Depreciation

Depreciation refers to the gradual and permanent decrease in the value of an asset from any cause.

​

​

Features of Depreciation

1. It is decline in the value of fixed assets.
2. This decline is of a permanent nature.
3. It is a non cash expense.
4. The term depreciation is used only in respect of tangible fixed assets.
5. It decreases the book value of the asset, not the market value.
6. It is the process of allocation of the cost of an asset to its effective span of life.
7. It is a gradual and continuing process because the value of the assets will decline either by their constant use, obsolescence or expiry of time.

​

​

​

​

Causes of Depreciation

1. Use: Wear and tear of assets due to their constant use in business operations.
2. Passage of time: The value of assets decreases with the passage of time even if they are not being put to use.
3. Obsolescence: Assets become obsolete (out of date) due to new and improved technologies.
4. Abnormal factors: Decline in the value of assets may be caused by abnormal factors such as accidents due to fire, floods, earthquakes etc.
5. Expiration of legal rights: Some assets lose their value after the expiry of predetermined period.

​

​

Need for providing Depreciation

1. For determining true profit or loss
2. For determining true and fair view of financial position
3. For avoiding overpayment of tax
4. Matching of costs and revenue

​

Factors affecting the amount of Depreciation

1. Cost of asset
2. Estimated scrap value
3. Estimated useful life of asset

Methods of Providing Depreciation

1. Straight line method/Original cost method/ Fixed instalment method
2. Written down value method/Diminishing balance method

Straight Line Method

Under this method, depreciation is charged at a fixed percentage on the original cost of the asset.

Annual Depreciation = (Original cost of asset – Estimated scrap value)/Estimated life of asset

​

QUESTION

If the original cost of the asset is Rs 100,000 and its scrap value is likely to be Rs 15,000 after its estimated life of 10 years, what will be the annual depreciation?

Annual Depreciation = (Original cost of asset – Estimated scrap value)/Estimated life of asset

= (100,000 – 15,000)/10

= Rs 8,500

​

ACCOUNTING TREATMENT (Journal)

1. For purchase of asset:

Asset A/c Dr.

To Bank A/c

2. For providing depreciation at the end of each year:

Depreciation A/c Dr.

To Asset A/c

3. For sale of asset:

Bank A/c Dr.

To Asset A/c

ACCOUNTING TREATMENT (Journal)

4. For loss on sale of asset:

Statement of Profit & Loss A/c Dr.

To Asset A/c

5. For profit on sale of asset:

Asset A/c Dr.

To Statement of Profit & Loss A/c

​

QUESTION

On 1^st April 2014, a limited company purchased a machine for Rs 190,000 and spent Rs 10,000 on its installation. At the date of purchase, it was estimated that the scrap value of the machine would be Rs 50,000 at the end of sixth year.

Prepare machine a/c and depreciation a/c in the books of company for 3 years after providing depreciation by straight line method.

Solution

Annual Depreciation = (Original cost of asset – Estimated scrap value)/Estimated life of asset

= (200,000 – 50,000)/6

= 150,000/6

= 25,000

Rate of depreciation = (25,000/200,000)X100

= 12.5%

​

Machine A/c

​

​

QUESTION

A plant is purchased for Rs 60,000 on 1^st April 2014. It is estimated that the scrap value of this plant at the end of its working life of 10 years will be Rs 20,920. Depreciation is to be provided at 10% p.a. on diminishing balance method.

You are required to show plant a/c for 3 years, assuming that the books are closed on 31^st March every year.

Plant A/c

​

​