This document discusses depreciation accounting and various depreciation methods. It begins by defining depreciation as the reduction in value of an asset due to factors like usage, passage of time, wear and tear, etc. Depreciation is allocated over the useful life of an asset using methods like straight line, reducing balance, etc. The document then discusses various depreciation methods in detail like sinking fund method, insurance policy method, annuity method, and machine hour rate method. It also discusses accounting standard 6 related to depreciation accounting.

1. DEPRECIATION ACCOUNTING
Meaning of Depreciation: Every business acquires some non-trading fixed assets. These fixed
assets are used in the business for facilitating its trading activities and enhancing its revenue
earning capacity. These assets are basically purchased for the business with the intention of
permanent use and not for resale.
All fixed assets except the value of land decreases with the passage of time. The value of these
assets decrease each year. Such gradual reduction or decrease in the value of fixed assets for the
purpose of earning revenue is called depreciation.
In general words, depreciation is the reduction in the value of an asset due to usage, passage of
time, wear and tear, technological out dating or obsolescence, depletion, inadequacy, decay or
other such factors.
In accounting, depreciation is a term used to describe any method of attributing the historical or
purchase cost of an asset across its useful life. Depreciation is calculated on all depreciable assets
which can be defined as those which have a useful life for more than one accounting period but
is limited and are held by an enterprise for use in the production or supply of goods and services.
Examples of depreciable assets are machines, plants, furniture, buildings, computers, trucks,
vans, equipment, etc. Moreover, depreciation is the allocation of 'depreciable amount' which is
the 'historical cost' or other amount substituted for historical cost less estimated salvage value.
Depreciation has significant effect in determining and presenting the financial position and
results of operations of an enterprise. Depreciation is charged in each accounting period by
reference to the extent of the depreciable amount.
A systematic procedure for allocating the cost over the periods of its useful life in a rational
manner is called depreciation accounting.
Causes of Depreciation: Following are the main causes of depreciation:
1.Physical deterioration: It is caused mainly from wear and tear when the asset is in use and
from erosion, rust and decay from being exposed to wind, rain, sun and other elements of nature.
2.Economic factors: These may be said to be those that cause the asset to be put out of the use
even though it is in good physical condition. These arise due to obsolescence and inadequacy.
Obsolescence means the process of becoming obsolete or out of date. Old machinery in good
physical conditions may be rendered obsolete by the introduction of new model which produce

2. more than the old machinery. Inadequacy refers to the termination of the use of an asset because
of growth and changes in the size of the firm. But obsolescence and inadequacy do not
necessarily mean that the asset is scrapped. It is merely put out of use by firm.
3.Time factor: There are certain assets with a fixed period of legal life such as lease, patents and
copyrights. For instance, a lease can be entered into for any period while a patent’s legal life is
for some years but on certain grounds this can be extended. Provision for the consumption of
these assets is called amortization rather than depreciation.
4.Depletion: Some assets are of wasting characters perhaps due to extraction of raw materials
from them. These materials are then either used by the firm to make something else or are sold in
their raw state to other firms. Natural resources such as mines, quarries and oil wells come under
this heading. To provide for the consumption of an asset of a wasting character is called
provision for depletion.
Need for providing Depreciation:
1. To know the correct profits.
2. Show correct financial position.
3. Make provision for replacement of assets.
Methods of Depreciation
Different methods of calculating provision for depreciation are mainly accounting customs
which may be used by different concerns taking into consideration the individual peculiarities.
The following are the main methods of providing depreciation.
1. Straight Line Method.
2. Reducing Balance Method.
3. Change in Method of Depreciation
4. Sinking Fund Method
5. Insurance Policy Method.
6. Annuity Method.

