depriciation . defination , methods , numericals, need, etc . for bcom students accounting and finance basic chapter of depriciation

1. ACCOUNTS HONOURS
DEPRICIATION POLICY
PRESENTED TO:-
MAM sangam kapoor

2. o Meaning of Depreciation
o Why is Depreciation important?
o Depreciation is an Estimate
o Methods of Depreciation
o Depreciation under Companies and
Income Tax Act
o Recording of Depreciation

3. The term depreciation is derived from the Latin words ‘do’
meaning down and ‘pretium’ meaning price. It means putting
down the value of an asset due to wear and tear , passage of
time, obsolescence, etc. According to Malchman and Slavin ‘
Depreciation refers to the process of estimating and recording
the periodic charges to expense due to expiration of the
usefulness of a capital asset”

4.  According to J.N. Carter, “Depreciation is the
gradual and permanent decrease in the value of an
asset from any cause.”
 According to J.R. batiliboi , “Depreciation represents
loss or diminution in the value of an asset consequent
upon wear and tear , passage of time, obsolescence, or
fall in the market value.”
 The institute of chartered Accountants of England
and Wales has described depreciation as thus :
“ Depreciation represents that part of the cost of fixed
assets to its owner which is not recoverable when the
asset is fully put out of use by him.

5.  From the above definitions it is clear that depreciation is the
gradual , continuing and permanent fall in value of fixed assets
.
 The main cause for this fall in value are wear and tear, passage
of time, obsolescence, or fall in the market value, inadequacies,
depletion etc.
 In recent editions of English language dictionaries the word
depreciation has been described as decline in the value of an
asset due to such causes as wear and tear , passage of time,
obsolescence and inadequacy.

6. CHARATERISTICS OF
DEPRECIATION
The Depreciation charged on fixed assets has the following
features:
 Depreciation is always a fall in the value of asset.
 This fall is always gradual.
 The fall is of permanent character and it cannot be
recouped afterwards.
 The depreciation is a continuous process and it does not
matter whether the asset was put to use during the period
or not.

7.  Depreciation is always on fixed assets and not on
current or floating assets .
 NOTE - Fixed assets are those assets which are of material value not meant
for resale and having fairly long life and are used in business . With the
exception of LAND all fixed assets have a limited useful life such as plant
and machinery ,furniture , motor van and building.
 Depreciation is the fall in the book value of the
asset not in market or exchange value.
 Depreciation is the result of the use of assets,
passage of time and obsolescence.

8. CAUSES OF DEPRECIATION
1. Use of the asset or wear and tear
2. Accident
3. Expiration of Certain Legal Rights
4. Obsolescence
5. Inadequacy
6. Depletion

9. NEED FOR PROVIDING
DEPRECIATION
The providing of depreciation on fixed assets is important
because of the following:
 To know the true Profit or Loss: The depreciation is an
expense though not payable to any outside party and does
not involve outflow of funds. But even then when the fixed
assets are put to use I the business , the toss in their value
must also be acknowledged to know the true profit or losses
.as per matching principal of accounting all costs must be
recorded whether paid or not which are incurred to earn
revenue.

10.  To show true and fair view of financial
position: The correct financial position of a
business is depicted by balance sheet. While
preparing balance sheet it is necessary that
fixed assets are shown at figures derived after
deducting depreciation from their book values.
If not ,fixed assets might be over stated and
balance sheet may not show true and fair view
of financial position.

11.  To provide funds for replacements of assets .
Depreciation is a source of funds for replacements
of assets . After useful life , sufficient funds will
be required at the deposal of the firm if proper
depreciation provision are made otherwise firm
may face financial difficulties for replacement
after the assets become useless.

12. Concept of depreciation accounting
The growing importance of depreciation accounting in the
twentieth century may be attributed to several factors as
follows:
 With the growth of mechanization in production ,
depreciation has become a sizeable amount affecting the cost
of production.
 Capital budgeting also needs the determination of proper
amount of depreciation . A considerable amount of capital is
required for the replacement of old assets at the end of their
useful life.
 The fluctuations in prices of assets at the end of their useful
life.
 The technological developments have increased the incidence
of obsolescence of assets.

13. Basic factors in estimating
DEPRECIATION
To determine the amount of depreciation of a fixed
asset, the following factors are to be taken into
consideration:
1. Cost of the asset ;
2. Useful life of the asset ;
3. Salvage value ;
4. Method of depreciation

14.  Cost of Asset: The cost of the asset includes all
reasonable expenses that are incurred to bring the asset
in a workable condition.
 Useful life of the Asset: The determination of the useful
life of an asset is of great importance because it is the
useful life over which the whole cost of the asset is to be
written off by way of depreciation. The useful
serviceable life is estimated either from depreciation rates
by income tax authorities or from opinions of engineers
or experience with similar assets.

