Accounting for Depreciation

Issues in Accounting for Fixed/Non Current

Assets
• Determining the cost of asset
• Allocating the cost to several accounting periods
• Recording the disposal of an item of asset

• Neither expensing the entire cost in the year of acquisition nor

retaining the cost on the books until disposal of the asset will
provide a satisfactory measurement of periodic income
• Appropriate allocation of asset cost to the periods of benefit
received is required
Introduction
• Concept of depreciation -
• Matching Concept - By charging deprecation a part of capitalized cost
is converted into an operating expense
• It is important to charge depreciation (to show the usage) even if
market value of the asset has appreciated
• It’s the process of cost allocation, not asset valuation
• Deprecation – from the time the asset is ready to be used till the asset
is disposed
Types of Assets
• Depreciation on all tangible assets - These assets have a limited
useful life and are expected to be used during more than one
accounting period and are not intended for resale

• Land – not depreciated – does not have definite useful life

• Intangible assets - Apportionment of the cost is referred to as

amortization
How to assess the amount of depreciation
• Depreciable Amount = Cost of Fixed Asset – Residual Value

• Cost of the asset – Discussed in Fixed Assets

• Estimated residual value of the asset at the end of the useful life.
 Difficult to estimate
Normally taken as NIL
If significant - estimated at time of acquisition and deducted from
cost of asset
Assess the amount of depreciation
• Expected useful life of the asset
Expected Period of use of asset
Requires managerial judgement – based on past experience / other
firms in industry
Physical life may be different from useful life
• Extent of use / physical wear and tear/ no. of shifts/ Repairs
• Reduced by obsolescence – technology changes, improvement in
production methods, change in market demand

Cost – Residual value (Depreciable Amount)

Depreciation = ---------------------------------
Useful life
Method of Depreciation
• Factors affecting the method of depreciation :
• Type of asset – whether becomes obsolete faster
• Nature of use of asset – frequent or infrequent
• Tax consideration

• Best method – which matches consumption of asset with benefits

received in each period
Methods of Depreciation – Straight Line method
• Assumes that the asset provides similar economic benefits for each year over its
useful life and hence same depreciation is charged to each period

Cost (Rs.100) – Residual value (Rs.10)

Depreciation = ---------------------------------
Useful life (5 years)

• Depreciation arises only because of time and effect of usage on the service value
of the asset is insignificant – Building decline by age whether used or not
• But service quality of most assets decline over time – Older cars give less mileage
• By assuming same benefit in each year SLM undercharges depreciation in earlier
years
Illustration 1
• Cost of machine Rs.52,00,000
• Useful Life – 5 years
• Consideration expected on disposal – Rs.2,60,000

• Annual Depreciation for all years as per SLM

• Calculate Rate of Depreciation
• Disclosure of Machine in Balance Sheet for all years
• Accounting Policy on depreciation of Machine
 52,00,000 – 2,60,000
Annual Depreciation = --------------------------------- = Rs.9,88,000
5
Rate of Depreciation = 9,88,000 * 100 = 19%
52,00,000
Year Annual Depreciation Accumulated Depreciation
1 9,88,000 9,88,000
2 9,88,000 19,76,000
3 9,88,000 29,64,000
4 9,88,000 39,52,000
5 9,88,000 49,40,000
• Disclosure in Balance Sheet
Details Year 1 Year 2 Year 3 Year 4 Year 5
Fixed Assets :
Machine
Cost 52,00,000 52,00,000 52,00,000 52,00,000 52,00,000
Less: 9,88,000 19,76,000 29,64,000 39,52,000 49,40,000
Accumulated
Depreciation
Net Book 42,12,000 32,24,000 22,36,000 12,48,000 2,60,000
Value
• Accounting Policy: The company provides Depreciation as per SLM
expecting its useful life to be 5 years and estimating its residual value
to be 5% of cost. The effective rate of depreciation is 19% p.a.
Methods of Depreciation – Written Down Value Method
• Assumes that asset provides higher economic benefits in the initial
years and hence should be subject to higher depreciation
• In later years the asset's operational efficiency goes down and so
should the depreciation charged
• WDV method is more appropriate where the benefit to be gained
from the use of the asset is more in earlier years
• Depreciation is calculated at fixed rate on the cost of asset in the first
year and on the carrying amount of the asset in subsequent years
Illustration 2
• Cost of machine Rs.52,00,000
• Useful Life – 5 years
• Consideration expected on disposal – Rs.2,60,000
• Rate of depreciation – 45%

