1.
By
W.Infant Emiliya
Assisatant Professor

2.
Depreciation Methods
 Straight Line Depreciation Method
 Diminishing Balance Method
 Annuity Method
 Sinking Fund Method
 Insurance Policy Method

3.
Straight Line Depreciation
Method
 This is the most commonly used method to calculate
depreciation. It is also known as fixed instalment method.
Under this method, an equal amount is charged for
depreciation of every fixed asset in each of the accounting
periods.This uniform amount is charged until the asset gets
reduced to nil or its salvage value at the end of its
estimated useful life.
 So, this method derives its name from a straight line graph.
This graph is deduced after plotting an equal amount of
depreciation for each accounting period over the useful life
of the asset.
 Thus, the amount of depreciation is calculated by simply
dividing the difference of original cost or book value of the
fixed asset and the salvage value by useful life of the asset.

4.
The advantages of straight-line depreciation :
 Straight-line depreciation is easy to calculate
and consistently applied.
 It has wide application to many fixed assets,
especially when their obsolescence is simply due
to passage of time.
 Straight-line amortization schedules are simple
and reduce the amount of required record-
keeping.

5.
Disadvantage of straight-line depreciation
 Some assets are more correctly depreciated
based on output, input or usage.
 It requires the use of MACRS recovery periods to
be acceptable for U.S. tax purposes, prompting
the need for additional calculations.
 Some assets experience accelerated
obsolescence in their early years, such as
computers and vehicles.
 Estimates for useful life and salvage value can be
subjective and inconsistent among different
companies.

6.
Straight Line Depreciation
Formula
 The formula for annual depreciation under straight
line method is as follows:
 Annual Depreciation Expense = (Cost of an asset –
SalvageValue)/Useful life of an asset
 Where,
 Cost of the asset is purchase price or historical cost
 Salvage value is value of the asset remaining after its
useful life
 Useful life of the asset is the number of years for
which an asset is expected to be used by the
business

7.
Diminishing Balance Method
 This method is also known as reducing balance method, written down value
method or declining balance method.A fixed percentage of depreciation is
charged in each accounting period to the net balance of the fixed asset under
this method.This net balance is nothing but the value of asset that remains after
deducting accumulated depreciation.
 Thus, it means that depreciation rate is charged on the reducing balance of the
asset.This asset is the one reflected in the books of accounts at the beginning of
an accounting period.So, the book value of the asset is written down so as to to
reduce it to its residual value.
 Now, as the book value of the asset reduces every year so does the amount of
depreciation. Accordingly, higher amount of depreciation is charged during the
early years of the asset as compared to the later stages.
 Thus, the method is based on the assumption that more amount of depreciation
should be charged in early years of the asset.This is on account of low repair cost
being incurred in such years.As an asset forays into later stages of its useful life,
the cost of repairs and maintenance of such an asset increase. Hence, less
amount of depreciation needs to be provided during such years.

8.
Some of the merits of diminishing balance method are
as follows −
 Recognised by income tax authorities.
 Minimises impact of obsolescence.
 Depreciation amount decreases year by year.
 Suitable for assets where scrap value equals to zero.
Some of the demerits of diminishing balance method
are as follows −
 Asset value can be zero.
 Interest is not considered.
 Calculation of profit/loss is complicated.
 Emphasis on historical cost.

9.
Diminishing Balance Method Formula
Depreciation Expense = (Book value of asset
at beginning of the year x Rate of
Depreciation)/100

10.
Annuity Method
 The annuity method of depreciation is a process
used to calculate depreciation on an asset by
calculating its rate of return—just as if it were an
investment. It is commonly used with assets that
have a large purchase price, long life, and a fixed (or
at least constant) rate of return.
 This annuity method of depreciation requires the
determination of the internal rate of return (IRR) on
the cash inflows and outflows of the asset.The IRR is
then multiplied by the initial book value of the asset,
and the result is subtracted from the cash flow for
the period to find the actual amount of depreciation
that can be taken.

11.
Advantages and Disadvantages of the Annuity
Method of Depreciation
 The annuity method of depreciation is useful for
assets that have a high initial cost and a long life
span, such as property and buildings secured
under leases. It takes into account the interest lost
on the money spent to buy the asset, which many
depreciation methods don't do.
 Some disadvantages of using this method are that
it can be difficult to understand and that it may
require frequent recalculations depending on the
asset. Also, it can be burdensome to profit and loss
accounting over time, as the level of depreciation
diminishes with every year.

12.
Sinking fund method
 Sinking fund method is a method of calculating
depreciation for an asset in which apart from
calculating depreciation, it also keeps aside a fund
for replacing the asset at the end of its useful life.
 This method is used when the assets that need to be
replaced are of high cost.To avoid paying for the
replacement of assets at a time, companies maintain
a sinking fund that will help them recover the cost of
the asset while also accounting for its depreciation.
 Sinking fund method is put into use by large scale
industries such as utility industries that have a
requirement for expensive long-term assets to
function.

13.
Advantages:
 A sinking fund helps the company to pay its liability well in advance.
 A company is able to pay the debt in time because a company has
already pulled a money well before.
 A sinking fund is also used to redeem the bond or any other liability in
a mid-way also.
 A sinking fund also increases the goodwill of the company by paying
the debt in time, and this will increase the faith of investors and
attract more investment.
Disadvantages:
 When a company uses the sinking fund to buy bonds before maturity,
investor losses the interest on that particular time.
 When a company uses this fund to purchase bonds at a discount or
par value, so this will lose to the investors.
 When a company has sufficient fund to buy back, the investors
cannot take advantage of the company and that will make
uncertainty to the investors.

14.
Insurance policy method
 Insurance policy method is just like sinking
fund method of depreciation, but in this
method, the money is used to pay premium
for insurance company. Premium will be
charged at the start of the year. Money at the
end of maturity can be used to buy a new
asset.

15.
Advantages of insurance policy method are −
 Insurance for fixed asset.
 Risk loss is covered.
 Funds for replacement of asset is available.
 Better security.
Disadvantages of insurance policy method are −
 More expensive.
 Not suitable for assets where additions are
needed.
 Difference between interest received and
premium paid is more.