DepreciationDepreciable assets are physical objects that retain their size and

shape but that eventually wear out because obsolete. They are not physica1ly consumed, as are assets such as supplies, but nonetheless their economic usefulness diminishes over time. Examples of depreciable assets include buildings and all types of equipment, fixtures, furnishings—and even railroad tracks. Land, however, is not viewed as a depreciable asset, as it has an unlimited useful life. .Each period, a portion of a depreciable asset’s usefulness expires. Therefore, a corresponding portion of its cost is recognized as depreciation expense. Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, efflux ion 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 amortization of assets whose useful life is predetermined. The depreciation method applies to all depreciable assets, except the following items to which special considerations apply:—

Forests, plantations and similar regenerative natural resources; Wasting assets including expenditure on the exploration for and

extraction of minerals, oils, natural gas and similar non-regenerative resources;

expenditure on research and development; goodwill; Live stock.

This statement also does not apply to land unless it has a limited useful life for the enterprise.

Depreciable assets are assets which

Are expected to be used during more than one accounting period; and

Have a limited useful life; and Are held by an enterprise for use in the production or supply of

goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of business.

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Depredation Is Only an Estimate

‘The appropriate’ amount of deprecation expense is only an estimate. After all we cannot look at a building or a piece of equipment and determine precisely how much of its economic usefulness has expired during the current period.The most widely used means of estimating periodic depreciation expense is the straight line method of depreciation under the straight line approach, an equal portion of the asset’s cost is allocated to depreciation expense in every period of the asset’s estimated useful ‘life. The formula for computing depreciation expense by the straight-line method is:

Depreciation expense (per period) = Cost of the asset ---------------------- Estimated useful life

The use of an estimated useful life is the major reason that depreciation expense is only an estimate. In most cases, management does not know in advance exactly how long the asset will remain in use.

Useful life is either (i) the period over which a depreciable asset is expected to be used by the enterprise; or (ii) the number of production or similar units expected to be obtained from the use of the asset by the enterprise.Depreciable amount of a depreciable asset is its historical cost, or other amount substituted for historical cost2 in the financial statements, less the estimated residual value.

Explanation

1. Depreciation has a significant effect in determining and presenting the financial position and results of operations of an enterprise. Depreciation is charged in each accounting period by reference to the extent of the depreciable amount, irrespective of an increase in the market value of the assets.2. Assessment of depreciation and the amount to be charged in respect there of in an accounting period are usually based on the following three factors: (i) historical cost or other amount substituted for the historical cost of the depreciable asset when the asset has been revalued; (ii) expected useful life of the depreciable asset; and (iii) estimated residual value of the depreciable asset.3. Historical cost of a depreciable asset represents its money outlay or its equivalent in connection with its acquisition, installation and

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commissioning as well as for additions to or improvement thereof. The historical cost of a depreciable asset may undergo subsequent changes arising as a result of increase or decrease in long term liability on account of exchange fluctuations, price adjustments, changes in duties or similar factors.4. The useful life of a depreciable asset is shorter than its physical life and is:(i) Pre-determined by legal or contractual limits, such as the expiry dates of related leases;(ii) Directly governed by extraction or consumption;(iii) Dependent on the extent of use and physical deterioration on account of wear and tear which again depends on operational factors, such as, the number of shifts for which the asset is to be used, repair and maintenance policy of the enterprise etc.; and(iv)Reduced by obsolescence arising from such factors as:

(a) Technological changes;(b) Improvement in production methods;(c) Change in market demand for the product or service output of the asset; or(d) Legal or other restrictions.

5. Determination of the useful life of a depreciable asset is a matter of estimation and is normally based on various factors including experience with similar types of assets. Such estimation is more difficult for an asset using new technology or used in the production of a new product or in theprovision of a new service but is nevertheless required on some reasonable basis.6. Any addition or extension to an existing asset which is of a capital nature and which becomes an integral part of the existing asset is depreciated over the remaining useful life of that asset. As a practical measure, however, depreciation is sometimes provided on such addition or extension at the rate which is applied to an existing asset. Any addition or extension which retains a separate identity and is capable of being used after the existing asset is disposed of, is depreciated independently on the basis of an estimate of its own useful life.7. Determination of residual value of an asset is normally a difficult matter. If such value is considered as insignificant, it is normally regarded as nil. On the contrary, if the residual value is likely to be significant, it is estimated at the time of acquisition/installation, or at the time of subsequent revaluation of the asset. One of the bases for determining the residual value would be the realizable value of similar assets which have

