Fixed asset and Depreciation

Learning Objectives

Understand the Factors to be

Causes of Objectives of Journal Entries
Meaning of considered for
Depreciation Depreciation for Depreciation
Depreciation Depreciation
 Depreciation
Permanent Decrease in the value of a fixed asset,

A portion of the total cost of fixed asset used/consumed

Within an accounting period.

Different accounting policies for depreciation are adopted by different enterprises.

Disclosure of accounting policies for depreciation followed by an enterprise is necessary

Quantum of depreciation involves the exercise of judgment by management in the light

of technical, commercial, accounting and legal requirements.
Causes of Depreciation

Wear and Tear due to actual use

Efflux of time

Obsolescence

Accidents

Fall in market price

Depreciation Objectives
Calculate Correct Profits

Present True and Fair view of financial position

Accumulate funds for Replacement Assets

Calculate correct Cost of Production

Depreciation accounting applies to all depreciable assets, except the
following :-

Forests, plantations and similar regenerative natural resources;

Wasting assets including expenditure on the exploration for and extraction of
minerals, oils, natural gas and similar non-regenerative resources;
Expenditure on research and development;
Goodwill;
Live stock.

It does not apply to land unless it has a limited useful life for the enterprise
 Depreciable assets
Expected to be used during more than one accounting period;

Have a limited useful life; and

Held by an enterprise for

use in the production or supply of goods and services,

for rental to others, or

for administrative purposes and

not for the purpose of sale in the ordinary course of business.

Factors to be consider for Depreciation

Scrap/
Residual
Useful life Value
of the fixed
Cost of the asset
Fixed Asset
 Cost of the Depreciable Asset
Acquisition, installation and commissioning as well as additions or improvement cost.

Purchase price includes import duties or other taxes, stamp duty and registration charges.

Any trade discount or rebate offered by any supplier to be deducted.

Expenses incurred on initial delivery and handling, on installation and or on foundation of

plant, professional fees of engineers and architects, cost of testing etc.

Cost of self constructed asset: all expenses relate directly to the asset.

Assets are purchased for consolidated amount: cost apportioned or distributed on fair basis
as determined by competent valuer.
 Useful Life of the Asset
The period over which a depreciable asset is expected to be used by the enterprise; or

The number of production or similar units expected to be obtained from the use of the asset
by the enterprise.

Pre-determined by Companies Act 2013 (Schedule II)

Reduced by obsolescence arising from such factors as:

technological changes;
improvement in production methods;
change in market demand for the product or service output of the asset
 Residual Value
If insignificant, it is normally regarded as nil.

If significant, it is estimated at the time of acquisition/installation, or at the time of

subsequent revaluation of the asset.

Residual value of an asset shall not be more than 5% of the original cost of the asset.
 Depreciation: Any addition or extension to
an existing asset
A capital nature

An integral part of the existing asset, depreciated over the remaining useful life of that
asset.

At the rate which is applied to an existing asset.

A separate identity and is capable of being used after the existing asset is disposed of,
Depreciated independently on the basis of an estimate of its own useful life.
The statute governing an enterprise may provide the basis for computation of the
depreciation.

E.g. the Companies Act, 2013 lays down the rates of depreciation in respect of various
assets. http://www.mca.gov.in/SearchableActs/Schedule2.htm

The estimate of the useful life of an asset is shorter than that envisaged under the
statute,
the depreciation provision is appropriately computed by applying a higher rate.

If estimate of the useful life of the asset is longer than that envisaged under the statute,
depreciation rate lower than that envisaged by the statute.
 Disclosure
Depreciation methods used,

Total depreciation for the period for each class of assets,

Gross amount of each class of depreciable assets and the related accumulated
depreciation

A change in the method of depreciation is treated as a change in an accounting policy

and is disclosed accordingly.
 Methods for Depreciation

Straight Line method

Diminishing Balance Method

 Straight Line Method
Also known as Fixed Installment Method

Depreciation is charged evenly every year during the effective life of the asset.

The amount of depreciation is fixed for each financial year.

Value of fixed asset reduced evenly until it reaches its scrap value.

Suitable for assets which are expected to render equal or uniform services
Depreciation =

Original Cost of the asset – estimated scrap value

Estimated life of the asset in years
Diminishing Balance Method

Written Down Value method or Reducing Balance method

Depreciation is charged on the book value of an asset every year

Amount of depreciation goes on decreasing every year.

Following examples solve with SLM and WDV Method
Disposal of Fixed Asset
Fixed asset is eliminated from the financial statement on its disposal.

Gains and losses arising out of the disposal are recognized in P/L a/c.
 Leo Consultant bought a screen projector on April 1st 2014, for Rs. 40,000. It had an
estimated useful life of nine years and an estimated residual value of Rs. 4,000. Straight
line depreciation was charged. The projector was disposed off on September 30th 2019. The
company’s reporting period corresponds to the calendar year. (Disposal of fixed asset)
Prepare Projector a/c and depreciation a/c assuming following three possibilities,
a. Sold for Rs. 18,000.
b. Sold for Rs. 21,800
c. Sold for Rs. 16,500.
 Depletion Cost:
Depletion is the portion of the cost of natural resources that is allocated for extraction or
production of resources over time.

Depletion rate = (Acquisition and development costs – Residual value)/ Estimated

recoverable units

Depletion cost = depletion rate X no. of units

M/s R.K. & Co. took a mine on lease on 1st January 2010 for Rs. 50 lakhs. As per the
technical estimate, the total quantity of mineral deposits is 1,00,000 tonnes. Depreciation
is charged on the basis of depletion method. The actual output in 2010 was 5,000 tonnes,
in 2011, it was 12000 tonnes; and in 2012, it was 20,000 tonnes.
e.g. solution
Acquisition and development costs – Rs. 50,00,000
Estimated recoverable units – 1,00,000 tonne
Thus, Depletion Rate = Rs.50/ tonne
Therefore, Depletion Cost in
2010 = 5000 X 50 = Rs. 2,50,000
2011 = 12000 X 50 = Rs. 6,00,000
2012 = 20000 X 50 = Rs. 10,00,000
 Amortization Cost:

The cost of acquiring intangible long term operating assets is allocated over the life of the
assets, this cost at each period of the asset’s life.

Amortization per period = cost of an intangible asset/ expected life in periods

In 2014, ABC Company spent Rs. 5,00,000 on developing a new software, Big Bull, to be
used by stockbrokers and financial analysts. The technological feasibility of software was
established in 2015, during which the company spent a further Rs. 7,00,000. The product was
successfully completed in 2015. The company expects the product to yield revenues for next
5 years.

Amortization = Rs.12,00,000 / 5 = Rs.2,40,000 p.a

 Terms of write offs for long term assets
Long term Assets Term of Expenses for Write - offs

1. Tangible Assets

a. Land (Free hold ) None

b. Lease Hold land Write off or amortization

c. Plant, Building, Equipment Tools, Furniture, Fixtures, Depreciation

Vehicles, etc.

d. Natural resources such as oil, timber, coal and mineral Depletion

deposits

2. Intangible assets such as patents, copyrights, trademarks, Amortization

goodwill, etc