Depreciation

CA Ekta Jain

DEPRECIATION

Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortisation of assets whose useful life is predetermined

Depreciation covers
Depletion (ehaustion of natural resources) Amortisation (expiration of intangible assets) Obsolescence ( deteriotion by invention , taste, fashion or to increase the existing plant)

Causes
Physical wear & tear With passage of time Changes in economic environment Expiration of legal rights

Needs for charging dep

To ascertain true results of operation To present true & Fair view of financial position To ascertain true cost of production To comply with legal requirements To accumulate funds for replacement of assets

Methods of Providing Dep

The (1.)Straight-Line method is generally the most commonly used method due to its simplicity and consistency of allocating depreciation evenly over the useful life of the asset. To calculate depreciation under this method, the Cost of the Asset is reduced by the salvage or residual value to arrive at the depreciable basis. The resulting depreciable basis is then divided by the estimated useful life.

The straight line depreciation method divides the cost by the life. SL = Cost / Life Example: A desk is purchased for $487.65. The expected life is 5 years. Calculate the annual depreciation as follows: 487.65 / 5 = 97.53 Each year for 5 years $97.53 would be expensed.

On 1st july 1991, a company installed a plant at a cost of Rs. 1,00,000. The company depreciated the asset @ 10% per annum on Straight Line Method Show the plant account for the year ended 31/12/94 according to SLM and WDV

(2) WDV(Diminishing Balance method)

This method yields its diminishing annual depreciation charge by applying a constant rate to the written down value of the cost of an asset.

On Jan 1, 2011 M/s Ram & Sons purchased a machinery for Rs. 2,00,000. They spent Rs.12,000 on its freight & Rs. 8,000 for its installation. Expected Life of the machine is 10 years. It is expected that machine will b sold Rs.20,000 after its useful life. Preapre Machine A/c & Dep A/c for 3 years. Books of accounts are closed on DEc31, every year.

On 1st Jan ,2011 a company bought P&M costing Rs.35,000. It is estimated that its working life is 10years, at the end of which it will fetch Rs.5000. Additions are made on 1st Jan 2012 to the value of Rs.20,000.(Residual value Rs.2000). More additions are made on july 1,2013 to the value of Rs.10,000 ( Break up value Rs.10,000). The working life of both the additional plants & machiner is 20years. Show the P&M account for the first four years, if dep is w/o according to SLM. The accounts are closed on 31st Dec evry yr.

Kaushal Traders purchased a second hand machinery on 1st Jan 2000 for Rs. 23000 & spent Rs. 2000 on its repairs. Dep according to WDV @20%. Prepare the machinery a/c from 2000 to 2002 & show profit & Loss as it was sold on 31st Dec2002 for Rs.10,800. The accounts are closed on 31st every year.

(3)Machine-Hour Rate Method

This method is applied for depreciating machines also known as Service Hours Method. The life of the machines is fixed in terms of hour. The total cost of the asset less depreciations is divided by the expected life of the machine in terms of hours. Depreciation to be charged is ascertained by multiplying the hourly rate of depreciations by the number of hours the machine actually works during the year. For example, the life of a machine costing Rs. 10,000 is estimated 10,000 hours. The hourly rate thus comes to Re 1/- per hour. If the machine is run 1000 hours in a year, the total depreciation chargeable for the year will be Rs. 1000 @ Re 1/ per hour. This method is useful for costly machines where a fair estimate of the life of asset can be made n terms of working hours.

(4)Depletion Method
Also known as Productive Output Method.This method is used in case of wasting assets such as mines, oil and gas resources, timber etc. These assets exhausted by exploitation. In such cases, the price paid for the acquisition of asset is dividend by the estimated contents of the mines in terms of tons which will be the price paid for one ton. The amount of total depreciation is calculated for the year by multiplying the total output in tons with the price paid per ton. Thus the total price paid is recouped during the life of the asset.