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reached the end of their useful lives and have operated under conditions similar to those in which the asset will be used.8. The quantum of depreciation to be provided in an accounting period involves the exercise of judgment by management in the light of technical, commercial, accounting and legal requirements and accordingly may need periodical review. If it is considered that the original estimate of useful life ofan asset requires any revision, the unamortized depreciable amount of the asset is charged to revenue over the revised remaining useful life.9. There are several methods of allocating depreciation over the useful life of the assets. Those most commonly employed in industrial and commercial enterprises are the straight-line method and the reducing balance method. The management of a business selects the most appropriate method(s) based on various important factors e.g., (i) type of asset, (ii) the nature of the use of such asset and (iii) circumstances prevailing in the business. A combination of more than one method is sometimes used. In respect of depreciable assets which do not have material value, depreciation is often allocated fully in the accounting period in which they are acquired.10. The statute governing an enterprise may provide the basis for computation of the depreciation. For example, the Companies Act, 1956 lays down the rates of depreciation in respect of various assets. Where the management’s estimate of the useful life of an asset of the enterprise is shorter than that envisaged under the provisions of the relevant statute, the depreciation provision is appropriately computed by applying a higher rate. If the management’s estimate of the useful life of the asset is longer than that envisaged under the statute, depreciation rate lower than that envisaged by the statute can be applied only in accordance with requirements of the statute.11. Where depreciable assets are disposed of, discarded, demolished or destroyed, the net surplus or deficiency, if material, is disclosed separately.12. The method of depreciation is applied consistently to provide comparability of the results of the operations of the enterprise from period to period. A change from one method of providing depreciation to another is 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 the change would result in amore appropriate preparation or presentation of the financial statements of the enterprise. When such a change in the method of depreciation is made, depreciation is recalculated in accordance with the new method from the date of the asset coming into use. The deficiency or surplus arising from retro sportive recompilation of depreciation in accordance with the new method is adjusted in the

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accounts in the year in which the method of depreciation is changed. In case the change in the method results in deficiency in depreciation in respect of past years, the deficiency is charged in the statement of profit and loss. In case the change in the method results in surplus, the surplus is credited to the statement of profit and loss. Such a change is treated as a change in accounting policy and its effect is quantified and disclosed.13. Where the historical cost of an asset has undergone a change due to circumstances specified the depreciation on the revised unamortized depreciable amount is provided prospectively over the residual useful life of the asset.

DAPRECIATION METHOD

THE STRAIGHT-LINE METHOD Under the straight-line method, an equal) Portion of the asset’s cost is recognized as depreciation expense in each period of the asset’s useful life. Annual depreciation expense is computed by deducting the estimated residual value (or salvage value) from the cost of the asset and dividing the remaining depreciable cost by the years of estimated useful life. Using the data in our example, the annual straight-line depreciation is computed as follows:

Cost-Residual Value = $17000-$2000 = $3000 per year

Year of useful Life 5Year

THE DECLINING-BALANCE

The most widely used accelerated depreciation -method is called fixed-percentage-of decliningba1ançe depreciation. However the method is used primarily in income tax re turns rather than financial statements. Under the declining-balance method, an accelerated depreciation rate Is computed as a specified percentage of the straight-line depreciation rate. Annual depreciation expense then is computed by applying this accelerated depreciation rate to the un depreciated cost (current book value) of the asset. This computation may be summarized as follows:

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Depreciation Expense = Remaining Book Value X Accelerated Depreciation Rate

The accelerated depreciation rate remains constant through out the life of the asset. Hence, the rate represents the “fixed-percentage’ described in the name of this depreciation method. The book value (cost minus accumulated depreciation) decreases every year and represents the “dec1ipin-ba1ance.’

Thus far we have described the accelerated depreciation rate as a specified percentage’ of the strtight-1ihe rate. Most often, this specified percentage is 200 percent, meaning that the accelerated rate is exact1y twice the straight-line rate. Asaresu1t, the declining-balance method of depreciation often is called double-declining-balance (or 200 percent declining-balance). Tax rules, however, often specify a lower percentage, such as 150 percent of the straight-line rate. This version of the declining-balance method may be described as “150 percent declining-balance.

