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Accounting Standards 6

Depreciation Accounting

Accounting standards
The accounting standard(AS) 6, ’Depreciation Accounting’, issued by the ICAI. This standard was first issued in November 1985 and made mandatory from 1st April, 1995.

Learning Objectives: 1) Definition of Depreciation 2) Causes of Depreciation 3) Factors that affect the calculation of Depreciation 4) Methods of Depreciation a) Straight-line method b) Reducing balance method 5) Conclusion .

AS-6: DEPRECIATION ACCOUNTING According to Accounting Standard (AS 6) “Depreciation is a measure of the wearing out. consumption or other loss of value of a depreciable asset arising from use effluxion of time or obsolescence through technology and market changes” .

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 calculate this figure as accurately as possible. Since depreciation is a provision. it is important to spread the cost of the fixed asset over these years.Definition of Depreciation It represents the diminution in value of a fixed asset over a period of time.

Why do we have to include depreciation in the balance sheet and P & L A/c ? The depreciation charge in the profit and loss account represents a cost of expense and can be viewed as the cost of using the fixed asset over the period that the profit and loss account covers. .

ii) Erosion.Causes of Depreciation 1) Physical deterioration i) Wear and tear – When a motor vehicle or machinery or fixtures and fittings are used. rot and decay – Land may be eroded or wasted away by the action of wind. they eventually wear out. . rust. sun and other elements of nature. rain.

replacing a computer with old operating system with a new computer with XP system. For example.) 2) Economic factors i) Obsolescence: Process of becoming out of date. a small ferryboat that is operated by a firm at a coastal resort will become entirely inadequate cause of popularity. ii) Inadequacy: Arises when an asset is no longer used because of the growth and changes in the size of the firm. For example. . so the firm may replace it with a large ferryboat.Causes of Depreciation (cont.

the patents. perhaps due to the extraction of raw materials from them.Causes of Depreciation (cont. For example. For example. Rent some buildings for 10 years. . and leasehold.) 3) The time factor (the effluxion of time) Some assets might have a legal life fixed in terms of years. quarries and oil wells come under this heading. 4) Depletion Other assets are of wasting character. Natural resources such as mines.

4) Method of calculating depreciation .Factors that affect the calculation of Depreciation 1) Cost of asset (include expenses and capital expenditure incurred eg. the legal fees) 2) Estimated useful life of asset This is the number of years that the asset is expected to be used 3) Residual or scrap value of the asset This is the value of the asset at the end of its life. The installation fees.

INSURANCE POLICY METHOD Amount of depreciation of each year is paid as an insurance premium. For eg: Furniture & fixtures 2) WRITTEN DOWN VALUE METHOD  Rate of depreciation is fixed. 3)  ANNUITY METHOD Depreciation is calculated from annuity table. SINKING FUND METHOD The amount of depreciation created is invested outside. 4)  5)  .  Useful to assets whose service remain uniform throughout the year.Methods of Depreciation 1) STRAIGHT LINE METHOD  Amount of depreciation is fixed.

11) STATUATORY METHOD  Depreciation value/rate is fixed by this method. . 8) LABOUR HOUR RATE METHOD  Depreciation is calculated on the basis of labour hour worked.Methods of Depreciation (cont.) 6) ANNUAL EVALUATION METHOD 7) KILOMETRE METHOD  Depreciation calculated on the distance run by the transportation means. 10) PRODUCTION UNIT METHOD  Mostly used in mines to calculate the depreciation on production. 9) GLOBAL METHOD  Depreciation is calculated on the sum of all the assets.

Straight Line Method It is a very popular method because its simplicity & consistency. .

Straight Line Method a) Straight-line method (using equation) Straight-line method of depreciation is based on the cost of an asset that is then depreciated. Bought a machine at a cost of Rs.000. 14. The machine has an expected useful life of 5 years and at the end of the 5th year. Cost – Estimated Disposal Value Depreciation per annum = Expected useful life Example 1: ABC Ltd.000 . over the estimated useful life of the asset. it can be sold for Rs.000. by the same amount. 80. Depreciation per annum = Rs. 10.

Straight Line Method Depreciation for 5 years would be:   Cost Annual  Depreciation   Provision for  Depreciation   NBV Date of purchase 80.000 38.000 80.000 42.000 14.000 70.000 14.000 .000 80.000 80.000 10.000 End of 1st year End of 2cd year End of 3rd year End of 4th year End of 5th year 80.000 14.000 80.000 28.000 14.000 80.000 24.000 52.000 66.000 14.000 14.000 56.

If an additional asset is acquired.Straight Line Method ADVANTAGES 1. the amount to be charged as depreciation needs to be calculated. The valuation of the asset each year in the balance sheet is reasonably fair. 2. DISADVANTAGES 1. It is simple to calculate & easy to understand. 2. . It ignores the fact that the service yielding ability of the asset fall while the repairs & maintenance cost increase with the passage of time. 3. It can reduce the book value of the asset to zero.

LIFE OF ASSETS .Reducing Balance Method Amount of depreciation goes on declining every year.

419 30.000 x 15%  = 7.706 x 15%  = 4.185 .100 22.500 13.500 42.125 30.b) Reducing balance method Depreciation is calculated on a fixed percentage on the Diminishing Balance of the Asset (the NBV).500 36.606 26.000 End of 1st year End of 2cd year End of 3rd year End of 4th year End of 5th year 50.000 50.000 50. 50.875 19.000 50.000 50.000 is to be depreciated at 15% on Reducing Balance Method.375 36.000 0 50.915 7. Example 2: A machine costs Rs.815 42.706 26.000 50.   Cost Annual Depreciation Provision for  Depreciation NBV Date of purchase 50.100 x 15%  = 3.294 23.900 27. This results in a higher depreciation charge in the earlier years of the asset’s estimated useful life.125 x 15% = 5.500 x 15%  = 6.

2. the percentage used to calculate depreciation is very large . 4. Appropriate for assets which lose value quickly in the early year Appropriate for assets which become outdated/obsolete Easy calculation. 4. 3. For assets which have a short life. DISADVANTAGES: 1. 3. Balanced effect on profit or loss account of different years.Reducing Balance Method ADVANTAGES: 1. 2. Asset is never completed written off Loss of Interest Unequal burden of Profit & Loss A/c.

To Cash/Bank A/c. Dr. Dr. xx xx For Depreciation of Fixes Asset Depreciation A/c. To Depreciation A/c. To Machinery / Asset A/c. Dr. xx Xx For Transfer of Depreciation to P & L A/c. P & L A/c.Double entry records for Depreciation For Purchase of Fixed Asset Asset A/c. xx xx .

Dr. xx xx For Profit or loss on sale of Asset Machinery/ Asset A/c. To Profit on sale of asset A/c. xx xx For Selling Asset  Cash Received Cash/bank A/c. To Machinery / Asset A/c. Dr. Loss on Sale of asset A/c. To Machinery / Asset A/c. Dr. xx xx .Double entry records for Depreciation For Selling Asset  Depreciation till date Depreciation A/c. xx xx Dr. To Machinery A/c.

xx For Transferring Prov.Double entry records for Depreciation For Providing Depreciation on Asset Depreciation A/c. For Depn. xx Xx . xx To Provision for Depn. A/c. A/c. On Asset Sold Prov. Dr. For Depn. Dr. To Asset Sale A/c.

• For showing asset at fair and true value in the balance sheet.CONCLUSION • For determination of net profit or net loss. • Distribution of dividend out of profit only. • Provision of funds for replacement of assets. • Ascertaining accurate cost of production. .

Thank you .

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