Depreciation

Chapter Objectives
• Understand the concept of depreciation
• Identify the causes of depreciation
• Explain the meaning of depreciation accounting
• Compute depreciation according to different methods of providing
depreciation

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• Explain the role of depreciation policy

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Depreciation
• Depreciation is defined as the gradual decrease in the value of an
asset.
• Causes of depreciation are:
• Wear and tear
• Exhaustion

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• Obsolescence
• Efflux of time
• Accidents

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Features of Depreciation
• It is applicable to all fixed assets except some assets like land and
antique.
• It is a charge against profits and true profit of a business can only be
computed after charging depreciation.
• It differs from maintenance expenses, which are incurred for

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keeping the machines in a workable state.

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Depreciation Accounting
• Depreciation accounting is concerned with distributing the cost of a
tangible asset over its estimated useful life.
• Objectives of depreciation accounting are:
• To determine true profit of business
• To provide true financial position of business

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• To provide funds for the purchase of new assets

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Fixation of Depreciation
Amount
• Depreciation amount of a particular asset is computed and is
charged to the profit and loss account.
• Depreciation amount in respect to a particular asset depends upon
the following factors:
• Cost of asset

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• Estimated scrap value
• Estimated useful life

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Methods for Providing Depreciation
• The methods used for computing depreciation are classified into
three categories:
• Uniform charge methods
• Declining charge or accelerated depreciation methods
• Other methods

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Uniform Charge Methods
• In these methods a uniform depreciation amount is charged every
year.
• The various uniform charge methods are:
• Fixed installment method: It is also known as Straight Line Method
(SLM). It provides a fixed amount of depreciation every year. In this,

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depreciation is computed by dividing the difference of original cost of
asset and estimated scrap value by the estimated life of the asset in
years.

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Declining Charge Depreciation Methods
• In these methods, the depreciation amount to be charged
decreases with the expected life of the asset.
• The various declining charge depreciation methods are:
• Diminishing balance method: Depreciation is computed on the book
value of the asset. Depreciation rate is obtained using the formula:

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Depreciation Policy
• Objectives of depreciation policy:
• To recover the amount invested in purchasing an asset before the
expiry of the economic life of the asset.
• To ensure that a uniform rate of return on investment is achieved.
• To generate funds for purchasing of new asset after the expiry of an old

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asset.
• To determine correct profit and loss information of the business.

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Depreciation Policy (contd.)
• Aspects that should be considered while developing the
depreciation policy:
• An appropriate method for computing depreciation should be selected
depending upon the nature of assets and objectives of the
management.

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• The provisions for depreciation should be periodically reviewed.
• The depreciation policy should be evaluated in the context of tax, price
level changes and Government regulations.

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Methods of Recording Depreciation (contd.)

• The Depreciation account is debited with the depreciation

amount chargeable in a year and the same amount is
credited to the Asset account.
• The Depreciation account is transferred to the Profit and

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Loss account.

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