• Calculate
• Annual Depreciation and Accumulated Depreciation for all years as per WDV
• Disclosure of Machine in Balance Sheet for all years
• Accounting Policy on depreciation of Machine
Year Annual WDV at the end of the Accumulated
Depreciation year Depreciation
1 23,40,000 28,60,000 23,40,000
45% of 52,00,000 (52,00,000-23,40,000)
2 12,87,000 15,73,000 36,27,000
45% of 28,60,000 (28,60,000 – 12,87,000) (23,40,000+12,87,000)
3 7,07,850 8,65,150 43,34,850
45% of 15,73,000 (15,73,000 – 7,07,850) (36,27,000 + 7,07,850)
4 3,89,318 4,75,832 47,24,168
45% of 8,65,150 (8,65,150 -3,89,318) (43,34,850 +3,89,318)
5 2,14,124 2,61,708 49,38,292
45% of 4,75,832 (4,75,832 – 2,14,124) (47,24,168 +2,14,124)
• Disclosure in Balance Sheet
Details Year 1 Year 2 Year 3 Year 4 Year 5
Fixed Assets :
Machine
Cost 52,00,000 52,00,000 52,00,000 52,00,000 52,00,000
Less: 23,40,000 36,27,000 43,34,850 47,24,168 49,38,292
Accumulated
Depreciation
Net Book 28,60,000 15,73,000 8,65,150 4,75,832 2,61,708
Value
• Accounting Policy: The company provides Depreciation as per WDV
expecting its useful life to be 5 years and estimating its residual value
to be 5% of cost. The effective rate of depreciation is 45 % p.a.
Illustration 3
• Cure well Hospitals Limited bought a MRI machine at a cost of Rs 60
Million. Though the physical life of the machine is 10 years, the
company feels that due to technical changes it will have to replace the
machine after five years. At the end of fifth year, the machine is
expected to be taken back by the manufacturer at a value of Rs 20
million. Calculate the depreciation expenses for the first two years in
each of the following cases.
• Company follows SLM for charging depreciation.
• Company decides to charge depreciation at the rate of 30% on
reducing balance method.
Solution
• Depreciation = (Rs 60 Million- 20 Million)/5 = 8 Million.
• Depreciation will be charged at Rs 8 Million every year under SLM
method

• Depreciation for the first year will be 30% of Rs 60 Million= 18 Million.

• The Book value after the first year will be Rs 60 Million less Rs 18
Million or Rs 42 Million.
• Depreciation for the second year will be 30% of Rs 42 Million = 12.6
Million
• Comparison of methods
• Comparison
• Cost of machine Rs.52,00,000 Useful Life – 5 years
• Total Depreciation is almost
• Consideration expected on disposal – Rs.2,60,000
same and Net book value at the
• Rate of depreciation – 45% end of 5 years is same
• SLM Depriciation = 52,00,000-2,60,000/5 =9,88,000 every year
• SLM depreciation is uniform ,
WDV depreciation is declining
Year Annual Depreciation Annual Depreciation
(WDV Method) (SLM) • WDV depreciation is higher in
1 23,40,000 9,88,000 initial 2 years and reverses from
3rd year
2 12,87,000 9,88,000
3 7,07,850 9,88,000 • If company chooses WDV, profits
will be lower in first 2 years and
4 3,89,318 9,88,000
hence lower taxes. From third
5 2,14,124 9,88,000 year company will pay more tax
TOTAL 49,38,292 49,40,000 – (assuming same rate of taxes)
• WDV method may be beneficial
considering time value of money
– deferred tax liability
Comparison
Method Merits Demerits
SLM 1. Easy to apply 1. Undercharges
2. Suitable when assets depreciation in earlier
depreciate with time years when the assets
rather than usage are more productive

WDV 1. Charges higher 1. Lower profits after asset

depreciation in earlier acquisition , so managers
years when the assets don’t prefer it
are more productive
2. Suitable for assets which
have high rates of
obsolescence
CHANGE IN THE METHOD OF
DEPRECIATION
• Depreciation method once chosen is applied over the useful life of the
asset – Consistency

• However a change in method is permitted if it will result in more

appropriate presentation of the financial statements of the
enterprise.
Illustration 4
• Cost of machine Rs.52,00,000
• Useful Life – 5 years
• Consideration expected on disposal – Rs.2,60,000
• The company plans to change the method of depreciation from SLM to
WDV from the 3rd year @ 40%

• Calculate
• Annual Depreciation and Accumulated Depreciation for all years
• Disclosure of Machine in Balance Sheet for all years
• Accounting Policy on depreciation of Machine
 52,00,000 – 2,60,000
Annual Depreciation = --------------------------------- = Rs.9,88,000
(SLM) 5
Rate of Depreciation = 9,88,000 * 100 = 19%
52,00,000
Year Annual Depreciation Accumulated Depreciation
1 9,88,000 9,88,000
2 9,88,000 19,76,000

