higher and repairs remains, more or less, equal
improved techniques, changes in the taste or fashion of the existing
in the later years. throughout the life of the asset.
asset.

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Q.3- List the factors required for calculating the amount of depreciation.
Q.2- State the objectives of depreciation. Also give the components of original cost.

Answer:

Answer: (a) Factors/elements required to calculate The original cost of the assets.
depreciation Estimated residual value or scrap value.
The estimated useful life of the assets.

Objectives of Depreciation To ascertain the correct cost of

(b) Original cost Original cost =
production
Purchase price + Freight + Installation cost +
To retain funds for a replacement.
Any other expenses incurred before the asset is
To ascertain the correct Profit or Loss.
put to use for the first time.
To show a true and fair view of the
In the case of second-hand assets, even
financial position.
expenses incurred on repair & overhauling,
before putting it to use, are also included in the
original cost.

Q.1- Amortisation refers to writing off the cost of: Q.2- ________refers to decline in the value of assets
(a) Fixed Assets due to Innovation or improved techniques, changes
(b) Tangible Assets in the taste or fashion of the existing asset.
(c) Intangible Assets (a) Intangible Assets
(d) All of the above (b) Obsolescence
(c) Amortisation
(d) Depreciation

Q.3- Depreciation is a ________expense.

(a) Non-cash
(b) Cash
(c) Credit
(D) All of the above