THE UNITS-OF-OUTPUT METHOD

Under the Units-of-output method, depreciation is based on some measure of output rather . than on the passage of time. When. depreciation based on units of output, more depreciation is recognized in the periods in which the assets are most heavi1y used. To illustrate this method, consider S&G’ de1iver’ truck, which cost $17,000 and has an estimated salvage value of $2,000 Assume that S&G plans to retire this truck after it has been driven 100000 miles. The depreciation rate per mi1e of operation is 15 cents, computed as follows: -

Cost — Residual Value = Cost per Unit of Output(Mile) Estimated Units of Output (MiIes)

$17,000 -$2,000 100000 miles =$0.15 Depreciation per Mile

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At the end of each year, the amount of depreciation to be recorded is determined by mñtip1y- mg the 15-cent rate by the number of miles the truck has been driven during the year After the truck has gone 100,000miles, it is fully depreciated, and the depreciation process is stopped This method provides an excellent matching of expense with revenue. However, the method should be used only when the total units of output can be estimated with reasonable accuracy Also, this method is used only for assets such as vehicles and certain types of machinery Assets such as buildings, computers, .and furniture do not have wellc1efined “units of output’ In many cases, units-of-output is an accelerated method. Often assets are used more extensively in the earlier years of their useful lives than in the later years.

MACRS Most businesses use a depreciation method called MACRS (Modified Accelerated Cost Recovery System) in their federal income tax returns. Some small businesses also use this method-in their financial statements, so they do not have to compute 4epréciation in several different ways MACRS is based on the declining-balance method, but should be considered for use in financial statements only if the designated recovery periods” and the assumption, of no salvage value are reasonable. For publicly traded companies, the use of MACRS m financial statements is usually not considered to be in conformity with generally accepted accounting principles.

SUM-OF-THE-YEARS-DIGITS Sum-of-the-years’ digits, or SYD, is a form of accelerated depreciation It generally produces results that lie between the -double-declining-balance and 150 percent-declining-balance methods. SYD is a traditional topic that is- included m many accounting textbooks But it is the most complex of the accelerated methods-especially when partial years are involved SYD is rarely used in today’s business world. Only 6 of the 600 corporations surveyed—less than 1 percent—make any use of this method Because of its complexity, it is even less frequently used in small businesses SYD is seldom used for income tax purposes, because tax laws usually define allowable depreciation rates in terms the declining-balance method for these reasons, we defer coverage of the mechanics of this method to later accounting courses.

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DEPRECIATION METHOD IN USE

Every year, the American Institute of Certified Public Accountants (AICPA) conducts a survey of 600publicly owned companies to determine the accounting methods most widely used in financial statements. The various depreciation methods in use during a recent -year are summarized in diagram. Notice that the number of methods in use exceeds 600. This is because some companies use different depreciation methods for different types of assets.

600 Companies surveyed

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Practical study

HBL established operations in Pakistan in 1947 and moved its head office to Karachi. Our first international branch was established in Colombo, Sri Lanka in 1951 and Habib Bank Plaza was built in 1972 to commemorate the bank’s 25th Anniversary.

With a domestic market share of over 40%, HBL was nationalized in 1974 and it continued to dominate the commercial banking sector with a major market share in inward foreign remittances (55%) and loans to small industries, traders and farmers. International operations were expanded to include the USA, Singapore, Oman, Belgium, Seychelles and Maldives and the Netherlands.

On December 29, 2003 Pakistan's Privatization Commission announced that the Government of Pakistan had formally granted the Aga Khan Fund for Economic Development (AKFED) rights to 51% of the shareholding in HBL, against an investment of PKR 22.409 billion (USD 389 million). On February 26, 2004, management control was handed over to AKFED. The Board of Directors was reconstituted to have four AKFED nominees, including the Chairman and the President/CEO and three Government of Pakistan nominees.

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Rating HBL is currently rated AA (Long term) and A-1+ (Short term) and has a balance sheet size of over USD 11 billion. It is the first Pakistani bank to raise Tier II Capital from external sources.  