Book Value of the Asset at the end of 2nd year = Rs.32,24,000 (52,00,000-19,76,000)

This will be the WDV to charge depreciation @ 40% from year 3

Year Annual Depreciation WDV at the end of the year Accumulated
Depreciation
1 9,88,000 42,12,000 (52,00,000- 9,88,000
9,88,000)
2 9,88,000 32,24,000 19,76,000
(42,12,000-9,88,000)
3 12,89,600 19,34,400 32,65,600
(40% on 32,24,000) (32,24,000-12,89,600)
4 7,73,760 11,60,640 40,38,760
(40% on 19,34,400) (19,34,400 – 7,73,760)
5 4,64,256 6,96,384 45,03,016
(40% on 11,60,640) (11,60,640-4,64,256)
• Disclosure in Balance Sheet
Details Year 1 Year 2 Year 3 Year 4 Year 5
Fixed Assets :
Machine
Cost 52,00,000 52,00,000 52,00,000 52,00,000 52,00,000
Less: 9,88,000 19,76,000 32,65,600 40,38,760 45,03,016
Accumulated
Depreciation
Net Book 42,12,000 32,24,000 19,34,400 11,60,640 6,96,384
Value

• Accounting Policy: The company provides Depreciation as per SLM for

first 2 years and changes to WDV method from year 3. The useful life
is estimated to be 5 years and estimating its residual value to be 5% of
cost. The effective rate of depreciation as per WDV is 40 % p.a.
Illustration 5
• A bought a car for Rs.5,00,000. It had an estimated useful life of 6
years and residual value of Rs.50,000. He follows SLM method.
• At the beginning of 4th year he decided to switch to WDV method with
a depreciation rate of 40%. There is no change in residual value
• What will be the depreciation charged for year 4?
Solution
• Cost Rs. 5,00,000
• Less: Residual Value Rs. 50,000
• Depreciable Amount Rs.4,50,000
• Original Useful Life 6 years
• Annual Depreciation 4,50,000 /6 = 75,000
• Accumulated Depreciation for 3 years 2,25,000
• Book Value (5,00,000- 2,25,000) 2,75,000
• Depreciation rate 40%
• Depreciation for year 4 1,10,000
EXERCISE – Q2
• Satluj Cements ltd purchased a machine costing Rs 15 Million. As per
suppliers warranty, the physical life of the machine is estimated to be
8 years. However, the management would like to replace the machine
after 5 years. At that time the machine is expected to fetch a residual
value of Rs 5 million.
• What will be the annual depreciation if the company follows the
straight line method of charging depreciation?
• How will the asset and depreciation appear in the second years’
balance sheet & P&L account of Satluj Cements ltd after acquisition of
the machine?
Solution
• Annual Depreciation = 15-5/5 = Rs. 2 million