3. 7. Machine Hour Rate Method.
8. Service Hour Method.
9. Depletion Method
10. Revaluation Method
11. Sum of Digits Method
Change in Method of Depreciation: According to Accounting Standard 6 issued by ICAI, the
depreciation method selected should be applied consistently. A change in the method of
providing depreciation can be made only in the following cases:
1. Adoption of new method is required by law or accounting standard.
2. The change is necessary for a better presentation of financial statements.
When the method of providing depreciation is changed, the depreciation should be recalculated
in accordance with the new method from the date of the asset coming to use. The deficiency or
surplus arising from retrospective re-computation should be adjusted in the books of accounts by
passing an adjusting entry.
Sinking Fund Method : This method is also known as Depreciation Fund Method. Under this
method sinking fund is created to provide a definite amount at a certain future date for a specific
purpose of replacement of the asset at the end of its useful life. An amount equal to the annual
depreciation of the asset is charged against the profits every year and accumulated in the form of
Depreciation Fund. At the time of replacement of the asset, the investment made are realised and
the available money is used in replacing the asset concerned.
Advantages of this method:
1.It is considered as scientific method from the point of accounting.
2. This method not only provides for the depreciation but also makes provision for replacement
of old asset, when it becomes useless.
Disadvantages: Under this system, the burden on the Profit and Loss Account in respect of
depreciation and repairs of an asset is not uniform year after year. This is because, though the

4. amount of depreciation debited to the profit and loss account every year is constant, the amount
of repairs debited to Profit and Loss Account goes increasing as the asset becomes older.
This method is adopted when it is desired not only to provide for depreciation but also to make
provision for replacement of old asset by new one.
Steps involved in the working of Sinking Fund Method:
Step 1 Calculate the amount of depreciation to be provided for with the help of sinking fund
table.
Step 2 Set aside the amount of depreciation at the end of each year.
Step 3 Purchase the Investments at the end of each year except last year.
Step 4 Receive the interest on investments at the due dates.
Step 5 Repeat Step 2,3,and 4 each year except last year.
Step 6 Realise the investments in the year of replacement of asset.
Step 7 Transfer profit/loss on sale of investments to Depreciation Fund Account.
Step 8 Transfer the balance left in Depreciation Fund Account to Respective Asset Account.
Accounting Entries
At the end of the 1st
year
1. For providing Depreciation
Depreciation A/c .............................Dr. (with the amount of depreciation)
To Depreciation Fund A/c
2. For closure of depreciation A/c
Profit and loss A/c ..........................Dr. (with the amount of depreciation)
To Depreciation A/c
3. For making Investments
Depreciation Fund Investments A/c................Dr. (with the amount of investments made)
To Bank A/c

5. At the end of 2nd
year and subsequent years
4. For receiving the interest on Depreciation Fund Investments
Bank A/c .................................Dr. (with the amount of interest received)
To Interest on Depreciation Fund Investments A/c
5. For transfer of interest on Depreciation Fund Investments
Interest on Depreciation Fund Investments A/c..........Dr. (with the amount of interest)
To Depreciation Fund A/c
6. For Providing Depreciation
Depreciation A/c .....................................Dr. (with the amount of depreciation)
To Depreciation Fund A/c
7. For closure of Depreciation A/c
Profit and loss A/c ..........................Dr. (with the amount of depreciation)
To Depreciation A/c
8. For making Investments
Depreciation Fund Investments A/c................Dr. (with the amount of investments made)
To Bank A/c
At the end of last year
9. For receiving the interest on Depreciation Fund Investments
Bank A/c .................................Dr. ( with the amount of interest received)
To Interest on Depreciation Fund Investments A/c
10. For transfer of interest on Depreciation Fund Investments
Interest on Depreciation Fund Investments A/c..........Dr. (with the amount of interest)
To Depreciation Fund A/c
11. For Providing Depreciation
Depreciation A/c .....................................Dr. (with the amount of depreciation)

6. To Depreciation Fund A/c
12. For closure of Depreciation A/c
Profit and loss A/c ..........................Dr. (with the amount of depreciation)
To Depreciation A/c
13. For realising the Depreciation Fund Investments
Bank A/c ........................................Dr.(with the sale proceeds of investments sold)
To Depreciation Fund Investments A/c
14. For transfer of profit or loss on realisation of Depreciation Fund Investments
a) In case of profit
Depreciation Fund Investments A/c..........Dr. (with the amount of profit)
To Depreciation Fund A/c
b) In case of loss
Depreciation Fund A/c ......................Dr. (with the amount of loss)
To Depreciation Fund Investments A/c
15. For transfer of the balance in Depreciation Fund A/c
Depreciation Fund A/c ......................Dr. (with the balance in depreciation fund account)
To Respective Asset A/c
16. For sale of Asset as scrap
Bank A/c .............................Dr. (with the scrap realised)
To Respective Asset A/c
17. For closure of Asset A/c
a) In case of Debit Balance
Profit and Loss A/c...................Dr. (with the balance in asset Account)
To Respective Asset A/c
b) In the case of Credit Balance

