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Depreciation

Depreciation is the allocation of the cost of a tangible asset over its useful life. The document discusses different depreciation methods like straight line, WDV and units of production and provides examples of their application and

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218 views19 pages

Depreciation

Depreciation is the allocation of the cost of a tangible asset over its useful life. The document discusses different depreciation methods like straight line, WDV and units of production and provides examples of their application and

Uploaded by

amit pal
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Depreciation

‘Depreciation is a measure of the wearing out,


consumption or other loss of value of a depreciable
asset arising from use, efflux ion of time or
obsolescence through technology and market
changes’

Depreciation accounting is the process of


allocating the cost of the tangible fixed asset less its
salvage value over its serviceable life.
The method of depreciation is applied consistently to
provide comparability of the results of the operations of the
enterprise from period to period. A change from one method
of providing depreciation to another is made only

 If the adoption of the new method is required by statute

 or for compliance with an accounting standard or

 If it is considered that the change would result in a more


appropriate preparation or presentation of the financial
statements of the enterprise.
Straight Line Method
(Fixes or Equal Installment Method
 It is called Straight Line because it
allocates an equal amount of
depreciation in each of the accounting
periods of the service life of the asset.
This method assumes that each
accounting period receives the same
benefit from using the asset as every
other period.
The depreciation charge for each
accounting period is therefore not affected
by the extent of use of the asset, its age or
efficiency. The formula for calculating
depreciation charge for each accounting
period is :
Annual Depreciation

Original Cost - Estimated Salvage Value


---------------------------------------------------------
Estimated Useful Life in years
For example if the machinery is purchased for
Rs. 1,00,000 on jan 1 and the installation charges
are Rs. 30,000 with an estimated scrap value of
Rs. 10,000 and estimated life of 5 years
Then depreciation as per SLM is :

Depreciation = 100,000 + 30000 – 10,000


_____________________________
5
120000
= __________
5
 Rate of depreciation
= Amount of depreciation
____________________________
Original cost
24,000
= ________ x 100
1,30,000

= 18.46%
 Advantages of Straight Line Method:
 This method is easy to use
 There is no change in the rate or the
amount of depreciation over the useful
life of the asset, such a procedure
provides a sound basis for comparison
 This method is recognized by the
Ind AS 16
 Disadvantages:
 i) It is illogical because depreciation is
considered to be a function of time rather
than a function of use.
 ii) It is based on the wrong assumption of
equal utility of the asset during its useful life
 iii) The amount of depreciation is same in
all the years , although the usefulness of the
asset is more in the beginning years than
that it is in later years
 The total charge in respect of an asset
is not equal from year to year though
depreciation is same for all the years.
Under this method, the amount of
repairs and maintenance together with
depreciation is much less in earlier
years than what it is in later years. The
burden on P&L A/c is more in later
years.
 WDV (Written down value method)
 It is also known as diminishing balance method
or reducing balance method.
 Under this method a fixed rate or percentage is
applied to the original cost in the first year and
to the book value in the subsequent years. The
book value of the asset means the undepreciated
balance of the asset cost, i.e, balance of the
asset cost not yet depreciated.
 In other words, the depreciation is calculated on
the reducing balance (asset cost--
depreciation) and not on the original cost.
 Rate of Depreciation

S
1 - ------ X 100
C

Where n = number of years assets life


S = Salvage value
C = Cost of the asset
 Advantages:

 The higher depreciation is charged in the earlier


years when the machine is most efficient. This
matches higher cost with larger revenues
resulting from the increased production.
 The obsolescence problem is given due care
because the major of the depreciation is charged
in the earlier years and the management has no
difficulty in replacing the asset.
 It equalizes the expenses of depreciation
and repairs taken together. It is assumed
that repairs are lowest in the initial years and
higher in the later years while the
depreciation under this method is higher in
the initial years and lower in the later years.
 The asset will never be completely written
off with the result that management can
keep a track of the asset
 This method is also recognized by Ind AS-16
 Disadvantages

 This requires much of figures work


 As the amount of depreciation varies year to
year, intra – enterprise comparability is lost
Units of Production Method
 In units of production method of depreciation,
depreciation is charged according to the actual usage of the
asset. In units of production method, higher depreciation is
charged when there is higher activity and less is charged
when there is low level of operation. Zero depreciation is
charged when the asset is idle for the whole period.

 Life of the asset is estimated in terms of number of


operations or number of machine hours etc.

 Such a method is useful where a company has many fixed


assets with varying usage.
Formula
The following formula is used to calculate depreciation under this method:

Number of Units Produced


Depreciation = × (Cost − Salvage Value)
Life in Number of Units
 A plant costing Rs. 1,10,000 was purchased on April
1, 2016. The salvage value was estimated to be
Rs10,000. The expected production was 1,50,000
units. The plant was used to produce 15,000 units till
the year ended March 31,2017. Calculate the
depreciation on the plant for the year ended March
31, 2017.

 Solution:
Depreciation = (15000/150,000) × (1,10,000 –
10,000) = 10,000
A coal mine was purchased by X Corporation for 16,00,000
million. It was estimated that the mine has capacity to produce
200,000 tones of coal. The company extracted 46,000 tones,
35,000 tonnes & 33,000 tonnes during its first, second and
third year of operation respectively. Calculate

a) Accumulated depreciation amount at the end of third year


of depreciation.
b) Carrying amount of the coal mine as at the end of second
year.
a) 9,12,000

b) 9,52,000

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