DEPRECIATION

EFFORTS BY: SHRUTI SAXENA 11TH A

MEANING

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.

OBJECTIVES OF DEPRECIATION

• To ascertain the correct cost of production:

Depreciation should be taken into consideration for calculating the cost of production. if it is not cost of production, It will not be correct.•To show a true and fair view of the financial position:Depreciation, if not charged, would result in assets being stated at a higher value. As a result of this the positional statement would not present a true and fair view of the financial positional

• To ascertain the correct profit and loss:

Depreciation is a loss. So Unless it is considered like all other expenses and losses, true profit or loss cannot be ascertained. In other words, depreciation must be considered in order to into out true profit or loss of a business.

CAUSES OF DEPRECIATION

1. EFFLUX 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

2.ACCIDENT

Assets may be destroyed by abnormal reasons such as fire, earthquake, flood etc. In such a case the destroyed asset must be written off as loss and a new one purchased

3.WEAR AND TEARWear and tear refer 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.

4. 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.

METHODS OF DEPRECIATION

STRAIGHT LINE METHOD

Straight line method depreciates cost evenly through out the useful life of the fixed asset. Straight line depreciation is calculated as follows:

(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 is no need to charge the portion of cost equaling 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.

ITS MERITS … It is a simple method of calculating the

depreciationIn this method ,assets can be depreciated

up to the estimated scrap value.In this method, it is easy to know the

amount of depreciation.Every year the profit and loss account is

debited by the same amount of depreciation, so there is the same effect on profit and loss account every year

ITS DEMERITS….There is no arrangement of

interest on capital invested in assets in this method.

With the passage of time, work efficiency of assets decreases and repair expenses increases.

Sometimes in this method, the book value of assets become nil, still the asset are used in the business.

DIMINISHING BALANCE METHOD

Diminishing balance method is also known as written down value method or reducing installment method. Under this method the asset is depreciated at fixed percentage calculated on the debit balance of the asset which is diminished year after year on account of depreciation.

ITS MERITS… There is same weightage on profit

and loss account of depreciation and repair expenses.

On the expansion and increase in assets the depreciation can be computed easily by this method.

This method is accepted under the income tax act.

ITS DEMERITS..

In this method ,the value of assets can never be zero.

It is difficult task to ascertain the proper rate of depreciation

In this method also, there is no provision of interest on capital invested in use of assets.