Depreciation of HBL Assets

TangibleSurplus on revaluation of fixed assets to the extent of the incremental depreciation charged on the related assets is transferred by the Bank to un-appropriated profits (net of deferred tax).All operating assets are being depreciated over their expected economic lives using the straight-line method from the date the assets are available for use.Depreciation is calculated so as to write-off the assets over their expected economic lives at the rates specified to these financial statements. The depreciation charge for the year is calculated after taking into account residual value, if any. The residual values, useful lives and depreciation method are reviewed and adjusted, if appropriate, at each balance sheet date.Fixed assets and capital work-in-progress, are stated at cost or revalued amount less accumulated depreciation, where applicable, and accumulated impairment losses (if any).Cost of fixed assets of foreign branches includes exchange differences arising on translation at year-end rates. Land and buildingsare revalued by independent professionally qualified values with sufficient regularity to ensure that the net carrying amount doesnot differ materially from the fair value. Surplus arising on revaluation is credited to the ‘surplus on revaluation of fixed assets’account (net of deferred tax). Under the provision of the Companies Ordinance, 1984, deficit arising on revaluation of fixed assets is adjusted against the balance in the above surplus account.

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Depreciation on addition and deletion of tangible assets during the year is charged in proportion to the period of use.Normal repairs and maintenance are charged to the profit and loss account as and when incurred. However, renewals are capitalized.Gain or losses arising on the disposal of fixed assets are included in income currently. Surplus on revaluation of fixed assets (net of deferred tax) realized during the year is transferred directly to un-appropriated profit.

IntangibleIntangible assets having a finite useful life are stated at cost less accumulated amortization and accumulated impairment losses, if any. Such intangible assets are amortized using the straight-line method over their estimated useful lives. Amortization is charged at the rate stated. Amortization on additions and deletions of intangible asset during the year is charged in proportion to the period of use. The useful life and amortization method are reviewed and adjusted, if appropriate at each balance sheet date.Intangible assets having an indefinite useful life are stated at acquisition cost.

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Data Collection Method

Primary Data

BOOKS

Financial & Managerial Accounting

14th Edition

Chapters# 4, 9

Pages # 148, 149, 405, 408,410

Web site

www.wikipedia.org

www.investorwords.com/1416/ depreciation .html www.investopedia.com/terms/d/ depreciation .asp www.businessdictionary.com/definition/ depreciation .html

Secondary Data

Organization

Habib Bank Limited

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Web site

http://www.habibbankltd.com

SWOT Analysis

Strength

Habib bank is one of an old bank of Pakistan there fore they have great reputation in country.

Habib bank has many fix assets in foam of Lands and buildings.

Habib bank using the straight-line method which is very useful and common.

Weakness

Surplus on revaluation of fixed assets (net of deferred tax) realized during the year is transferred directly to un-appropriated profit.

Opportunities

The bank has an opportunity to get the rent building for branches and the depreciation charges are used to renovate these buildings.

Threats

The competition in banking sector of Pakistan is also effect the organization.The economical condition and inflation in business is also one of a big threat

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ConclusionConclusion

In this assignment we discuss the depreciation of different assets. In my opinion the commercial banks are the best example of assists depreciation.

Commercial banks normally using the straight-line method which is very commonly used in banking sector. They follow a proper principles and they depreciate there fixed assets according to there product.

Today's commercial banks are more diverse than ever. We can find a tremendous range of opportunities in commercial banking, starting at the branch level where you might start out as a teller to a wide variety of other services such as leasing, credit card banking, international finance and trade credit.

The banking sector in Pakistan has been going through a comprehensive but complex and painful process of restructuring since 1997. It is aimed at making these institutions financially sound and forging their links firmly with the real sector for promotion of savings, investment and growth. Although a complete turnaround in banking sector performance is not expected till the completion of reforms, signs of improvement are visible. The almost simultaneous nature of various factors makes it difficult to disentangle signs of improvement and deterioration. The Habib bank is one of an old bank they have a good reputation and there fixed assets are in large of number and for there depreciation they used the straight-line method which is very effective.

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Recommendations

As we already discuss that the Habib bank is one of an old bank they have a good reputation and there fixed assets are in large of numbers they using a proper the straight-line method which is very successful depreciation method and I recommend them to keep it continues because it is very supportive method.

References

BOOKS

Financial & Managerial Accounting

14th Edition

Chapters# 4, 9

Pages # 148, 149, 405, 408,410

Web site

www.wikipedia.org

www.investorwords.com/1416/ depreciation .html www.investopedia.com/terms/d/ depreciation .asp www.businessdictionary.com/definition/ depreciation .html http://www.habibbankltd.com

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