Depreciation 3.10.11

8/3/2019 Depreciation 3.10.11

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DepreciationCA Ekta Jain


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DEPRECIATION

Depreciation is a measure of the wearing out,consumption or otherloss of value of a depreciableasset arising from use, effluxion of time orobsolescence through technology and market

changes. Depreciation is allocated so as to chargea fair proportion of the depreciable amount in each

accounting period during the expected useful life ofthe asset. Depreciation includes amortisation of

assets whose useful life is predetermined


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Depreciation covers

Depletion (ehaustion of naturalresources)

Amortisation (expiration of intangible

assets) Obsolescence ( deteriotion by

invention , taste, fashion or to increase

the existing plant)


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Causes

Physical wear & tear

With passage of time

Changes in economic environment

Expiration of legal rights


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Needs for charging dep

To ascertain true results of operation

To present true & Fair view of financialposition

To ascertain true cost of production

To comply with legal requirements

To accumulate funds for replacementof assets


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Methods of Providing Dep

The (1.)Straight-Line method isgenerally the most commonly usedmethod due to its simplicity andconsistency of allocating depreciationevenly over the useful life of theasset. To calculate depreciation underthis method, the Cost of the Asset isreduced by the salvage or residual valueto arrive at the depreciable basis. Theresulting depreciable basis is thendivided by the estimated useful life.


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The straight line depreciation methoddivides 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 asfollows:

487.65 / 5 = 97.53Each year for 5 years $97.53 would beexpensed.


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On 1st july 1991, a company installeda plant at a cost of Rs. 1,00,000. Thecompany depreciated the asset @

10% per annum on Straight LineMethod

Show the plant account for the year

ended 31/12/94 according to SLM andWDV


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(2) WDV(Diminishing Balance method)

This method yields its diminishingannual depreciation charge byapplying a constant rate to the writtendown value of the cost of an asset.


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On Jan 1, 2011 M/s Ram & Sonspurchased a machinery for Rs.2,00,000. They spent Rs.12,000 on itsfreight & Rs. 8,000 for its installation.

Expected Life of the machine is 10years. It is expected that machine will bsold Rs.20,000 after its useful life.

Preapre Machine A/c & Dep A/c for 3years. Books of accounts are closed onDEc31, every year.


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On 1st Jan ,2011 a company bought P&Mcosting Rs.35,000. It is estimated that its

working life is 10years, at the end of whichit will fetch Rs.5000. Additions are made on1st Jan 2012 to the value of

Rs.20,000.(Residual value Rs.2000). Moreadditions are made on july 1,2013 to thevalue of Rs.10,000 ( Break up valueRs.10,000). The working life of both theadditional plants & machiner is 20years.

Show the P&M account for the first fouryears, if dep is w/o according to SLM. The

accounts are closed on 31st Dec evry yr.


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Kaushal Traders purchased a secondhand machinery on 1st Jan 2000 forRs. 23000 & spent Rs. 2000 on its

repairs. Dep according to WDV@20%. Prepare the machinery a/cfrom 2000 to 2002 & show profit &

Loss as it was sold on 31st

Dec2002for Rs.10,800. The accounts areclosed on 31st every year.


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(3)Machine-Hour Rate Method

This method is applied for depreciating machines alsoknown as Service Hours Method. The life of the machinesis fixed in terms of hour.

The total cost of the asset less depreciations is divided bythe expected life of the machine in terms of hours.Depreciation to be charged is ascertained by multiplyingthe hourly rate of depreciations by the number of hours themachine actually works during the year. For example, thelife of a machine costing Rs. 10,000 is estimated 10,000hours. The hourly rate thus comes to Re 1/- per hour. If themachine 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 fairestimate of the life of asset can be made n terms ofworking hours.


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(4)Depletion Method

Also known as Productive OutputMethod.This method is used in case of wastingassets such as mines, oil and gas resources,timber etc.

These assets exhausted by exploitation. In such

cases, the price paid for the acquisition of assetis dividend by the estimated contents of themines in terms of tons which will be the pricepaid for one ton. The amount of total depreciationis calculated for the year by multiplying the total

output in tons with the price paid per ton. Thusthe total price paid is recouped during the life ofthe asset.


