DEPRECIATION

INTRODUCTION
The monetary value of an asset decreases over time due to use,
wear and tear or obsolescence. This decrease is measured as
depreciation.
DEFINATION
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.
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 companys total income
Causes of Depreciation
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
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

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.

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

Accidents. An asset may meet an accident and ,

therefore, it may get depreciated in its value.
Basic Features of Depreciation

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

Depreciation is a charge against profit. This means that true profit of the
business cannot be ascertained without charging depreciation

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

4. All depreciation although the process may be invisible or gradual

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.

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.
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.
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.

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.

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 usually adopted in case of pant & Machinery

Merits of Diminishing Balance Method.

 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

It is easy and simple to understand this method

It is recognized by the tax authorities

Demerits

It takes longtime to bring down the asset value to scrap

value

It is calculate depreciation rate

This method give more importance to historical cost