DEPRECIATION [ DEPRECATION tefers to allocation of the cost of the asset over time. | It is anon cash ex; Cay ed cost of an asset is allocated through depreciation. ipense. Pt ¥ STRAIGHT LINE METHOD : Depreciation = (Original cost - Salvage value) / Useful Life ¥ ACCELERATED : More depreciationis repostedin the initial years of the life of the asset and less in the later years. ¥ DOUBLE DECLINING BALANCE: DDB Depreciation = (2 / depreciable life in years) % * Book value at beginning of period ¥ UNIT OF PRODUCTION METHOD : Depreciation = ( (original cost ~ salvage value) / life in no. of units ) “no. of units in the year. It affects the pre tax income Higher useful life and Effects of a: || and tax expense and also the salvage value reduces BEE | ieccoceiatex experne Grcese depreciation and thus oo of accelerated method) increases profits,Causes of Deprec External Internal Wearand Tear Obsolescence Disuse Effluxion of time Maintenance Time factor DepletionSTRAIGHT LINE METHOD DEPRECIATION C MEANING me ADVANTAGES Under the straight-line depreciation method, the division of the cost of the asset is equal duing its useful life. (Cost — Expected Salvage Value) / Useful Life Determine the cost of the asset Subtract the residual value from cost Determine the useful life of the asset Depreciation = Divide Depreciable amount by useful life of asset DIS-ADVANTAGES Simplest Method Asset can be written off completely Total depreciation charge is known Suitable for small businesses Pressure on final years Does not have provision of replacement Interest loss and illogical method Not useful for an asset with long life and assets having more value.ED DEPRECI The reduction of value of the asset due to wear and tear is termed as depreciation. When the calculation of the depreciation estimate is higher in early years as compated to the later years, then this depreciation method is referzed as accelerated depreciation method. C USES yg ACC. DEP. METHODS | * All the methods of depreciation do not result in an accelerated depreciation method. * Faster Reduction in value in the earlieryears : The wear and tear reduce value of some assets at a faster rate in the early years. "= Declining balance depreciation method, Double declining depreciation method, and Sum of digits depreciation method are some of the accelerated depreciation methods. Benefit in tax : The additional expense reduces the income and therefore the tax in the early years.DOUBLE DECLINING DEPRECIATION C MEANING DG ADVANTAGES This is an accelerated depreciation method Rischices taxobligatons where depreciation expense decreases with the ‘Matched Maintenance Cost age of asset. Higher depreciation sate is used at Good Interest the start of the period. The Minimum Loss at the Disposal Deterinine Opening Book Value, DIS-ADVANTAGES Usefil life and residual value Calculate the SLM Depreciation Depicts Poor Performance Low Dividend STEPS Double Decl. Dep Rate = SLM X 2 Depreciation = Rate X Book value Repeat until asset depreciates. More Complicated Value of Asset can Never be Zero ‘ORMULAE 2* cost of asset * depreciation rate OR 2 * cost of the asset / useful life of the assetSUM OF YEARS DIGITS DEPRECIATION method is an accelerated method of depreciation in which depreciation in initial years is more than in later years. DEPRECIABLE BASE * (REMAINING LIFE/SYD) Depteciable Base = Cost of Asset ~ Salvage Value SYD = Sum of Years Digit till its useful life. (For Eg : If asset’s useful life is 5 years, then SYD = 1 +2+3+4+5=15) ‘This method is more practical as it itectenges ein depreciation in intl assumes more usage in initial years se Maintains balance between depreciation and repair cost Hence profit in initial years is less as Italso ensures that the earning do not compared to following years. get distorted. J ¥ years. a = ‘This method can indirectly influence Provides company with tax shield in hee the initial years Bi Better to go with this method when asset is more productive in the earlier years than in later years (for eg : Automobiles). Better to go with this method when asset becomes obsolete quickly. eFinanceManagementUNIT OF PRODUCTION DEPRECIATION The decrease in the value of an asset * This method of the depreciation is based upon the Hiserta'file-ticemal wear endear number of units a plant or machinery produces in : the year. aan ace ae iba Sh + The estimated total production of the asset obsolescence, etc. is called becomes the criteria for calculating the depreciation on that asset. depreciation. + The useful life of an airplane is measured in the number of decompression cycle. + A machine has the capacity to produce 2,00,00,000 meters of cloth in its life. So using the unit of production method to calculate the depreciation is advisable in this case. s: FORMULAE :: Annual Depreciation= Units Produced during the year/Estimated total production* Depreciable valueSALVAGE VALUE SALVAGE VALUE is amount that company expects to get at end of usefil life of asset. Company estimates salvage value to assess annual amount of depreciation expense IMPORTANCE IC DETERMINING VALUE Itis significant as it allows to calculate the depreciation. Under and Overestimation of Salvage Value Wrong estimation may deal to following : Wrong depreciation expense, Under/Over valuation of equity, Fixed Asset will give inaccurate picture, debt-to-equity ratio would also be inaccurate ‘Three ways of determining salvage value : + Estimate the number of years asset will be usable. Then look at sale price of similar asset. If found different, take average (Ly where S = Salvage Value; P = Original cost of the asset; i = depreciation rate; y = number of years ‘Most common approach = To take salvage value as zero. Formulae approachvalue of assets which based on figures in the balance sheet. MARKET VALUE is the value which is based on the market forces of demand and supply. ‘The concept of carrying amount applies to all types of assets, including fixed and current. EXAMPLES ww Accounts Receivables : Carrying amount is Gross Accounts Receivables less Provision for Doubtful debts. Fixed Assets : Camying amount is gross fixed assets less accumulated depreciation till date. Bonds : Face value Plus unamortized premium Less unamortized discount Less Unamortized Issue Costs. Intangible Assets : Gross Value less Till date amortization expense. CARRYING VALUE Carrying amount depends on the value in the company’s books or the balance sheet. Canying amount of an asset is always dropping. Market value, on the other hand, is based on supply and demand factors. Market value may decrease o increase.ACCUMULATED DEPRECIATION ACCUMULATED DEPRECIATION is The fixed asset is not treated as an expense total depreciation amount for an asset that a at the time of purchase. It is treated as company charged as expenses; since time of, expense over its useful life, This is the reason purchase of asset, or when it was available for use, for accumulated depreciation. > The depreciation amount for an year is accumulated in a special account named accumulated depreciation account. It is a asset account with credit balance. » Gross cost of asset is reduced with this accumulated depreciation account amount to get the net book value. The net book value does not mean the market value. » When the asset is discarded, the entire amount of accumulated depreciation amount is transferred to the asset account for further calculation of profit and loss on sale/disposal. > When we talk about Tangible Assets, we use the word ‘Depreciation’ > When we talk about Intangible Assets (like patents etc), we use the term ‘Amortization’ > When we talk about Natural Resources, we use the word ‘Depletion’ ‘The purpose and treatment of all these words is same as depreciation.& Finance IMPAIRMENT vs Management DEPRECIATION Basis IMPAIRMENT Netse@ile A permanent reduction in The distribution of asset the value of the asset. cost over its useful life. BOTT) Due to changed customer Due to normal wear and preferences, natural tear or the use of the asset disasters, etc. for day-to-day operations. BiccNetoumm § [rcated as loss. Treated as expenses ade Dobrecucting sa\nainre, BS i etored Subtract the fair value of an Straight-line method, asset from its book value. WDV method. SiISENMEEE Can be on fixed, current & | On tangible assets only Peat} intangible assets.