Depreciation with different methods

1. Depreciation

2. INTRODUCTION
The monetary value of an asset decreases over time
due to use, wear and tear or obsolescence. This
decrease is measured as depreciation.

3. Definition
According to PICKLES, Depreciation is the
permanent and continuing diminution in the quality
or value of and asset
From the above definition it can be concluded that
depreciation is a gradual decrease in the value of an
asset from any cause.

4. OBJECTIVE OF DEPRECIATON
 1. Reflect reduction in the book value of the asset
due to obsolescence or wear and tear,
 2. Spread a large expenditure (Purchase Price of
the asset ) proportionately over a fixed period to
match revenue receive from it,
 3. Reduce the taxable income by charging the
amount of depreciation against the company‘s total
income

5. Causes of Depreciation
 1. Wear And Tear
Wear and tear refers to a decline in the efficiency of asset due to its
constant use. When an asset losses its efficiency, its value goes down
and depreciation arises. This is true in case of tangible assets like plant
and machinery, building, furniture, tools and equipment used in the
factory.
 2. Effusion of Time
The value of asset may decrease due to the passage of time even if it is
not in use. There are some intangible fixed assets like copyright, patent
right, and lease hold premises which decrease its value as time elapse.

6. Continuing
 3. Exhaustion
An asset may loss its value because of exhaustion too. This is the case with
wasting assets such as mines, quarries, oil-wells and forest-stand. On account of
continuous extraction, a stage will come where mines and oil-wells get
completely exhausted.
 4. Obsolescence
Changes in fashion are external factors which are responsible for throwing out of
assets even if those are in good condition. For example black and white
televisions have become obsolete with the introduction of color TVs, the users
have discarded black and white TVs although they are in good condition. Such as
loss on account of new invention or changed fashions is termed as obsolescence
 5. Accidents.
An asset may meet an accident and , therefore, it may get depreciated in its
value.

7. Basic Features of Depreciation
1. The Term depreciation is used only in respect of
fixed assets. Of course, the current assets may
also lose their value. Loss on account of fall in
their value is taken care of by valuing them for
balance sheet purposes, at cost or market price
whichever is less
2. Depreciation is a charge against profit. This
means that true profit of the business cannot be
ascertained without charging depreciation

8. Basic Features of Depreciation
3. Depreciation is different from maintenance.
Maintenance expenses are incurred for keeping
the machine in a state of efficiency. However.
Any degree of maintenance cannot assure that the
asset will never reach a state of scrap. Of course
good maintenance delays this stage but it cannot
absolutely prevent it

9. Basic Features of Depreciation
4. All depreciation although the process
may be invisible or gradual

10. Methods of Depreciation
 Straight Line Depreciation Method
 Straight line method depreciates cost evenly throughout the useful life
of the fixed asset. Straight line depreciation is calculated as follows:
 Depreciation per annum = (Cost +Installation cost- Residual Value) /
Useful Life
Where:
 Cost includes the initial and any subsequent capital expenditure.
 Residual Value is the estimated scrap value at the end of the useful life
of the asset. As the residual value is expected to be recovered at the end
of an asset's useful life, there does no need to charge the portion of cost
equal the residual value.
 Useful Life is the estimated time period an asset is expected to be used
from the time it is available for use to the time of its disposal or
termination of use. Useful life is normally calculated in units of years
but it may be calculated based on an alternative basis. Useful life of an
oil extraction company may for example be the estimated oil reserves.

11. Example :
 An asset has a useful life of 3 years.
 Cost of the asset is $2,000.
 Residual Value is $500.
 Annual Depreciation cost will be $500 = (2000 - 500) /
3years
 Straight line depreciation method is appropriate where
economic benefits from the asset are expected to be
realized evenly during its useful life. It is also
convenient where no reliable estimate can be made
regarding the pattern of economic benefits over an
asset's useful life.

12. Example :
A firm purchases a plant for a sum of 10,000 AFN on
1st January,2007. installation charges are 2,000 AFN.
Plant is estimated to have a scrap value or 1,000
AFN at end of its useful life of fiver years. You are
required to prepare Plant Account for five years
charging depreciation according to Straight Line
Method.

13. Example :
ABC Co. Purchased Machinery Amount 20,00,000
on 1st January 2009, 25,000 was spent on Installation
of the Machine. The Company follows Straight Line
Method of Depreciation. Life of the Machine is 5
Years. Scrap Value is 2,00,000.

14. Example :
The original cost of machine is 12,00,000 AFN it
was purchased on 1-2-2008. it has a life of 5 years
and a scrap value is 40,000 AFN. Depreciation is
provided on the straight line method on 31st
December each year. Prepare the machinery account
for 4 years.

15. Diminishing Balance Method
Under this method depreciation is charged at fixed
rate on this reducing balance
Formula
Where r stand for depreciation rate and S stands for
salvage and C stands for cost of acquisition. The written
down value methods acts as a tax shield. Asset never
becomes Zero. This method can be applied only when
there is some residual . This method is usuallly adopted in
case of pant & Machinery

16. Merit of Diminishing Balance
Method.
1. Depreciation and repairs charges continues to be
uniform through the assets life. In the first year
depreciation amount is higher and repair charges
are less, but at the end of the assets life
depreciation is less and repairs charges are more
2. It is easy and simple to understand this method
3. It is recognized by the tax authorities

17. Demerits
1. It takes longtime to bring down the asset value to
scrap value
2. It is calculate depreciation rate
3. This method give more importance to historical
cost

18. Example
The original cost of the machine is 9,00,000 it was
purchased on 01-04-2009. it has a life of 7 years
and has scrap value of 25,000. Depreciation is
provided on diminishing balanced method. The
company closes accounts every year by 31st
March . Prepare Machinery account for five
years.

19. Example
The opening balance of furniture as on 1-1-2007
shows Amount 25,000 the rate of depreciation is
10 % per year and closes accounts annually on
31st March.
Prepare Furniture Account up to the end of
financial year 2011.

20. Example
ABC Co. purchased a plant for 2,85,000 on 1-4-
2007 and immediately installed it at and
additional cost of 15,000 the company closes its
books on 31st March every year. It follows
diminishing balance method for providing
depreciations @ 20 % p.a. show the plant
account for four years.

21. Sum of Years digits Method
This method is on the pattern of diminishing balance
method. The amount of depreciation to be
charged to the profit and loss account under this
method goes on decreasing every year the
depreciation is calculated according to the
following formula
formula= Remaining Life of the Asset / Sum of all
the digits of the life of the asset in years *
Original cost

22. Example
If the cost of an asset is 10,000 and it has 5 years
life the amount of depreciation to be written off
each year will be computed as follows