Every accountancy professional and student is aware of the importance of Depreciation while preparing financial statements. I have elaborated on this topic of accountancy. I hope this topic is going to be helpful for them.

1. DEPRECIATION IN ACCOUNTANCY
Definition of Depreciation
It is a gradual decrease in the efficiency of assets expressed in monetary
terms due to its use and wear and tear.
Causes of Depreciation:
Internal Causes:
1. Wear & Tear
Continued use of assets causes depreciation e.g use of machinery at the factory for producing
items.
2. Depletion
Some assets decline in value proportionate to their quantum of production e.g Mine, oil well, etc. As
extraction is made out of oil well or mine, its value continues to diminish until on full extraction it
becomes nill.

2. External Causes:
1. Obsolescence
Some assets become obsolete not because of their efficiency reduction but due to some other
causes. For example, a machine becomes obsolete if a new machine comes into the market with
more productivity.
2. Efflux of time
Some assets lose value even if they are not used e.g patent rights, copyrights, leasehold property,
etc.
3. Accidents
Some assets lose their value because of some abnormal reasons e.g flood, earthquake, fire, etc.
Why Depreciation is necessary
It is necessary to account for depreciation due to the following reasons:
Ascertainment of true profit or loss.
As depreciation is an expense item, it must not be ignored to account for to
arrive at the actual profit or loss for the period.
Ascertainment of the true cost of production
As production is made with the help of machinery and other assets if depreciation is ignored in
calculating the cost of production the actual cost of production cannot be ascertained.

3. The true value of the assets
The true value of assets cannot be ascertained if depreciation is not considered. In absence of
accounting for depreciation, assets continue to appear at more than their actual value.
Replacement of assets
If depreciation is for throughout the life of the assets the total profit is not withdrawn. hence there is
an amount that becomes available for the purchase of a new asset.
Keeping capital intact
The depreciation is accounted for keeping the capital. If no depreciation is taken then profits will
continue to show more than actual and as such will be withdrawn more. As a result, working capital
will continuously decrease which weakens the business.
Legal restriction
Sometimes it is legally required to account for depreciation e.g Companies Ordninace 1984 requires
that companies cannot declare dividends if depreciation is not provided on fixed assets.
Some important terms in calculating depreciation:
1. Cost Price of Asset
It is the purchase price of the asset and all the expenses incurred to bring the asset in working
condition e.g carriage, installation expenses, overhauling expenses, etc.
2. Scrap Value/ Salvage Value/ Residual Value
It is the value expected to be realized at the end of the useful/ working life of the asset.
3. Useful Life/ Working Life
It is the span of time during which an asset remains useful/ productive for the business.
Methods of Calculating Depreciation
1. Straight Line Method / Original Cost Method
Under this method, depreciation is calculated every time on the original cost of the asset. For
example, if machinery is bought for Rs. 1,00,000, the depreciation will be calculated at a given rate
of Rs. 1,00,000 every year.

4. Under this method the annual depreciation is calculated as under:
Annual Depreciation = Cost-Scrap Value
Estimated Life
If Annual Depreciation is to be expressed in percentage/ rate:
Annual Depreciation = Annual Depreciation x 100
Depreciable Value
2. Diminishing Balance Method / Declining Balance Method
Under this method, depreciation is calculated on the book value of the asset at a fixed rate.
Book Value = Cost - Depreciation
3. Double Declining Balance Method
Under this method, the depreciation is calculated on the book value of the asset at double the fixed
rate.
4. Sum of the Years digits Method (S.Y.D.)
Under this method, a constantly decreasing rate is applied to the original cost of the asset, and at
the end of its useful life, the asset's value is reduced to zero.
Under this method, we simply take the sum of individual years of asset's life as "denominator" and
individual year as "numerator".
For example:
Assets Cost = Rs. 1,00,000, Scrap Value = Rs. 10,000, and useful lif = 5 years
First of all, we will find denominator as follows:
1+2+3+4+5 = 15
Then to find the depreciation for the 3rd year for example, the depreciation will be calculated as
below:

5. 3rd year's depreciation = 3/15 x Rs90,000 = Rs. 18,000
Note: Depreciable value = Rs.1,00,000 (Asset's Cost)- Rs.10,000 (Scrap Value)
The above methods are related to I. Com and B. Com students.
Oher methods of depreciation are as below:
5. Annuity Method
6. Sinking Fund Method
7. Insurance Policy Method
8. Revaluation Method
9. Depletion Method
10. Machine Hour Rate Method
11. Mileage Method
12. Global Method
Relevant International Accounting Standard applicable to Property, Plant and Equipment
regarding depreciation is IAS 16
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