Deprciation Created Wednesday, December 27, 2006


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Deprciation Created Wednesday, December 27, 2006

  1. 1. Depreciation Arunesh Chand Mankotia - Wednesday, December 27, 2006 1
  2. 2. Contents to discuss…Ω Depreciation: ● Definition; ● Characteristics; ● Causes; ● Objectives;Ω Depreciation & other related concepts;Ω Basis of providing Depreciation;Ω Methods to calculate Depreciation; 2
  3. 3. Meaning of Depreciation: Ω Depreciation is the allocation of the cost of a fixed asset to expense over its useful service life in a rational & systematic manner; Ω Depreciation is the diminution in intrinsic value of the asset due to use or lapse of time; Ω It can be defined as a part of the cost of the fixed asset which has expired on account of its usage; 3
  4. 4. Characteristics:Ω Depreciation reduces the book value of an asset;Ω Reduces the book value but not the market value;Ω It is a continuing process;Ω The term depreciation is used only for the tangible assets;Ω It takes place gradually unless there is a quick physical deterioration or obsolescence due to technological developments ; 4
  5. 5. Causes:Ω Wear & Tear;Ω Obsolescence;Ω Accidents;Ω Fall in market prices;Ω Efflux of time; 5
  6. 6. Objectives:Ω To ascertain the profit or loss properly;Ω To show the asset at its proper value;Ω To retain out of profits funds for replacement;Ω To show the true & fair view of the financial position. 6
  7. 7. Depreciation & other related concepts 7
  8. 8. Amortization:Ω Depreciation & Amortization: ● Amortization refers to writing off the proportionate value of the intangibles such as Goodwill, Copyrights etc;Whereas ● Depreciation refers to the writing off the expired cost of the tangible assets like Machinery, Building etc; 8
  9. 9. Obsolescence:Ω Depreciation & Obsolescence: ● Obsolescence refers to decrease in usefulness caused on account of the asset becoming out of date, old fashioned etc…Whereas ● Depreciation, is a loss in value of an asset due to regular wear & tear; ● Obsolescence is a cause; 9
  10. 10. Depletion:Ω Depreciation & Depletion: ● Depletion is used in respect to the extraction of natural resources like quarries, mines etc… that reduces the availability of quantity of the material or asset.Whereas ● Depreciation is the reduction in value of asset because of wear & tear. 10
  11. 11. Basic Factors forProviding Depreciation 11
  12. 12. Ω Original cost of the asset: ● Cost will include all expenses incurred like freight charges until the asset is ready for use;Ω Estimated scrap value at the end of its life: ● Residual/Scrap value is an estimated sale value of the asset at the end of its economic life;Ω Estimated effective or commercial life: ● An asset can work for twenty years but can lose its commercial value within ten years, thus, life for the purpose of accounting should be considered only ten years. (Therefore, physical life is not important) 12
  13. 13. Methods To Calculate Depreciation: Straight line method; Written down Method; 13
  14. 14. Straight Line Method:Ω In this method a suitable percentage of original cost is written off the asset every year.Ω The amount is uniform from year to year. 14
  15. 15. Depreciation calculated as… Depreciation: Cost – Estimated scrap value Number of years of expected lifeDepreciation Account……………..Dr. To Asset Account;Instead of crediting the asset, the credit maybe placed in the Provision for DepreciationAccount, so that the asset account willcontinue to appear at the original cost.Depreciation Account………………Dr. To Provision for Dep. Account 15
  16. 16. Cont…with an exampleΩA firm bought a machinery for $38000 & itslife was estimated to be 8years. The scrapvalue at the end of the period was $6000.Find out the depreciation: Depreciation: $38000 - $6000 = $ 4000 8 yearsDepreciation Account………………Dr.$4000 To Provision for Dep. Account $4000(Being depreciation $4000 charged annually onmachinery through a provision created for Dep.) 16
  17. 17. Merits & DemeritsΩ Simple method of Ω No arrangement of calculating interest on capital; depreciation;Ω Asset can be Ω By pass of time, work depreciated up to the efficiency of asset scrap value; decreases & repair expenses increases,Ω Easy to know the thus more weightage amount of on P&L account; depreciation; Ω Book value of theΩ Same effect on P&L account; asset becomes zero17
  18. 18. Written Down Value Method: Ω In this method the depreciation is charged at a fixed rate on the reducing balance every year i.e. cost less depreciation; Ω In other words, the cost of asset less estimated scrap value has to be written off over its estimated useful life; Ω A certain percentage is applied to the book value, not the cost of the asset. 18
  19. 19. Cont…with an exampleΩSuppose the cost of a plant is $20000 on 1st ofJan 2000 & the percentage to be written offeach year is 10% for the next 3 years. Calculatethe depreciation charged. Depreciation: $20000 * 10 = $2000 100Depreciation Account………………Dr.$2000 To Provision for Dep. Account $2000(Being depreciation $2000 charged annually onmachinery at the rate of 10%.) 19
  20. 20. Machinery AccountDate Particulars Amt Date Particulars Amt2000, 2000, By Provision for 2000 1st To Bank 20000 31st Dep. Account Jan Dec 18000 By Bal c/d 20000 200002001, 2001, By Provision for 1st To bal b/d 18000 1800 31st Dep. Account Jan Dec By Bal c/d 16200 18000 180002002, 2002, By Provision for To bal b/d 1620 1st 16200 31st Dep. Account Jan Dec 14580 By Bal c/d2003, 16200 16200 2002, 1st 14580 31st By Provision for Dep. 1458 Jan To bal b/d Dec Account 20
  21. 21. Merits & DemeritsΩ Same weightage on Ω The value of asset can P&L account of never be zero; depreciation & repair expenses; Ω There is a difficult task to ascertain theΩ Accepted by the proper rate of Income-tax Act; depreciation;Ω When increase in Ω There isn’t any assets, the provision of interest on depreciation can be capital invested in use easily computed; of asset; 21
  22. 22. The two methods…Ω M/s Bullock purchased machine for $80000 on 1st Jan 1988. Depreciation is provided at 10%p.a. for the next three years.Ω The difference of working b/w the two accounts is as following:Year Straight Line Method Written Down Method Book value of asset Depreciation Book value of asset Depreciation $ $1988 80000 8000 80000 80001989 72000 7200 72000 80001990 64000 8000 64800 6480At beginning of year 1991: 24000 21680 22
  23. 23. Thank You 23