7. Respective Asset A/c ...............Dr. (with the balance in asset Account)
To Profit and Loss A/c
Insurance Policy Method: Under this method in order to provide for replacement of the asset at
the end of its useful life an amount equal to annual depreciation charged is used to pay premium
on insurance policy. At the end of the period the insurance company agrees to pay policy value,
which is used in purchasing a new asset.
Accounting Entries
A) For first and subsequent years:
1. In the beginning of the year for paying insurance premium.
Depreciation Insurance Policy A/c ....................Dr.
To Bank A/c
2. At the end of the year
Profit & Loss A/c ..............................Dr.
To Depreciation Reserve A/c
B) At the end of last year:
3. When money is received from insurance Co.
Bank A/c ..........................Dr.
To Depreciation Insurance Policy A/c
4. For transfer of accumulated depreciation to the asset A/c
Depreciation Reserve A/c ..........................Dr.
To Asset A/c
5. When new asset is purchased
New Asset A/c ................................Dr.
To Bank A/c

8. Annuity Method: This method is based on the presumption that when an asset is used in a
business the total loss to the business during the life of the asset is not only the original cost of
the asset but also the interest which could have been otherwise earned had the money spent in the
acquisition of the asset was invested in interest bearing securities. Under this method not only the
original cost of the asset but also the interest on the money invested on the asset is written off as
depreciation over the life of the asset. The amount of depreciation is uniform and is determined
on the basis of annuity table.
Journal Entries-
1. When the asset is purchased
Asset A/c .....................Dr.
To Bank
2. When interest is charged to the asset
Asset A/c ......................Dr.
To Interest A/c
3. When depreciation is charged
Depreciation A/c ...............Dr.
To Asset A/c
4. When interest is transferred to P & L A/c
Interest A/c ...................Dr.
To P & L A/c
5. When depreciation a/c transferred to P& L A/c
P & L A/c ........................Dr.
to Depreciation A/c

9. Machine Hour Rate Method: Under this method depreciation is calculated on the basis of time
during which the asset is used. Examples of assets which are depreciated under this method are
machinery, vehicles etc. the following formula is used to calculate depreciation.
Depreciation = Original cost of Asset—Scrap Value
Life of Asset in Hours
Service Hour Method: Service hour method is mostly useful for depreciating transport vehicles.
It takes into consideration the 'running time' of the asset for calculating the depreciation. Under
this method the depreciation is calculated by dividing the net total cost of the asset by its
estimated service life.
Depletion Method: Depletion means the exhaustion of natural resources. This method is
adopted in cases where it is possible to estimate the probable quantity of output available, for
example, oil well, mines quarries etc. Here the purchase price is paid for the acquisition of a
natural resource. Depreciation is calculated on one unit of the output by dividing the total value
of the acquisition of asset by the number of units expected to be produced.
Revaluation Method: Under revaluation method of depreciation, the assets are revalued each
year. The method is normally adapted to charge depreciation on numerous inexpensive fixed
assets like small tools, live stock, patents, copy rights and other assets of such nature which are
constantly changing and their period of life is most uncertain.
Illustration: (Revaluation Method)
On 1st July 2013, a firm has loose tools worth Rs 10,000. During the year they purchased tools
of Rs 6, 000 On December 2013, the loose tools valued at Rs 13,500.
On 1st June 2014, loose tools of Rs 8,000 were purchased. During the year, tools worth Rs 1,000
were stolen by the workers. The remaining tools valued at Rs 20,000.
During the year 2015, tools worth Rs 800 were broken and sold as scrap for Rs 150. In the same
year tools for Rs 800 purchased. Dec. 2015, tools were valued at Rs 18,500. Prepare Loose Tools
Account and Depreciation Account for three years.

