DEPRECIATION

DEPRECIATION

• Value of Fixed Assets decreases with passage of

time and its utilisation. Value of the portion of asset
utilised 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
• 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’
 Characteristics of Depreciation
• Related to fixed assets only
• Fall in the book value of asset
• Permanent decrease in the book value of
an asset
• Continuous decrease in the book value of
an asset
CAUSES OF DEPRECIATION
• Physical wear and tear
• With the passage of time
• Changes in economic environment
• Expiration of legal rights
NEED FOR PROVIDING
DEPRECIATION

• Toascertain 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
FACTORS DETERMINING THE AMOUNT
OF DEPRECIATION

• Historical Cost
• Expected useful life
• Estimated residual value
Methods of Allocating Depreciation

• Straight Line Method

• Written Down Value Method
‘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
Illustration 1:
On 1st Jan., 2003, X Ltd. Purchased a second –
hand machine for Rs.52,000/- and spent Rs.
3,000/- as shipping charges, Rs.5,000/- as
import duty and Rs.2,000/- as installation
charges. It was estimated that machine will have
a scrap value of Rs.2,000/- at the end of its
useful life which is 10 years. On 30th Sep., 2003
repairs amounted to Rs.2,000/- . On 1st July,
2005 this machine was sold for Rs.30,600/-.
Prepare Machinery A/c for the first three years.
‘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
Illustration 2:
On 1st Jan., 2003, X Ltd. Purchased a
second – hand machine for Rs.58,000/-
and spent Rs. 2,000/- on its erection. On
1st July, 2005 this machine was sold for
Rs.28,600/-. Prepare Machinery A/c for
the first three years according to the
Written Down Value taking the
depreciation rate at 10% p.a.
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.
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.
Illustration 3: Change in the method of Depreciation

ABC Ltd. Purchased on 1st January,2001 second-hand plant for

Rs.30,000 and immediately spent Rs.20,000 in overhauling it. On
1stJuly,2001 additional machinery of a cost of Rs.25,000 was purchased.
On 1st July,2003, the plant purchased on 1st Jan.,2001became obsolete
and was sold for Rs.10,000. On that date new machinery was purchased
at a cost of Rs.60,000
Depreciation was provided for annually on 31st December, at 10% p.a.
on the original cost of the asset. In 2004, however, the company changed
this method of providing for depreciation and adopted the method of
writing off 15% on the diminishing value.
Show the Plant & Machinery Account as it would appear in the books of
the company for the years 2001 – 2005.
Illustration 4:
On 1st January 2001, X Ltd. purchased a machine for
Rs.58,000 and spent Rs.2,000 on its erection. On 1st July
2001, an additional machinery costing Rs.20,000 was
purchased. On 1st July 2003, the machine purchased on
1.1.2001 was sold for Rs.28,600 and on the same date a new
machine was purchased at a cost of Rs.40,000. Depreciation
was provided for annually on 31st December, at the rate of
10% p.a. on the written down value of the machinery. In
2004 company decided to change the method of depreciation
from written down value to straight line method @ 5% with
effect from 1st January 2001.
Prepare the Machinery Account for the first four calendar
years.
When a Provision for Depreciation 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.
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 Profit & Loss A/c Dr.
A/c To Depreciation A/c
3 On disposal of an asset
(i) For transfer of original cost Asset Disposal A/c Dr.
of asset disposed off To Asset A/c
(ii) For transfer of Provision for Depreciation A/c Dr.
accumulated depreciation on To Asset Disposal A/c
asset disposed off
(iii) For recording sale Bank A/c Dr.
proceeds To Asset Disposal A/c
(Iv) For transfer of balance in
Asset Disposal A/c
(a) In case of Profit Asset Disposal A/c Dr.
To Profit & Loss A/c
(b) In case of Loss Profit & Loss A/c Dr.
To Asset Disposal A/c
Illustration 5:
On 1st Jan.,2005 , X Ltd. Purchased a machinery for
Rs.12,00,000/-. On 1st July, 2007, a part of the
machinery purchased on 1st Jan., 2005 for Rs.80,000/-
was sold for Rs.45,000/- and a new machinery at a cost
of Rs.1,58,000/- was purchased and installed on the
same date. The company has adopted the method of
providing 10% depreciation on the original cost of the
machinery.
Show the necessary ledger accounts assuming that :
(a) Provision for Depreciation A/c is not maintained,
(b) Provision for Depreciation Account is maintained.
Solution : (Illustration 4)
Dr. Machinery A/c Cr.
Date Particulars Rs. Date Particulars Rs.

2001 2001
Jan.1 To Bank A/c 58,000 Dec.31 By Depreciation A/c 7,000
July 1 To Bank A/c 2,000 By Balance c/d 73,000
To Bank A/c 20,000
80,000 80,000

2002 To Balance b/d 73,000 2002 By Depreciation A/c 7,300

Jan 1 Dec.31 By Balance c/d 65,700
73,000 73,000
2003 2003
Jan.1 To Balance b/d 65,700 July 1 By Bank A/c 28,600
July 1 To Bank A/c 40,000 July 1 By Depreciation A/c 2,430
July 1 By P & L A/c 17,570
Dec. 31 By Depreciation A/c 3,710
Dec. 31 By Balance c/d 53,390
1,05,700 1,05,700

2004 2004
Jan.1 To Balance b/d 53,390 Dec.31 By Depreciation A/c 3,000
Dec. 31 To P & L A/c 3,110 Dec.31 By Balance c/d 53,500
(Dep. Written back on
account of change from
WDV to SLM) 56,500 56,500