3. CONCEPT
• Depreciation is the allocation of the
depreciable amount of an asset over its
estimated life.
• A permanent fall in the value of fixed
assets arising through wear and tear from
the use of those assets in business.
4. The Objective of Depreciation
• According to the matching concept,
revenues should be matched with
expenses in order to determine the
accounting profit.
• The cost of the asset purchased should be
spread over the periods in which the asset
will benefit a company.
5. • Value of Fixed Assets decreases with
passage of time and its utilization. Value of
the portion of asset utilized for generating
revenue must be recovered during that
accounting year to ascertain real income.
Portion of the cost of a fixed asset allocated
to a particular accounting year is called
Depreciation and is charged to Profit and
Loss Account
DEPRECIATION
6.
7. • According to American Institute of Certified
Public Accountants (AICPA) ‘Depreciation
Accounting is a system of accounting which
aims to distribute the cost or other basic value of
tangible capital assets, less Salvage value (if
any) over the estimated useful life of the unit
(which, may be a group of assets) in a
systematic and rational manner. It is a process
of allocation, not of valuation. Depreciation for
the year is portion of the total charge under such
a system that is allocated to the year’
8. NEED FOR PROVIDING DEPRECIATION
• To ascertain true results of operations
• To present true and fair view of the financial
position
• To ascertain the true cost of production
• To comply with legal requirements
• To accumulate funds for replacement of assets
9. CAUSES OF DEPRECIATION
• Physical wear and tear
• With the passage of time
• Changes in economic environment
• Expiration of legal rights
• Accidents
• Obsolescence (Out of date)
• Depletion (Exhausted)
10. FACTORS DETERMINING THE AMOUNT
OF DEPRECIATION
• Historical Cost or Original Cost of the Asset
• Expected useful life
• Estimated residual or scrap value
11. Non-Depreciable Assets
• Freehold Land
– It has an indefinite useful life, and it retains its value
indefinitely.
• Leasehold Land (Long Lease)
– It has an unexpired lease period not less than 50
years
• Investment Property
– Which construction work and development have been
completed
– Which is held for its investment potential, any rental
income being negotiated at arm’s length.
12. Methods of Allocating Depreciation
1. Straight Line Method or Fixed Installment Method
or Original Cost Method
2. Written Down Value Method or Declining Charge
Method or Diminishing Balance Method
3. Sum of years Digit method
4. Revaluation Method
5. Annuity method or compound interest method
6. Depreciation fund or Sinking fund method
7. Insurance Policy Method
8. Depletion Method
9. Machine hour method or Production unit method
13. ‘Straight Line Method’ of Depreciation
• A fixed and equal amount in the form of
depreciation, according to a fixed percentage on the
original cost, is written-off during each accounting
period over the expected useful life of the asset.
• Amount of Dep. = Original Cost – Residual Value
Expected Useful Life of the Asset
• Rate of Dep. = Amount of Depreciation x 100
Original Cost
14. Useful Economic Life & Residual Value
• Useful economic life is not equal to
physical life
• It is the period over which the present
owner intends to use the asset
• It is the amount received after disposal of
the asset
Cost of asset - Residual value = Total amount to be depreciated
15. ‘Written Down Value Method’ of Depreciation
• Depreciation according to a fixed percentage
calculated upon the original cost (in the first
year) and written down value (in subsequent
years) of an asset, is written off during each
accounting period over the expected useful
life of the asset.
• The rate of depreciation remains constant
year after year whereas the amount of
depreciation goes on decreasing.
16. Change in the Method of Depreciation
According to revised AS-6 issued by ICAI, the depreciation
method selected should be applied consistently, to provide
comparability of results of the operations of the enterprise from
period to period. A change from one method of providing
depreciation to another should be made only if, the adoption of
the new method is required by statute or for compliance with
an Accounting Standard or, if it is considered that a change
would result in more appropriate preparation of the financial
statements of the enterprise. When such change of method of
depreciation is made, depreciation should be recalculated in
accordance with the new method from the date of the asset
coming into use.
17. Change in method of Depreciation with Retrospective Effect
1. Calculate the aggregate Depreciation already provided on
existing assets (i.e. other than sold or discarded) under the
existing method up to the end of previous accounting year.
2. Calculate the aggregate depreciation on the existing assets
retrospectively from the date of the asset coming into use
under the new method up to the end of previous accounting
year.
3. Calculate the difference between the existing method (1) and
the new method (2)
4. Adjust the short depreciation (excess of step 2 over step 1)
by Dr. P&L A/c and Cr. Asset A/c
OR
Adjust the excess depreciation (excess of step 1 over step
2) by Dr. Asset A/c and Cr. P&L A/c
5. Charge depreciation from the current accounting year and
onwards by adopting new method.
18. When a Provision for Depreciation
account is maintained
In order to record depreciation, a provision
for depreciation may or may not be
maintained. In case a ‘Provision for
Depreciation Account’ is maintained, the
respective asset appears at its original
cost since the depreciation is credited to
‘Provision for Depreciation Account’
instead of the asset A/c.
19. Journal Entries when Provision for
Depreciation is maintained
1 For Providing Depreciation Depreciation A/c Dr.
To Provision for Depreciation A/c
2 For closure of Depreciation
A/c
Profit & Loss A/c Dr.
To Depreciation A/c
3 On disposal of an asset
(i) For transfer of
accumulated depreciation
on asset disposed off
Provision for Depreciation A/c Dr.
To Asset A/c
(ii) For recording sale
proceeds
Bank A/c Dr.
To Asset A/c
4 For transfer of balance in
Asset Disposal A/c
(a) In case of Profit Asset A/c Dr.
To Profit & Loss A/c
(b) In case of Loss Profit & Loss A/c Dr.
To Asset A/c
20. Depreciation of Different Assets
• Good will & Land – No depn.
• Buildings, P&M, Ship, etc. – Fixed installment or
WDV method
• Leasehold Land and Buildings - Fixed
installment method
• Loose Tools, Livestock etc. – Revaluation
Method
• Patents, Trade marks, Copy rights etc. - Fixed
installment
• Mines, Oil wells, Quarries etc. – Depletion
Method