10. Dr. Loose Tools A/c Cr.
Date Particulars Amount(Rs.) Date Particulars Amount(Rs.)
2013
July 1 To Balance b/d
To Bank A/c
10,000
6,000
2013
Dec. 31 By Depreciation A/c
By Balance c/d
2,500
13,500
16,000 16,000
Sum of Digits Method: Under this method, amount of the depreciation to be written off each
year is calculated by using the formula:
Remaining life of the asset(including the current year) * Cost of the asset
Sum of all the digits of the life of the assets in years
Suppose the life of an asset costing Rs. 2,00,000 is 10 years. The sum of all the digits 1 to 10 is
55. The depreciation to be provided in the first year will be:
10/55 *2, 00,000 = Rs. 36364
In the second year it will be
9/55 *2,00,000= Rs. 32727
in the third year it will be
8/55*2,00,000= Rs.29090

11. Accounting Standard 6- Depreciation Accounting
1. Depreciation is a measure of the wearing out, consumption or other loss of value of a
depreciable asset arising from use, passage of time or obsolescence through technology
and market changes. Depreciation is allocated so as to charge a fair proportion of the
depreciable amount in each accounting period during the expected useful life of the asset.
Depreciation includes amortization of assets whose useful life is predetermined.
2. The depreciable amount of a depreciable asset should be allocated on a systematic basis
to each accounting period during the useful life of the asset.
Depreciable assets are assets which
a) are expected to be used during more than one accounting period; and
b) have a limited useful life; and
[3] are held by an enterprise for use in the production or supply or for administrative
purposes.
3. --> Depreciable amount of a depreciable asset is its historical cost, or other amount
substituted for historical cost less the estimated residual value.
Useful life is the period over which a depreciable asset is expected to be used by the
enterprise.
The useful life of a depreciable asset is shorter than its physical life.
ϖ There are two method of depreciation:
1] Straight Line Method (SLM)
2] Written Down Value Method (WDVM)
Note: A combination of more than one method may be used.
ϖ The depreciation method selected should be applied consistently from period to period.
The change in method of depreciation should be made only if;

12. ♣ The adoption of the new method is required by statute; or
♣ For compliance with an accounting standard; or
♣ If it is considered that change would result in a more appropriate preparation of
financial statement; or
ϖ When there is change in method of depreciation, depreciation should be recalculated in
accordance with the new method from the date of the assets coming into use. (i.e
RETROSPECTIVELY)
The deficiency or surplus arising from such recomputation should be adjusted in the year
of change through profit and loss account.
Such change should be treated as a change in accounting policy and its effect should be
quantified and disclosed.
ϖ The useful lives of major depreciable assets may be reviewed periodically. Where there
is a revision of the estimated useful life, the unamortised depreciable amount should be
charged over the revised remaining useful life. (i.e. PROSPECTIVELY)
ϖ Any addition or extension which becomes an integral part of the existing asset should
be depreciated over the remaining useful life of that asset.
The depreciation on such addition may also be applied at the rate applied to the existing
asset.
Where an addition or extension retains a separate identity and is capable of being used
after the existing asset is disposed of, depreciation should be provided independently on
the basis of estimate of its own useful life.
ϖ Where the historical cost of a depreciable asset has undergone a change due to increase
or decrease in the long term liability on account of exchange fluctuations, price
adjustments, changes in duties or similar factors, the depreciation on the revised
unamortised depreciable amount should be provided prospectively over the residual
useful life of the asset.
ϖ This accounting standard is not applied on the following items.
• Forests and plantations

13. • Wasting assets
• Research and development expenditure
• Goodwill
• Live stock
ϖ Disclosure requirements
1] the historical cost
2] total depreciation for each class charged during the period
3] the related accumulated depreciation
4] depreciation method used ( Accounting policy)
5] depreciation rates if they are different from those prescribed by the statute governing
the enterprise.
1. A machine is purchased for Rs. 100,000 on 1st
January 2013. It was decided to
replace the machine at the end of the 4th
year. For this purpose an insurance policy
was taken out, the annual premium being Rs. 22,000.
Prepare a) Machinery A/c b) Depreciation fund A/c c) Depreciation Policy A/c
2. Abhay Tyres company Ltd. purchased a machinery on 1st
January 2013 for Rs. 50,000
and decided to make a provision for replacement by means of depreciation fund. The
investment yield 4% per annum. According to the sinking fund table Rs. 11,774.50
are to be invested annually. At the end of forth year the investments realised Rs.
36,700.
Prepare 1) Machinery A/c 2) Depreciation Fund A/c 3) Depreciation Fund Investment
A/c.
Objective Questions:

