2. Contents to discuss…
Ω Depreciation:
● Definition;
● Characteristics;
● Causes;
● Objectives;
Ω Depreciation & other related concepts;
Ω Basis of providing Depreciation;
Ω Methods to calculate Depreciation;
2
3. Meaning of Depreciation:
Ω Depreciation is the allocation of the
cost of a fixed asset to expense over
its useful service life in a rational &
systematic manner;
Ω Depreciation is the diminution in
intrinsic value of the asset due to use
or lapse of time;
Ω It can be defined as a part of the
cost of the fixed asset which has
expired on account of its usage; 3
4. Characteristics:
Ω Depreciation reduces the book value of
an asset;
Ω Reduces the book value but not the
market value;
Ω It is a continuing process;
Ω The term depreciation is used only for
the tangible assets;
Ω It takes place gradually unless there is a
quick physical deterioration or
obsolescence due to technological
developments ;
4
5. Causes:
Ω Wear & Tear;
Ω Obsolescence;
Ω Accidents;
Ω Fall in market prices;
Ω Efflux of time;
5
6. Objectives:
Ω To ascertain the profit or loss
properly;
Ω To show the asset at its proper
value;
Ω To retain out of profits funds for
replacement;
Ω To show the true & fair view of the
financial position. 6
8. Amortization:
Ω Depreciation & Amortization:
● Amortization refers to writing off the
proportionate value of the intangibles
such as Goodwill, Copyrights etc;
Whereas
● Depreciation refers to the writing off
the expired cost of the tangible assets
like Machinery, Building etc;
8
9. Obsolescence:
Ω Depreciation & Obsolescence:
● Obsolescence refers to decrease in
usefulness caused on account of the
asset becoming out of date, old
fashioned etc…
Whereas
● Depreciation, is a loss in value of an
asset due to regular wear & tear;
● Obsolescence is a cause; 9
10. Depletion:
Ω Depreciation & Depletion:
● Depletion is used in respect to the
extraction of natural resources like
quarries, mines etc… that reduces the
availability of quantity of the material
or asset.
Whereas
● Depreciation is the reduction in value
of asset because of wear & tear. 10
12. Ω Original cost of the asset:
● Cost will include all expenses incurred like freight
charges until the asset is ready for use;
Ω Estimated scrap value at the end of its life:
● Residual/Scrap value is an estimated sale value of the
asset at the end of its economic life;
Ω Estimated effective or commercial life:
● An asset can work for twenty years but can lose its
commercial value within ten years, thus, life for the
purpose of accounting should be considered only ten
years. (Therefore, physical life is not important)
12
13. Methods To Calculate
Depreciation:
Straight line method;
Written down Method;
13
14. Straight Line Method:
Ω In this method a suitable
percentage of original cost is
written off the asset every year.
Ω The amount is uniform from year to
year.
14
15. Depreciation calculated as…
Depreciation: Cost – Estimated scrap value
Number of years of expected life
Depreciation Account……………..Dr.
To Asset Account;
Instead of crediting the asset, the credit may
be placed in the Provision for Depreciation
Account, so that the asset account will
continue to appear at the original cost.
Depreciation Account………………Dr.
To Provision for Dep. Account
15
16. Cont…with an example
ΩA firm bought a machinery for $38000 & its
life was estimated to be 8years. The scrap
value at the end of the period was $6000.
Find out the depreciation:
Depreciation: $38000 - $6000 = $ 4000
8 years
Depreciation Account………………Dr.$4000
To Provision for Dep. Account $4000
(Being depreciation $4000 charged annually on
machinery through a provision created for Dep.)
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17. Merits & Demerits
Ω Simple method of Ω No arrangement of
calculating interest on capital;
depreciation;
Ω Asset can be Ω By pass of time, work
depreciated up to the efficiency of asset
scrap value; decreases & repair
expenses increases,
Ω Easy to know the thus more weightage
amount of on P&L account;
depreciation;
Ω Book value of the
Ω Same effect on P&L
account;
asset becomes zero17
18. Written Down Value Method:
Ω In this method the depreciation is
charged at a fixed rate on the
reducing balance every year i.e. cost
less depreciation;
Ω In other words, the cost of asset less
estimated scrap value has to be
written off over its estimated useful
life;
Ω A certain percentage is applied to
the book value, not the cost of the
asset. 18
19. Cont…with an example
ΩSuppose the cost of a plant is $20000 on 1st of
Jan 2000 & the percentage to be written off
each year is 10% for the next 3 years. Calculate
the depreciation charged.
Depreciation: $20000 * 10 = $2000
100
Depreciation Account………………Dr.$2000
To Provision for Dep. Account $2000
(Being depreciation $2000 charged annually on
machinery at the rate of 10%.)
19
20. Machinery Account
Date Particulars Amt Date Particulars Amt
2000, 2000, By Provision for 2000
1st To Bank 20000 31st Dep. Account
Jan Dec 18000
By Bal c/d
20000 20000
2001, 2001, By Provision for
1st To bal b/d 18000 1800
31st Dep. Account
Jan Dec
By Bal c/d 16200
18000 18000
2002, 2002, By Provision for
To bal b/d 1620
1st 16200 31st Dep. Account
Jan Dec 14580
By Bal c/d
2003, 16200 16200
2002,
1st
14580 31st By Provision for Dep. 1458
Jan To bal b/d
Dec Account 20
21. Merits & Demerits
Ω Same weightage on Ω The value of asset can
P&L account of never be zero;
depreciation & repair
expenses; Ω There is a difficult task
to ascertain the
Ω Accepted by the proper rate of
Income-tax Act; depreciation;
Ω When increase in Ω There isn’t any
assets, the provision of interest on
depreciation can be capital invested in use
easily computed; of asset;
21
22. The two methods…
Ω M/s Bullock purchased machine for $80000 on
1st Jan 1988. Depreciation is provided at
10%p.a. for the next three years.
Ω The difference of working b/w the two
accounts is as following:
Year Straight Line Method Written Down Method
Book value of asset Depreciation Book value of asset Depreciation
$ $
1988
80000 8000 80000 8000
1989 72000 7200
72000 8000
1990 64000 8000 64800 6480
At beginning of year 1991: 24000 21680
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