Example of Depletion Method

If a mine is purchased for Rs. 20,000.00 it is estimated that total quantity of mineral in the mine is 40,000 tonnes, the rate of dep per tonne would amount to 50 paise per tonne. (Rs.20000/40000 tonnes). In case output in a year amounts to 10,000 tonnes, the amount of dep will be Rs.5000 (ie 10,000 tonnes *50 paise)

(5)Revaluation Method

Under this method assets are revalued at the end of each year. The difference of the revaluation price of the two years is the depreciation be charged to profit and loss account. Appraisal. The method is followed where it is not possible to provide for the depreciation on mathematical basis or the asset is represented by large number of small and diverse items of small unit cost such as loose tools or where the life of he asset is uncertain such as animals, jars, bottles etc. Example:1.04.10 Rs.50,000 Addition during the year (2010-11) Rs.15,000. 31.03.11 Revaluation at Rs.45,000. Depreciation Rs.(50,000+15,00045,000) equals to 20,000.

(6) Sum of the years digit (SYD)method

Depreciation rate is expressed in fractions; we have to add the numbers representing the period of life, use the sum thus obtained as a denominator and use as numerator, the same numbers taken in reverse order and finally multiply the net asset value by the fractions thus produced.

SYD Method
Example : If cost of an asset is Rs. 10000 & it has an effective life of 5 years , the amount of dep. To be w/o each year will be computed as follows: 1st year = 5/(1+2+3+4+5)*10000 = 3333 2nd year=4/(1+2+3+4+5)*10000 = 2667

(7)Replacement method

This method does not record depreciation until a unit is replaced. When unit is replaced at a time, the amount equal to the cost of the new asset less the salvage value is charged to depreciation.

(8) Annuity Method

The dep is charged on the basis that besides losing the original cost of the asset, the business also losses interest on the amount used for buying asset. The term Interest here means the interest which the business could have earned otherwise if the money used in purchasing the asset would have been invested in some other form of investment.

9. DEP( Sinking) Fund Method

The amount charged by way of dep. Is Invested in certain securities carrying a particular rate of interest. The amount received on account of interest from these securities is also invested from time to time together with the annual amount charged by the way of dep. At the end of the useful life of the asset , when replacement is required, the securities are sold away & money realised on account the sale of securities is used for purchase of a new asset.

10. Insurance Policy Method

Insurance Policy Method Under this method, an endowment insurance policy is taken on the life of the assert from an insurance company. The amount of premium is equal to the amount of depreciation and is paid in cash to the insurance company which goes on accumulating with the insurance company at a certain rate of in tersest and is paid back at the maturity of the policy. The amount of policy is such that it is sufficient to replace the asset when it is worn out. The amount so made available by the insurance company is used for purchasing the new asset. The method to a great extent is similar in spirit to Sinking Fund Method, of course the procedure is a little different

Change in Method of Dep

On 1st July2007 a company purchased a Plant for Rs.20,000. Dep was provided at 10% p.a. On SLM on 31st Dec every year with effect from 1.1.2009 the company decided to charge the method of dep to WDV @15%. On 1/7/10, the plant was sold for Rs.12000. Prepare Plant A/c from 2007 to 2010.

P&L Appropriation A/c

Profit and Loss Appropriation account is the part of financial statements of company. It is different from profit and loss appropriation account of partnership firm . When a company makes his profit and loss account, its net profit is transferred to the credit side of profit and loss appropriation account. Profit and loss account shows only the net profit or net loss from operation of business but profit and loss appropriation accounts shows all non- operational adjustment which is needed for proper distribution of net profit between shareholders and company for future growth. So, net profit of P/L A/c is used for providing reserve, dividend, dividend distribution tax and adjustment of income tax.

In the debit side of this account, we will show the following items

1.
2. 3. 4.

Transfer to reserve /general reserve. Transfer to dividend/interim dividend/proposed dividend. Debenture redemption fund account. Dividend equalization fund account.

5. Dividend Distribution Tax (A 15% dividend distribution tax and surcharge of 3% is paid by companies before distribution.) 6. 7. Income tax for previous year not provided for. Surplus transfer to balance sheet.

In the credit side of this account, we will show the following accounts

Balance of surplus of previous year. 2. Net Profit of this year.

3. Amount withdrawn from general reserve or any other reserve. 4. Provision such as income tax provision no longer required or excess of provision or refund of tax.