DEPRECIATION

Prepared by:

Mrs. Bhawna

PGT Commerce

JNV Mouli, Panchkula

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FIXED ASSETS

• Assets acquired not for resale.
• Help to earn revenue for more than 1 financial year.

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Examples :

- A printing machine in a printing company.

- A van in a courier service company.

DEFINITION OF DEPRECIATION

• Applies only to fixed assets.
• The whole cost of the fixed assets must be spread over its useful life.
• The portion of the cost allocated to a particular accounting period is charged as an expense against revenue (Matching principle).
• This portion of the cost is called Depreciation.

CAUSES OF DEPRECIATION

INTERNAL CAUSES�

• Wear and tear, exhaustion, depletion, deterioration etc., causes depreciation on assets which are internal in nature.

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INTERNAL CAUSES

• Wear and Tear: The value of capital assets like plant, machinery, building etc. decrease in value due to constant use. The wear and tear of an asset depends on the usage of asset. For example, when machinery is used for three shifts the wear and tear will be greater than the machinery which is used on a single shift.
• Exhaustion: Certain assets like plantations and livestock loose their value with lapse of time as they are being used or consumed.

• Depletion: Natural resources such as mines, quarries and oil wells are of a wasting character and are called as wasting asset. These assets loose their value due to extraction of oil, depletion of minerals and metals.
• Deterioration: Deterioration means erosion in value of those assets which have a very short period of life. The fall in value of those assets refers to depreciation.

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EXTERNAL CAUSES�

• External factors which

cause depreciation

include passage of time

, obsolescence, permanent

fall in market value and

due to weather and

accidental calamities.

These factors are not

connected to the inherent nature of the asset.

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EXTERNAL CAUSES�

• Passage of Time: For example, asset like lease hold property becomes valueless after the expiry of the period of lease.
• Obsolescence:  for example, the demand for a product or service falls to such a level that it is no longer viable to continue with that product or service

• Due to Weather and Natural Calamities: Some assets lose in value when they are constantly exposed to rain, sun, wind etc. and certain assets decline in value when they are affected by certain natural calamities like flood, earth quake, fire etc.
• Permanent fall in the Market Value:  Assets like investments lose in value due to permanent fall in market value of the asset. Such a fall in the price of an asset should be treated as depreciation.

METHODS OF DEPRECIATION

• Straight-Line
• Reducing Balance

STRAIGHT LINE METHOD

• A fixed asset is depreciated by an equal amount per year.
• Example: If an asset is depreciated by $1,000 in the first full year of usage, it will also be depreciated by Rs1,000 in the second year; Rs 1,000 in the third year and this continues annually until it is fully depreciated.

STRAIGHT LINE METHOD

• Advantages
• Easy to calculate.
• Easy to understand.
• Disadvantage
• Assumes fixed asset gives same amount of service annually throughout its useful life.

STRAIGHT LINE METHOD

• A machine X costs Rs20,000 is expected to last 4 years. At the end of the 4th year, it can be sold for Rs 2,000 as scrap.
• Depreciation per year = (Original cost - Residual value)/ Expected useful life
• = (20,000 – 2000) 4
• = Rs 4,500

REDUCING BALANCE METHOD OF DEPRECIATION

• The amount of depreciation per year diminishes with every successive year.
• Example: - If an asset is depreciated by Rs 2,000 in the first full year of usage, it will be depreciated by less than Rs2,000 (eg Rs1,600) in the second year; and even less (eg Rs1,300) in the third year. This continues until it is fully depreciated.

• Advantage
• REDUCING BALANCE METHOD •Disadvantages - Overall expenses ( including repairs and maintenance) charged for the use of a fixed asset would be fairly constant.
• Disadvantages
• Difficult to calculate.
• Assets are always left with a small value at the end of useful life.

• A machine Y costs Rs10,000 is depreciated at 20% per annum on the reducing balance method. Show depreciation for the first 3 years.

Difference between SVM and WVM

Journal Entries of Depreciation

• For recording purchase of asset

Asset A/c Dr.

To Bank/Vendor A/c

• Following two entries are recorded at the end of every year
• For deducting depreciation amount from the cost of the asset.

Depreciation A/c Dr. (with the amount of depreciation)

To Asset A/c

• For charging depreciation to profit and loss account.

Profit & Loss A/c Dr. (with the amount of depreciation)

To Depreciation A/c

Question

• Salman and Usman Bros. acquired a machine on July 1, 2014 at a cost of ` 70,000 and spent ` 5,000 on its installation. The firm writes off depreciation @ 10% on straight line method. The books are closed on December 31 every year. Show the machinery and depreciation account for three years.

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DEPRECIATION ACCOUNT

SOLUTION:

MACHINERY ACCOUNT