DEPRECIATION

By
Nishant Saluja
Roll no: 26
 AGENDA
 Introduction
 Definition of depreciation
 Causes of depreciation
 Factors that affect the calculation of depreciation
 Methods of depreciation
a) Straight-line method
i) Equation
ii) Fixed percentage of cost of asset
b) Reducing balance method (Fixed percentage)
 Introduction
• Fixed Assets
• Current Assets
Fixed assets are held and used by a business for a
number of years, but they wear out or lose their
usefulness over time. Every tangible fixed asset has a
limited life. The only exception is land held freehold or
on a very long leasehold
The Accounts of a Business recognize that the cost of
a fixed asset is consumed as the asset wears out, by
writing off the asset’s cost in the profit and loss account
over several accounting periods.
This process is known as Depreciation
 Definition Of Depreciation

‘Depreciation’ is an example of the ‘Matching’

Principle in action. It represents the diminution in
value of a fixed asset over a period of time.
Since depreciation is a provision, it is important to
calculate this figure as accurately as possible.
The Net Book Value( NBV) is the reduced fixed
asset value at any point in time after depreciation.

As a fixed asset has a life of over 1 year and is

expected to produce revenue over a number of years,
it is important to spread the cost of the fixed asset
over these years.
 Causes Of Depreciation

Fixed assets are said to depreciate over a period

of time due to the following factors:

 Physical Deterioration
 Economic Factors
 Time Factor
 Depletion
 Causes Of Depreciation (contd.)
 Physical Deterioration

i) Wear and tear – When a motor vehicle or

machinery or fixtures and fittings are used, they
eventually wear out. Some last many years, others last
only a few year.

ii) Erosion, rust, rot and decay – Land may be

eroded or wasted away by the action of wind, rain, sun
and other elements of nature. Similarly, the metals in
motor vehicles or machinery will rust away.
 Causes Of Depreciation ( contd.)

 Economic factors

i) Obsolescence
This is the process of becoming out of date. For
instance, replacing a computer with old operating
system with a new computer with XP system.

ii) Inadequacy
This arises when an asset is no longer used because
of the growth and changes in the size of the firm.
 Causes Of Depreciation ( contd.)

 The Time factor

Some assets might have a legal life fixed in terms of
years. For example, the patents, and leasehold.
You may agree to rent some buildings for 10 years.
This is normally called a Lease.
 Depletion
Other assets are of wasting character, perhaps due
to the extraction of raw materials from them.
These materials are then either used by the firm to
make something else, or are sold in their raw state
to other firms. Natural resources such as mines,
quarries and oil wells come under this heading.
 Factors Affecting Depreciation
 Cost of asset
Include expenses and capital expenditure incurred
eg. The installation fees, the legal fees

 Estimated useful life of asset

This is the number of years that the asset is
expected to be used

 Residual or scrap value of the asset

This is the value of the asset at the end of its life.

 Method of calculating depreciation

 Methods Of Depreciation

 Straight-line method
(a) using equation
(b) using fixed percentage of cost of asset

 Reducing balance method

 Straight-Line method

 Using Equation
Straight-line method of depreciation is based on the
cost of an asset that is then depreciated, by the same
amount, over the estimated useful life of the asset.

Cost – Estimated Disposal Value

Depreciation per annum =

Expected useful life

 Straight-Line method ( contd.)
Example 1:
ABC Ltd. Bought a machine at a cost of `80,000. The
machine has an expected useful life of 5 years and at the
end of the 5th year, it can be sold for `10,000.
 
Cost Annual Provision for NBV
Depreciation Depreciation
Date of purchase 80,000     80,000

End of 1st year 80,000 14,000 14,000 66,000

End of 2cd year 80,000 14,000 28,000 52,000
End of 3rd year 80,000 14,000 42,000 38,000
End of 4th year 80,000 14,000 56,000 24,000
End of 5th year 80,000 14,000 70,000 10,000
 Straight-Line Method

 Using fixed percentage of cost of asset

The depreciation expense can also be calculated by

writing off a fixed percentage of cost of the asset.

Example 2:
ABC Ltd. Bought a machine at a cost of `80,000. The
depreciation is to be charged at a 20% per annum on cost.

Depreciation per annum = `80,000 x 20%

= `16,000 per year
 Reducing Balance Method
Depreciation is calculated on a fixed percentage on the
Diminishing Balance of the Asset (the NBV). This results
in a higher depreciation charge in the earlier years of
the asset’s estimated useful life.

Fixed
Percentage =
S
n
C
S = Estimated Scrap value of Asset
C = Cost Of the Asset
 Reducing Balance Method
• Example 3: A machine costs `50,000 is to be
depreciated at 15% on Reducing Balance Method.
  Provision for
Cost Annual NBV
Depreciation Depreciation

Date of 50,000 0 - 50,000

purchase
End of 1st year 50,000 50,000 x 15% = 7,500 7,500 42,500

End of 2nd year 50,000 42,500 x 15% = 6,375 13,875 36,125

End of 3rd year 50,000 36,125 x 15% = 5,419 19,294 30,706

End of 4th year 50,000 30,706 x 15% = 4,606 23,900 26,100

End of 5th year 50,000 26,100 x 15% = 3,915 27,815 22,185

 Double Entry Records For Depreciation

The ledger accounting entries for depreciation:

Step 1:
Dr Depreciation Expense (Profit and Loss)
Cr Provision for Depreciation (Balance Sheet)

Step 2:
Dr Profit and Loss
Cr Depreciation Expense
 Depreciation Policies
TATA MOTORS
Depreciation is provided on straight line basis (SLM), at
the rates and in the manner prescribed in Schedule XIV
to the Companies Act, 1956 except in the case of :
Leasehold Land – amortized over the period of the lease
• Technical Know-how – at 16.67% (SLM)
• Laptops – at 23.75% (SLM)
• Cars – at 23.75% (SLM)
• Assets acquired prior to April 1, 1975 – on Written Down
Value basis at rates specified in Schedule XIV to
the Companies Act, 1956.
 Depreciation Policies (cond.)
PEPSICO INDIA
 Depreciation and amortization are recognized
on a straight-line basis over an asset’s
estimated useful life.
 Land is not depreciated and construction in
progress is not depreciated until ready for service
THANKYOU