14. Choose the correct alternative from the following:
1. The main object of providing depreciation is:
a. To calculate true profit.
b. To show true financial position.
c. To reduce tax.
d. To provide funds for replacement.
2. Depreciation arises because of:
a. Fall in the market value of an asset.
b. Physical wear and tear.
c. Fall in the value of money.
d. None of them.
3. Depreciation is a process of:
a. Valuation
b. Allocation
c. Both valuation and allocation
d. None of them
4. Under the straight line method of providing depreciation it:
a. Increase every year.
b. Remain constant every year.
c. Decreases every year
d. None of them.
(3)
(a
.
(4)
(a)

15. (5) Under the diminishing balance
method depreciation it:
(a) Increases every
year.(b) Decreases
every year. (T)
(c) Remain constant
every year.
(d) None of them.
(6) Under the fixed installment
method of providing
depreciation it is calculated on:
(a) Original cost (T)
(b) on balance
amount(c) On scrap value
(d) None of
them
(7) Under the diminishing balance
method, depreciation is
calculated on:
(a) Scrap value
(b) On
original value(c) On book
value (T)
(d) None of them
(8) The amount of depreciation
charged on a machinery will be
debited to:
(a) Machinery
account (b)
Depreciation account (T)
(c) Cash account
d) Repair account
(9) Loss on sale of plant and
machinery should be written off
against:
(a) Share
premium(b)
Depreciation fund account (T)
(c) Sale account
(d) Profit & loss
account
(10) Loss on sale of machinery will
be:
(a) Debited on
machinery A/c(b)
Credited to machinery A/c (T)

16. (c) Credited to profit
and loss A/c
(d) None of them
(11) Asset which have a limited
useful life are termed as:
(a) Limited assets
(b)
Depreciation assets (T)
(c) Unlimited asset
(d) None of
these
(12) Process of becoming out of date
or obsolete is termed as:
(a) Physical
deterioration (b)
Depletion(c) Obsolescence
(T)
(d) Amortization
(13) Which of the term is used to
write off in reference to
tangible fixed assets.
(a) Depreciation(T) (b)
Depletion(c) Amortization
(d) Both (b)
and (c)
(14) The economic factors causing
depreciation:
(a) Time
factor(b) Obsolescence
and inadequacy (T)
(c) Wear and tear
(d) Money valuation
(15) Profit prior to incorporation is
an example of:
(a) Capital reserve (T)
(b) Revenue reserve(c)
Secret reserve
(d) None of these
(16) Total depreciation cannot
exceeds its:
(a) Scrap value
(b) Cost
value(c) Market value
(d)
Depreciable value (T)

17. (17) Depreciation value of an asset
is equal to:
(a) Cost + Scrap value
(b) Cost + Market
price(c) Cost – Scrap value
(T)
(d) None of these
(18) Depreciation does not depend
on fluctuations as:
(a) Market value of asset
(T)
(b) Cost of price of
asset(c) Scrap value of asset
(d) None of these
(19) Depreciation is:
(a) An income
(b) An
asset(c) A loss (T)
(d) A liability
(20) The books value of an asset is
obtained by deducting
depreciation from its:
(a) Market value
(b) Scrap
value(c) Market + Cost
price (d) Cost (T)
(21) Depreciation fund method is
also known as:
(a) Sinking fund
method (T)
(b) Annuity method
(c) Sum of years digits
method
(d) None of these
(22) The method is specially suited
to natural resources (mines,
quarries, sand, pits etc.) is said
to be:
(a) Annuity method
(b) Depletion
method (T)
(c) Revaluation method
(d) Sum of digits
method