Depreciation Accounting

Depreciation
 Depreciation means diminution in the value of an
asset, specially fixed asset, due to wear and tear,
obsolescing, etc.

7-3
 Depreciable Assets
 Depreciable Assets are those assets which
 Are expected to be used during more than one
accounting period.
 Have a limited and useful life
 Held by the organization to use in production
process not for sale in ordinary course of business.

7-3
 Factors that cause depreciation 
 Wear and tear due to actual use.
 Passage of time
 Obsolescence
 Accident

7-3
 Objectives of Providing Depreciation
 Correct income measurement
 True position statement
 Ascertainment of True cost of production

7-3
 Measurement of Depreciation
 Cost of assets including expenses for installation,
commission, trial run etc.
 Estimated useful life of assets.
 Estimated scrap value if any.

7-3
Accounting for Depreciation

 By charging to assets account directly

 By creating provision for
depreciation/Accumulated depreciation
account.
By charging to assets account directly

 In this method depreciation is directly

charged from the respective assets
account.
 Assets will be shown in the balance
sheet book value less depreciation.
By creating provision for
depreciation /Accumulated
depreciation account.

 Under this method assets account is not

at all affected by the depreciation
amount.
 Assets appears in the books at its
original cost until sold.
Journal Entries for Depreciation

 Purchase of assets
 Provide depreciation
 Close depreciation account
 Sale of assets
 To record profit and loss of assest
Methods of Charging Depreciation

 Straight Line Method

 Diminishing Balance Method
 Machine Hour Rate Method
 Production Unit Method
 Sum of the Years’ Digits Methods
 Annuity Method
 Sinking Fund Method
Straight Line Method
 This method, depreciation is calculated as a fixed
proportion on the original value of the asset. The
depreciation is charged as fixed in volume on the
original value of the asset at which it was purchased.
The original value of the asset is nothing but the
purchase value of the asset
Example
 Soloman purchases a machine for Rs. 1,00,000 and 1
January 2,000. Its estimated useful life is 5 years and
scarp Value Rs. 10,000. It is decided to write off
depreciation under straight line method. Pass
necessary journal entries for five years and open
necessary account in the ledger for the same period.
The accounting period ends on 31 March every years.
Example
 On 1st Jan 2006 X Purchased a machine for Rs.
160000 and spent Rs. 40000 on installation. The
residual value at the end of its expected useful life of
4 years is estimated at Rs. 80000 on sep 30 2008
this machine is sold for Rs. 100,000. Depreciation is
to be provided according to straight line method. You
are required to pass journal entries in the books of X
and prepare machinery account and depreciation
account for first three years assuming that the
accounts are closed on March 31st each year.
Diminishing Balance
Method/Written Down Value
Method/Reducing Balance Method
 In this case the depreciation is written off on the
basis of the balance in the account of the asset. If a
machine is acquired at a cost of Rs. 20,000 and
depreciation is written off at the rate 10% p.a. the
depreciation for the first year will be Rs. 2,000 i.e.,
10% of Rs. 20,000 and for the second year it will be
Rs. 1,800 i.e., 10% of Rs. 18,000 (Rs. 20,000 minus
Rs. 2,000).
Example
 On 1st Jan 2001 X ltd purchase a machinery for Rs.
80000 and spent Rs. 2000 on its installation. On 30 th
sep 2003 this machine is sold for Rs. 50000.
Depreciation is to be provided @ 20% p.a. according
to written down value method. You are required to
prepare Machine and depreciation account for first
three years assuming that the accounts are closed on
31st March each year.
Sum of Years Method
 In this method annual depreciation is calculated by
multiplying the original cost of assets less its
estimated scrap value by the fraction represented
by:
 Depreciable amount X Number of year (including
current year) of remaining life of assets/ Total of all
digits of the life of the assets.
Example

Mr. Raj purchased a machinery for Rs. 100000.

Estimated life and scrap value were 10 years and
12000 respectively. The Machine was put to use in
1/1/2001. show machine account and depreciation
account in the books for 31 December 2011 by
using sum of years digits method.
Machine Hour Rate Method
 A machine was acquired on 1st April 2004 at a cost
of Rs 45000, the cost of installation was RS. 5000. It
is expected that its total life will be 1,00,000 hours.
During 2004 , it worked for  8,000 and during 2005
for 12000 hours. Write up the machinery account for
31st march 2005 and 2006.
Production Units Methods
 Under this method depreciation of the asset is
determined by compering the annual production with
the estimated total production.


