Depreciation Accounting
Introduction
Depreciation is the gradual and permanent decrease in the value of a tangible fixed asset due to use, efflux of time, or obsolescence.
Related Terms
- Depreciation: Used for Tangible Fixed Assets (e.g., Machinery, Building).
- Amortization: Used for Intangible Assets (e.g., Goodwill, Patents).
- Depletion: Used for Wasting Assets (e.g., Mines, Oil wells, Quarries).
- Obsolescence: Fall in value due to new inventions/technology or change in fashion.
Causes of Depreciation
- Wear and Tear: Physical deterioration due to usage.
- Efflux of Time: Value decreases with passage of time (Leasehold properties).
- Obsolescence: Outdated due to new technology.
- Accidents: Unexpected damage.
Factors Affecting Depreciation
- Cost of Asset: Purchase Price + Installation + Freight + Improvements.
- Estimated Useful Life: Period for which asset is expected to be used.
- Scrap Value (Residual Value): Estimated sale value at the end of useful life.
Methods of Depreciation
1. Straight Line Method (SLM)
Also known as Original Cost Method or Fixed Installment Method. A fixed percentage of the Original Cost is written off every year.
- Amount of depreciation remains constant.
- Value of asset can become zero.
- Suitable for assets with low repairs and obsolescence (e.g., Leases, Patents).
2. Diminishing Balance Method (DBM)
Also known as Written Down Value (WDV) Method or Reducing Balance Method. A fixed percentage of the Reducing Balance (Book Value) is written off every year.
- Amount of depreciation decreases every year.
- Value of asset never becomes zero.
- Recognized by Income Tax Act.
- Suitable for assets with high repairs and obsolescence (e.g., Machinery, Vehicles).
SLM vs WDV
| Basis | Straight Line Method | Written Down Value Method |
|---|---|---|
| Basis of Calculation | On Original Cost | On Book Value (WDV) |
| Amount of Dep. | Constant every year | Decreases every year |
| Value at end | Can be Zero | Never Zero |
| Total Charge (Dep + Repairs) | Increases in later years (Unequal burden) | Remains almost constant (Equal burden) |
| Income Tax | Not recognized | Recognized |
Methods of Recording
1. Charging to Asset Account
Depreciation is deducted directly from Asset A/c.
Entry: Depreciation A/c Dr. to Asset A/c
2. Creating Provision for Depreciation
Asset appears at Original Cost. Accumulated depreciation is shown in 'Provision for Depreciation A/c'.
Entry: Depreciation A/c Dr. to Provision for Depreciation A/c
Numericals & PYQs
Part A: Numericals (10 Questions)
Dep = (Cost - Scrap Value) / Life
Dep = (1,00,000 - 10,000) / 10 = 90,000 / 10 = ₹9,000.
Dep per year = 10% of 50,000 = ₹5,000.
Total Dep for 3 years = 5,000 x 3 = 15,000.
Book Value = 50,000 - 15,000 = ₹35,000.
Year 1 Dep = 10% of 20,000 = 2,000. BV = 18,000.
Year 2 Dep = 10% of 18,000 = ₹1,800.
Period: July to Dec = 6 months.
Dep = 2,40,000 x 10/100 x 6/12 = ₹12,000.
Loss = Book Value - Sale Price.
Loss = 15,000 - 12,000 = ₹3,000 Loss.
Under SLM, depreciation remains distinct/constant on Original Cost.
Dep = 10% of 1,00,000 = ₹10,000.
Year 1 End: 1,00,000 - 20,000 = 80,000.
Year 2 End: 80,000 - 16,000 (20% of 80k) = ₹64,000.
Cost includes all expenses to bring asset to usage.
Cost = 50,000 + 5,000 + 1,000 = ₹56,000.
It is shown as a deduction from the concerned Asset on the Assets side (or as a Liability, but standard is deduction from asset).
Amt of Dep = (1,10,000 - 10,000) / 5 = 20,000.
Rate = (Amt of Dep / Cost) x 100.
Rate = (20,000 / 1,10,000) x 100 = 18.18%.
Part B: Previous Year Questions (PYQs) (10 Questions)
Wear and tear, obsolescence, efflux of time.
Wasting Assets (Mines, Oil wells).
Constant every year.
To ascertain true profit/loss.
Book Value (Opening Balance of the year).
Innovations and Inventions (Technological changes).
Written Down Value (WDV) Method.
Profit and Loss Account.
Machinery Account (Capitalized).
Intangible Assets.