Depreciation

MEANING:

Depreciation means decrease in the value of fixed assets caused by

use of asset, efflux of time or any other cause. Such annual loss in the

value of the asset is like any other expense and requires equitable

spread over the period of the useful life of the asset.

According to Accounting Standard (AS) - 6 (Revised 1994)

“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. Depreciation

is allocated so as to charge a fair proportion of the depreciable amount

in each accounting period during the expected useful life of the asset.

Depreciation includes amortization of assets whose useful life is

predetermined.”

CHARACTERISTICS OF DEPRECIATION

 Depreciation is always a fall in the value of only fixed assets.

 This fall is always gradual.

 The fall is of permanent character and it cannot be recouped after

words.

 The depreciation is a continuous process and it does not matter

whether the assets was put to use during the period or not.

 Depreciation is the fall in the book value of the assets and not in

market or exchange value.

 Depreciation is the result of the use of asset, passage of time and

 obsolescence.

Factors or Elements of Depreciation

1. Depletion: Depletion is an accounting concept used most often in

mining, timber, petroleum, or other similar industries. The depletion

deduction allows an owner or operator to account for the reduction of

a product's reserves

2. Amortisation: Amortization refers to expensing the acquisition cost

minus the residual value of intangible assets (often intellectual

property such as patents and trademarks or copyrights) in a

systematic manner over their estimated useful economic lives so as to

reflect their consumption, expiration, obsolescence or other decline in

value as a result of use or the passage of time.

3.Obsolescence: Due to technological developments, the asset in use

may become out dated and loose a large part of its value. This fall may

also be the result of changes in tastes and habits of customers,

changes in the supply and location of material resources, etc. in other

words, Obsolescence is a term used with the depreciation.

4. Abnormal Factors: There are some abnormal factors which also

lead to decrease the value of fixed assets. Examples of abnormal

factors are: Loss by fire; flood, earthquake, Theft etc.

CAUSES OF DEPRECIATION

 Wear and Tear due to use of the asset

 Accidents and Expiration of certain legal

 Obsolescence’s
Needs / Objectives / Importance of Depreciation

 To ascertain true profits

 To show true and fair view of financial position

 To provide funds for replacement of assets

 To keep the capital

 To Know the Correct amount of income tax

 Compliance with law

 Matching costs and Revenue:

Methods of Depreciation

1. Straight line method: Straight-line Method of depreciation is the

simplest and most commonly used technique, Under this method the

company forecasts the salvage value (Scrap value) of the asset at the

end of the accounting period during which it will be used to generate

revenues (useful life) and will expense a portion of original cost in

equal increments over that period.

2. Diminishing Balance method: It provides a higher depreciation

charge in the first year of an asset's life and gradually decreasing

charges in subsequent years are called accelerated depreciation

methods. This may be a more realistic reflection of an asset's actual

expected benefit from the use of the asset: many assets are most

useful when they are new. One popular accelerated method is the

declining-balance method.
 ACCOUNTING ENTRIES

(a) For writing off depreciation when provision for depreciation account

is not maintained-

(i) Depreciation account Dr.

To asset account

(Being the entry for providing depreciation on asset)

(ii) Profit and loss account Dr.

To depreciation Account

(Being the transfer of depreciation A/C to profit and loss A/C)

As a result of depreciation the asset appears at its reduced value in

the balance sheet.

(b) In case provision for depreciation account is maintained.

(i) Depreciation account Dr.

To provision for depreciation account.

(Being the entry for providing depreciation on asset.)

(ii) Profit and loss account Dr.

To depreciation account.

(Being the transfer of depreciation A/C to profit and loss A/C)

 Under this method, the asset account is not credited with the

amount of depreciation; instead provision for depreciation account is

credited.

 The asset appears in the balance sheet at its original cost and it

changes only on its sale, addition or when discarded.

 Provision for depreciation account which effects accumulated

 depreciation to date is either shown on the liabilities side of the

balance sheet or is deducted from the value of asset in the balance

sheet.

 When an asset is sold, the depreciation to the date of sale is

transferred from provision for depreciation account to the asset

account, as a result of which the fixed asset is brought down to its

written down value.

Provision for depreciation account Dr.

To asset Account

The difference between the sale price and the written down value of

the asset is profit or loss on sale. In case the sale price exceeds the

written down value of the asset, there shall be profit on sale. The

journal entry is:

(i) Cash / Bank account. .Dr. Sale price

To asset account

(ii) Asset Account...........Dr.

To profit and loss account Amount of profit

In case the sale of price of the asset is less than its written down value,

there shall be a loss on sale. The journal entry is:

Cash/Bank Account..............Dr Sale price

Profit and loss account.........Dr Amount of loss.
To asset account.........Written down value.
 Performa of Depreciation Account
Depreciation A/c

Date Particulars Amount Date Particulars

2009 2009
March March
31 By Asset A/c 31 By Profit & loss A/c

2010 2010
March By Asset A/c March By Profit & loss A/c
31 31

2011 By Asset A/c 2011 By Profit & loss A/c

March March
31 31

Provision for Depreciation Account:

Journal Entries:
1. Depreciation A/c Dr.

To Provision for Dep. A/c

(Being depreciation charged on asset)

2. Profit & Loss A/c Dr.

To Depreciation A/c
(Being Depreciation Transferred to Profit and Loss A/c)
 Performa of Provision for Depreciation Account
Provision for Depreciation A/c
Date Particulars Amount Date Particulars Amount
2010 2010
March March
31 By Balance c/d 31 By Depreciation
A/c

2011 2010
March By Balance c/d April1 By balance b/d
31 2011 By Depreciation
March A/c
31

2011 By Balance b/d

April 1

Asset Disposal Account:

Most commonly this method is used when a part of the asset is sold
and provision for depreciation account exists. Under this method a new
account ‘Asset Disposal account’ is maintained. This account may show
debit or credit balance, Debit balance shows Loss and Credit
Balance shows Profit. Asset disposal account is debited with the
original cost of asset, being sold, and credited with amount of Provision
for depreciation account. Amount of sale is also credited to Asset
disposal account.
 Performa of Asset Disposal Account
Asset Disposal A/c
Dat Particulars Amount Date Particulars Amount
e
2010 2010
Jan.1 Jan. 1
By Asset A/c By Provision for
Jan.1 Dep. A/c By Bank
Jan.1 (Sale)
By Profit & Loss
By Profit & A/c (Loss on
Loss A/c sale)
(Profit on
sale)