 Depreciation= Depreciable Amount X (Production

during the period/ Total Estimated Production)
Example
 A machine is purchased for Rs. 200000. its estimated
useful life is 10 years with a residual value of Rs.
20000. The machine is expected to produce 1.5 laks
units during the life time. Expected distribution
pattern of production is as follow
 Year 1-3: 20000 units per year
 Year 4-7: 15000 units per year
 Year 1-3: 10000 units per year
 Determine the amount of depreciation by production
units method.
Annuity Method
 Under annuity method of depreciation the cost of
asset is regarded as investment and interest at fixed
rate is calculated thereon. Had the proprietor
invested outside the business, an amount equal to
the cost of asset, he would have earned some
interest. So as a result of buying the asset the
proprietor loses not only cost of asset by using it, but
also the above mentioned interest. Hence
depreciation is calculated in such a way as will cover
both the above mentioned losses. The amount of
annual depreciation is determined from annuity table.
Journal Entries Under Annuity
Methods
 When the Asset is purchased
 For Charging Interest
 For Charging Depreciation
 Transfer of Depreciation on P & L A/C
 Amount required to write off Rs.1 by the annuity method.

Years 3% 3.5% 4% 4.5% 5%

3 0.353530 0.359634 0.360349 0.363773 0.367209

4 0.269027 0.272251 0.275490 0.278744 0.282012

5 0.218355 0.221418 0.224627 0.227792 0.230975

6 0.184598 0.187668 0.190762 0.193878 0.197017

7 0.160506 0.163544 0.166610 0.169701 0.172820

8 0.142456 0.145477 0.148528 0.151610 0.154722

Example
 A firm purchased a Machinery for Rs. 30000 on first
January 2001 and expected life of machine is 5
years. It is decided to write off depreciation on the
annuity method. Presuming the rate of interest to be
5% per annum prepare Machinery a/c for 5 years.
Accounts are prepared on 31 December each year.
Sinking Fund/ Depreciation
Fund Method
 Under depreciation fund method or sinking fund
method, a fund is created with the amount of annual
depreciation. An amount equal to annual depreciation
is invested each year in government papers or in some
other securities outside the business. The income
earned from investment is deposited into the fund and
immediately reinvested. This process is carried out
throughout the life of the asset and at the end of its
life a sum equal to the cost of the asset is accumulated
in the fund. Then the whole investment is sold and a
new asset is acquired with the sale proceeds
Sinking Fund/ Depreciation
Fund Method
 Purchase Assets
 Provide Depreciation
 Transfer of Depreciation in to P&L A/C
 Making Investment in Depreciation
Fund investment A/C
 Receiving Interest on Depreciation
Funds
Depreciation Account Dr.
To Depreciation Fund Account (or Sinking Fund A/c)

Depreciation Fund Investment A/c Dr.

To Bank A/c

Bank Account Dr.

To Depreciation Fund Account

Bank A/c Dr.

To Depreciation Fund Investment A/c

Depreciation Fund A/c Dr.

To Depreciation Fund Investment A/c
Depreciation Fund A/c. Dr.
To asset A/c
Example
 Vasant bought a machine on April 1, 2003 for a sum
of Rs. 200000 having useful life of five years. It is
estimated that machine will have a scrap value of
Rs.32000. he decided to charge depreciation
according to Depreciation Fund Method/Sinking fund
method. Sinking fund table shows that Rs. 0.180975,
if invested yearly @ 5% p.a. produces Rs. 1 at the
end of 5 years. The depreciation fund investments
are expected to earn interest @ 5% p.a. At the end
of fifty year investment were sold for Rs. 130000
and the scrap realized Rs. 340000
 A firm acquires a four-year lease on 1st January 2002
for Rs 40,000. The firm decides to establish a
Depreciation Fund for its replacement. Interest is
expected to be earned at 5%. The Sinking Fund
table’s show that Re 0.232012 has to be invested
every year to produce Re 1 at the end of four years
@ 5%. investments were sold for Rs 29,000 on 31
dec 2005.