• In the second year depreciation of Rs. 2 million will appear as expense

in the Profit and Loss Account
• Balance Sheet
Fixed Assets
PPE 15 million
Less: Acc Dep 4 million
Net Block 11 million
EXERCISE - Q3
• Assume that Satluj Cements Ltd charges depreciation on the Written
Down Value method basis and the rate of depreciation being 20% per
annum.
• Prepare the depreciation schedule for the above machine over its
useful life.
• How will the machine appear in the balance sheet after 3 years of
acquisition?
Year Annual WDV at the end of
Depreciation the year
1 30,00,000 120,00,000
2 24,00,000 96,00,000
3 19,20,000 76,80,000
4 15,36,000 61,44,000
5 12,28,800 49,15,200
Solution
• Balance Sheet
Fixed Assets
PPE 15 million
Less: Acc Dep 7.32 million
Net Block 7.68 million
EXERCISE – Q4
• After depreciating the machine for three years using SLM in the above
sum (Sum 2), in the fourth year Satluj Cements decided to change the
method of depreciation to WDV at 20% per annum. How will the
change affect the profit and loss account and balance sheet of the
company?
Solution
• The change in the method of depreciation will be recognized prospectively
• At the end of 3rd year the amount of machine in the books is Rs.9 million (15
mn- 6 mn {2mn dep per year}) after charging depreciation as per SLM method
• In the 4th year the statement of Profit and Loss depreciation will be charged of
Rs. 1.8 million (9 mn * 20%)
• In the Balance Sheet
Fixed Assets
PPE 15 million
Less: Acc Dep 7.8 million(6mn of first 3 years and 1.8 mn of 4th year)
Net Block 7.2 million
EXERCISE – Q6 Revised Useful Life and
Residual Value
• John bought a computer for Rs.1,00,000 with an estimated residual
value of Rs.10,000. At this time it seemed that the computer would be
useful for 6 years. After 3 years, he thinks that the computer will last
for only 2 more years at the end of which it is expected to realize
Rs.5,000. John follows SLM method
Solution
• Cost Rs. 1,00,000
• Less: Residual Value Rs. 10,000
• Depreciable Amount Rs.90,000
• Original Useful Life 6 years
• Annual Depreciation 90,000 /6 = 15,000
• Accumulated Depreciation for 3 years 45,000
• Book Value (1,00,000 -45,000) 55,000
• Less: Revised Estimated Residual Value 5,000
• Revised Depreciable amount 50,000
• Revised useful life 2 years
• Revised Yearly depreciation 25,000
ACCOUNTING FOR DEPRECIATION
• The assets are shown in the balance sheet at the historical cost (called
Gross Block or Gross Book value) Less Accumulated depreciation
• The difference is called the Net block or Net Book Value
• Depreciation expense for the year is charged to the profit & Loss
Account of the respective year
ACCOUNTING FOR DEPRECIATION
• At the time of buying asset.
Asset account Dr
To Bank/ Supplier Account
• For charging depreciation.
Depreciation A/c Dr
To Accumulated Depreciation/ Provision for Depreciation
The asset account is maintained at its gross value
• For transferring depreciation to Profit and Loss Account
Profit and Loss Account Dr
To Depreciation Account
• At the time of disposal of the asset
Bank Account Dr. (by the amount of consideration)
Accumulated Depreciation Account Dr. (by the balance amount in the account)
Loss on Disposal of Asset Dr. (by the loss amount)
To Asset Account (by the cost of the asset)
Illustration 6
• On 1st April 2017,Super technologies Ltd bought three computers at a
total cost of Rs 3,00,000/-.The estimated useful life of computers is 3
Years with a residual value of Rs 60,000/- The company follows SLM
for charging depreciation. On 31st March, 2020 these were sold for Rs
70,000/-
• Pass the necessary journal entries for 3 years in the books of Super
Technologies Ltd. to record the purchase, depreciation and sale of
computer
• How will the Asset and Depreciation appear in the financial
Statements of the company?
1st April 2017: for Buying the computers
Computer A/c Dr Rs 3,00,000/-
To, Bank A/c Rs 3,00,000/-
31st March 2018/2019 and 2020:
Depreciation A/c Dr Rs 80,000/-
To accumulated depreciation account Rs 80,000
31st March 2020: For disposal of asset
Bank Account Dr. Rs 70,000
Accumulated Depreciation Account Dr Rs 240,000
To Computers Account Rs 300,000
To Profit and Loss A/c Rs 10,000
 
Profit and loss account will show

Particulars 2017-18 2018-19 2019-20

Expenses
Depreciation 80,000 80,000 80,000
Misc Income    
Gain on sale of 10,000
asset
The balance sheet will appear as
Particulars 31st March 31st March 31st March 2020
2018 2019
Non- Current Assets
PPE- Gross Block 300,000 300,000 NIL
Less:Accumulated 80,000 160,000 NIL
Depreciation
Net Block 220,000 140,000 NIL
EXERCISE – Q1
• A- One Industries follows financial year as its accounting period. On 1st December
2007, the company bought five computers for a total consideration of Rs 5,00,000. The
company estimates the useful life of the computers to be four years with negligible
residual value. The company charges depreciation on a SLM basis. In the year of
acquisition and disposal proportionate depreciation is charged.
• On 15th January 2009, the hard disk of one of the computer became corrupted beyond
repairs and accordingly the computer was disposed off for Rs 30,000.
• The company sold two of the computers on 31st July 2010 for Rs. 80,000. The other
two computers are still in working condition.
• Prepare the depreciation schedule for the years 2007-08 to 2010-11.
• Pass the necessary journal entries in the books of A-One Industries.
• How would the remaining two computers appear in the balance sheet of the company
on 31st March 2011?
Solution – 2007-08
Computer Dr. 5,00,000
To Bank 5,00,000

Depreciation Dr. 41,667

To Provision for Depreciation 41,667

Profit and Loss Dr. 41667

To Depreciation 41667
Depreciation Schedule
Year 1 computer 2 computers sold Remaining 2 Total
sold in on 31.7. 2011 Computers Depreciation
15.1.2009
2007-08 8,333 16,667 16,667 41,667
Solution – 2008-09

Depreciation Dr. 1,19,792(19,792+ 1,00,000)

