Effect Of Policies Of Depn
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Effect Of Policies Of Depn

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    Effect Of Policies Of Depn Effect Of Policies Of Depn Presentation Transcript

    • Issues in Income Determination
      Effect of Policies of Depreciation
    • Learning Objectives
      Concept of Depreciation
      Meaning and Definition of Depreciation
      Objectives of Depreciation Accounting
      Features of Depreciation
      Causes of depreciation
      Objectives of providing Depreciation
      Determination of Depreciation Amount
      Methods for providing Depreciation
      Accounting policies in relation to Depreciation
    • Concept of Depreciation
      Fixed assets wear out, are consumed or lose their value either because of use, efflux of time or obsolescence due to technology and market change.
      Depreciation is viewed as a measurement of the diminution in the value of the fixed assets.
    • Meaning of Depreciation
      It is the allocation of the cost of an asset to the periods that are expected to benefit from its use.
      It is the gradual conversion of the cost of an asset into expense.
      AS – 6 requires that depreciation to be charged on a “systematic basis” to each accounting period during the life of an asset.
    • Definition - AICPA
      A system of accounting which aims to distribute the cost or other basic value of tangible capital assets, less salvage (if any), over the estimated useful life of the unit in a systematic and rational manner.
      It is a process of allocation, not of valuation.
    • Objective of Depn Accounting
      To absorb the cost of using the assets to different accounting periods in a way so as to give the true figure or profit or loss made by the business.
    • Features
      All tangible assets except land have a limited useful life.
      It is allocation of cost of asset to the period that benefit from the service of that asset.
      It is not a process of valuation.
      It is used only in respect of fixed assets.
      It is charge against profits
      It is different from maintenance.
    • Causes of depreciation
      Wear and Tear
      Exhaustion
      Obsolescence
      Efflux of time
      Accidents
    • Objectives of providing Depreciation
      Ascertainment of true profits
      Presentation of true financial position
      Replacement of assets
    • Determination of Depn Amount
      Cost of the asset
      Estimated scrap value
      Estimated useful life
    • Methods for providing Depreciation
      Uniform Charge Methods
      Straight line/Fixed installment
      Depletion method
      Machine Hour rate method
      Declining Charge/accelerated Depreciation
      Diminishing Balance/WDV method
      Sum of Years Digits method
      Double Declining method
      Other Methods
      Inventory system
      Annuity method
      Depreciation Fund
      Insurance policy
    • Straight Line Method
      Under the SLM, the depreciable amount of the asset is distributed equally over the life of the asset.
      It is based on the assumption that depreciation arises solely from the passage of time, and the effect of usage on the service value of the asset is insignificant.
    • Example:
      A machine costs Rs 8,00,000 and is expected to realize Rs 80,000 at the end of its estimated useful life of six years. Calculate the annual depreciation and show the depreciation schedule for the asset.
      Solution:
      Depreciation = (Rs 8,00,000 – Rs 80,000)/ 6 years
      = Rs 1,20,000 p.a.
    • Depreciation Schedule: SLM
    • Critical Evaluation of SLM
      Merits:
      Simple to understand and easy to apply/compute
      Asset value can be reduced to zero/scrap value
      Used particularly in case of leasehold properties, patents, etc..
      Demerits:
      Same amount is charged irrespective of the usage.
      Total charge for use of asset goes on increasing i.e. repairs and depreciation.
    • Diminishing Balance Method
      Depn is computed at a fixed rate % of the book value of the asset at the beginning of an accounting period.
      Thus, the depn expense for year 1 will be a certain % of the beginning book value (cost).
      From year 2 onwards, the depn charge would be related to the cost of the asset, less accumulated depn at the beginning of the year.
      Since the fixed % rate is applied to the beginning book value, the depn expense will keep decreasing from year to year.
      It is also known as Written-Down Value Method
    • Critical Evaluation of WDV
      Merits:
      Amount of depn decreases every year, so charge to asset is almost equal by adding repairs and depn.
      Simple to understand and easy to follow
      Demerits:
      Asset value can not be brought down to zero.
    • Accounting Policies in Relation to Depreciation
      Accounting policies have a great role to play in determining the amount of depreciation charged and ultimately influence the income figure.
      Depreciation charged also depends on the method adopted by the management. But, whatever method is selected, must be applied consistently.
    • Problem:
      ABC Ltd purchases a machinery for Rs. 16,000. Its estimated life is 5 years, at the end of which, it will have a scrap value of Rs. 1,244. The asset has to be depreciated at 40% on diminishing balance method. If the profits, before depreciation, are Rs. 10,000 p.a., show what will be the amount of profits after depreciation under (1) Straight line method and (20) Diminishing balance method.
    • Solution:
      Effect of change in method of Depreciation on profitability
      Under SLM, the amount of Depn and profits after Depn are constant for each of the years.
      Under WDV method, the depn charged is heavy in the earlier years resulting in reduced profits.