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Example of Depletion Method

If a mine is purchased for Rs.20,000.00 it is estimated that totalquantity of mineral in the mine is

40,000 tonnes, the rate of dep pertonne would amount to 50 paise pertonne. (Rs.20000/40000 tonnes). In

case output in a year amounts to10,000 tonnes, the amount of dep willbe Rs.5000 (ie 10,000 tonnes *50paise)


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(5)Revaluation Method Under this method assets are revalued at the

end of each year. The difference of therevaluation price of the two years is thedepreciation be charged to profit and loss

account.Appraisal. The method is followed where it is not

possible to provide for the depreciation onmathematical basis or the asset is representedby large number of small and diverse items ofsmall unit cost such as loose tools or where thelife 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 atRs.45,000. Depreciation Rs.(50,000+15,000-45,000) equals to 20,000.


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

Depreciation rate is expressed infractions; we have to add the numbersrepresenting the period of life, use thesum thus obtained as a denominatorand use as numerator, the samenumbers taken in reverse order and

finally multiply the net asset value bythe fractions thus produced.


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SYD Method

Example : If cost of an asset is Rs.10000 & it has an effective life of 5years , 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


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(7)Replacement method

This method does not record

depreciation until a unit is replaced.When unit is replaced at a time, theamount equal to the cost of the new

asset less the salvage value ischarged to depreciation.


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(8) Annuity Method

The dep is charged on the basis thatbesides losing the original cost of theasset, the business also losses

interest on the amount used for buyingasset. The term Interest here meansthe interest which the business could

have earned otherwise if the moneyused in purchasing the asset wouldhave been invested in some otherform of investment.


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9. DEP( Sinking) Fund Method

The amount charged by way of dep. IsInvested in certain securities carrying a particularrate of interest. The amount received on account

of interest from these securities is also investedfrom time to time together with the annual amountcharged by the way of dep.

At the end of the useful life of the asset , when

replacement is required, the securities are soldaway & money realised on account the sale of

securities is used for purchase of a new asset.


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10. Insurance Policy Method Insurance Policy Method Under this method, an endowment

insurance policy is taken on the life of the assert from aninsurance company.

The amount of premium is equal to the amount ofdepreciation and is paid in cash to the insurance company

which goes on accumulating with the insurance company at acertain rate of in tersest and is paid back at the maturity of thepolicy. The amount of policy is such that it is sufficient toreplace the asset when it is worn out. The amount so made

available by the insurance company is used for purchasingthe new asset. The method to a great extent is similar in spiritto Sinking Fund Method, of course the procedure is a littledifferent


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Change in Method of Dep

On 1st July2007 a companypurchased a Plant for Rs.20,000. Depwas provided at 10% p.a. On SLM on

31st Dec every year with effect from1.1.2009 the company decided tocharge the method of dep to WDV

@15%. On 1/7/10, the plant was soldfor Rs.12000. Prepare Plant A/c from2007 to 2010.


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P&L Appropriation A/c

Profit and Loss Appropriation account is the part of financialstatements of company. It is different from profit and lossappropriation account of partnership firm . When acompany makes his profit and loss account, its net profit istransferred to the credit side of profit and loss appropriation

account. Profit and loss account shows only the net profit ornet loss from operation of business but profit and lossappropriation accounts shows all non- operationaladjustment 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 incometax.


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In the debit side of this account, wewill show the following items

1. Transfer to reserve /general reserve.

2. Transfer to dividend/interim dividend/proposed dividend.

3. Debenture redemption fund account.

4. Dividend equalization fund account.

5. Dividend Distribution Tax (A 15% dividend distribution tax and

surcharge of 3% is paid by companies before distribution.)

6. Income tax for previous year not provided for.

7. Surplus transfer to balance sheet.


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In the credit side of this account, wewill show the following accounts Balance of surplus of previous year.

2. Net Profit of this year.

3. Amount withdrawn from general reserve or anyother reserve.

4. Provision such as income tax provision nolonger required or excess of provision or refund of tax.


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Documents

Depreciation 3.10.11