To Provision for Depreciation 1,19,792

Profit and Loss Dr. 1,19,792

To Depreciation 1,19,792

Bank Dr.30,000
Provision for Depreciation Dr. 28,125 (19,792 +8333)
Profit and Loss Dr.41,875
To Computer 1,00,000
Depreciation Schedule
Year 1 computer 2 computers sold Remaining 2 Total
sold in on 31.7. 2011 Computers Depreciation
15.1.2009
2007-08 8,333 16,667 16,667 41,667
2008-09 19,792 50,000 50,000 1,19,792
Solution – 2009-10
Depreciation Dr. 1,00,000
To Provision for Depreciation 1,00,000

Profit and Loss Dr. 1,00,000

To Depreciation 1,00,000
Depreciation Schedule
Year 1 computer 2 computers sold Remaining 2 Total
sold in on 31.7. 2011 Computers Depreciation
15.1.2009
2007-08 8,333 16,667 16,667 41,667
2008-09 19,792 50,000 50,000 1,19,792
2009-10 50,000 50,000 1,00,000
Solution – 2010-11

Depreciation Dr. 66,667 (16,667 + 50,000)

To Provision for Depreciation 66,667

Profit and Loss Dr. 66,667

To Depreciation 66,667

Bank Dr.80,000
Provision for Depreciation Dr. 1,33,333(16,666 +50,000+ 50,000 + 16,667)
To Computer 2,00,000
To Profit and Loss 13,333
Depreciation Schedule
Year 1 computer 2 computers sold Remaining 2 Total
sold in on 31.7. 2011 Computers Depreciation
15.1.2009
2007-08 8,333 16,667 16,667 41,667
2008-09 19,792 50,000 50,000 1,19,792
2009-10 50,000 50,000 1,00,000
2010-11 16,667 50,000 66,667
Balance Sheet
Fixed Assets
PPE 2,00,000
Less: Acc Dep 1,66,667
Net Block 33,333
Depreciation as per Companies Act, 2013
• Depreciation will be charged on pro-rata basis
• Schedule II of the Companies Act, 2013 prescribes the useful lives for various
categories of assets and residual values for calculating depreciation. The
useful life of an asset shall not be longer than the useful life as prescribed in
the schedule
• The residual value shall not be more than 5% of the original cost of the asset.
• If a company uses a useful life or residual value of an asset different from
what is prescribed, justification for the difference needs to be provided, in the
financial statements.
• Rates are calculated by managers based on cost, useful life and residual value
( Whether SLM or WDV)
Depreciation as per Income Tax Act, 1961
• Depreciation is allowed to be charged at the prescribed rates on the
written-down value of the asset
• As depreciation method and rates used for financial reporting and tax
accounting are different, it is major source of difference between
reported profit as per profit and loss account and taxable income
• Block of asset method is followed for charging depreciation
• Assets used for less than 180 days in a year are entitled to half the
normal depreciation allowance
 Profit and Profit and
Loss A/c Loss A/c
  (Accounting)         (Taxation)      
Op Stock 10Revenues 100  Op Stock 10Revenues 100 
Purchases 50Cl Stock 20  Purchases 50Cl Stock 20 
Gross Profit 60      Gross Profit 60     
Total 120Total 120  Total 120Total 120 
Gross
Exp 10 Profit 60  Exp 10Gross Profit 60 
Int 10Div 10  Int 10Div 10 
Dep Dep
( as per CO Act) 20      (Income Tax. Act) 15     
Profit Profit
(Book Profit) 30      (Taxable Profit) 35     
Total 70Total 70  Total 70Total 70 
EXERCISE – Q5
• Aar Dee Ltd bought a machine for Rs 6,00,000. The management
estimates a useful life of 10 years for the machine. After which it can
be sold for Rs 30,000. For accounting purposes, the company charges
depreciation on SLM basis. Whereas for Tax purposes the machine is
eligible for depreciation at 25% on WDV.
• Prepare the depreciation Schedule for Financial accounting as well as
tax accounting?
• How would the depreciation charge cause difference between taxable
income and reported profit in each of these years?
Year Depreciation as per SLM Depreciation as per WDV
1 57,000 1,50,000
2 57,000 1,12,500
3 57,000 84,375
4 57,000 63,281
5 57,000 47,461
6 57,000 35,596
7 57,000 26,697
8 57,000 20,023
8 57,000 15,017
10 57,000 11,263
• In the first 4 years, depreciation as per IT on WDV is higher as
compared to depreciation for financial accounting as per SLM
• So taxable income in the first 4 years will be lower than the reported
profit
• In subsequent years the taxable income will be higher than the
reported profit