15.  Salvage value : it is the amount that can be recovered
from the sale of the asset after the expiry of its useful
serviceable life. In those cases where this amount is
insignificant, it is ignored altogether but when this
amount is quite substantial, the depreciation is
calculated on net cost of the asset, that is original cost
less salvage value.

16. Depreciation is the value of wear and tear of a fixed asset
Such a value is calculated as:
Cost of the Fixed Asset — Estimated Scrap Value
Estimated Life of the Asset

17. METHODS OF DEPRECIATION
1. Fixed installment or straight line method
2. Diminishing balance method
3. Annuity method
4. Depreciation fund method
5. Insurance Policy method
6. Depletion method
7. Machine Hour Rate method

18. Fixed installment method is also know as straight line
method or original cost method. Under this method the expected
life of the asset or the period during which a particular asset will
render service is the calculated. The cost of the asset less scrap
value, if any, at the end f its expected life is divided by the
number of years of its expected life and each year a fixed amount
is charged in accounts as depreciation. The amount chargeable in
respect of depreciation under this method remains constant from
year to year. This method is also know as straight line method
because if a graph of the amounts of annual depreciation is
drawn, it would be a straight line.
FORMULA:
Annual Depreciation = [(Cost of Assets - Scrap Value)/Estimated
Life of Machinery]

19. MERITS OF FIXED INSTALMENT METHOD:
1. SIMPLE: It is very easy method of providing depreciation and the
calculations are very simple.
2.ASSET IS FULLY WRITTEN OFF: life. According to this
method, the asset account is written off fully at the end of its working
3. KNOWLEDGE OF TOTAL DEPRECIATION CHARGED: The
amount of total depreciation charged to profit and loss account can be
easily ascertained by multiplying the annual instament of depreciation
with the number of years , the machine has been used.
4. SUITABLE FOR FIXED LIFE ASSET: This method is very
suitable for those assets which have a fixed working life e.g. furniture
etc.

20. DEMERITS:
1. INTEREST ON CAPITAL: The interest on capital invested in
fixed assets is ignored under this method also, with the result
profits are overstated.
2. NO FUNDS FOR REPLACEMENT: This method does not
solve the problem of availability of funds at the time of
replacement of assets.
3. ASSET IS NOT REDUCED TO ZERO: The value of asset under
this method is never reduced to zero.
4. RATE OF DEPRECIATION: It is difficult to calculate the rate
of depreciation under this method.

21. 1.
Depriciation a/c Dr.
TO Asset a/c
(Being depriciation charged to asset)
Profit and loss a/c Dr.
To depriciation a/c
(Being the dpriciation charged transferred to P/L a/c.
Same entries are to be passed each year during the life of asset
and at the end of last year following entry would be passed.
Bank a/c Dr.
To asset a/c
(Being the scrap of asset sold)
Journal Entries:
The journal entries that will have to be made under this method are
very simple.
The journal entries will be as under:

22. On 1st January 1991 X purchased a machinery for $21,000. The estimated life of the machine is
10 years. After it its break up value will be $1,000 only. Calculate the amount of annual
depreciation according to fixed installment method (straight line method or original cost
method) and prepare the machinery account for the first three years.
Dr. Cr.
DATE PARTICULARS AMT. DATE PARTICULARS AMT.
1/1/91 To Bank a/c 21000 31/12 By machinery a/c 2000
By balance c/d 19000
21000 21000
1/1/92 To bal . b/d 19000 31/12 By depriciation a/c 2000
By balance c/d 17000
19000 19000
1/1/93 To bal b/d 17000 31/12 By depricition a/c 2000
By balance c/d 15000
17000 17000
EXAMPLE
Machinery Account
Machinery Account

23. DEPRECIATION FUND METHOD
Depreciation fund method is also know as sinking fund
method or amortization fund method. Under this
method, a fund know as depreciation fund or sinking
fund is created. Each year the profit and loss
account is debited and the fund account credited with
a sum, which is so calculated that the annual sum
credited to the fund account and accumulating
throughout the life of the asset may be equal to the
amount which would be required to replace the old
asset. In order that ready funds may be available at
the time of replacement of the asset an amount equal
to that credited to the fund account is invested outside
the business, generally in gilt-edged securities. The
asset appears in the balance sheet year after year at its
original cost while depreciation fund account appears
on the liability side.

24. 31 December PARTICULARS £
Original machine cost 75,000
2013 Depreciation in 2013 (40% cost) 30,000
Written down value at 31 December 20X3 45,000
2014 Depreciation in 2014 (40% of WDV @ 31 December 2013) 18,000
Written down value at 31 December 2014 27,000
2015 Depreciation in 2015 (40% of WDV @ 31 December 2014) 10,800
Written down value at 31 December 2015 16,200
2016 Depreciation in 2016 (40% of WDV @ 31 December 2015) 6,480
Written down value at 31 December 2016 9,720
2017 Depreciation in 2017 (40% of WDV @ 31 December 2016) 3,888
Written down value at 31 December 2017 5,832
EXAMPLE