DEPRECIATION BASICS AND DIFFERENT TYPES OF METHODS

depreciation schedule II


A business or entity doing business requires some assets for regular use and not for resale. The life of asset is not unlimited except for land, all other assets have a limited useful life. The benefit of a asset is received throughout its life. So, the cost paid for the machine to be enjoyed from it over a number of years and spread over such years.

Depreciation means continuing decrease in the value of an asset due to normal wear and tear, Obsolescence (out of fashion or outdated). A certain percentage of total cost of fixed assets which has expired and as such turned into expense during the process of its use in a particular accounting period.

Layman view:- 

The purchase of assets and raw material both are having flow of funds from the organization but the benefit from both are different as raw material is consumed immediately to produce the product and the same can be treated as expense in profit and loss account but in case of fixed assets like machinery will have benefits more than a year so, the cost incurred to purchase machine was appropriated over a useful life, the appropriated cost is known as depreciation and the same is treated as expenses.
                                   
MACHINE



Causes for depreciation:

INTERNAL CAUSES

Wear and tear: The plant and machinery, furniture, Motor vechicle etc. suffer from loss for utility due to vibration, rusting etc.

Depletion(exhaustion): The utility of resources of wasting assets( Mines) decrease due to extraction.


EXTERNAL CAUSES:

Obsolescence :Innovation of better substitute, change in market demand may result into discarding an asset.

TIME ELEMENT: with passage of time some intangible assets like lease,copy rights,patents will los their value

Objectives and necessity for providing depreciation


  1. Correct calculation of cost of production or cost of a product
  2. Correct calculation of profits
  3. Provision for replacement cost for purchasing new machine in future after sale of old machine
  4. Correct disclosure of fixed assets at reasonable value.
  5. Compliance with legal requirement


Measurement of depreciation


It is difficult to provide exact amount of depreciation since they depend on the following factors:

  • The actual cost of machine
  • The additions to machine
  • The estimated useful life of the asset
  • The scrap of asset and its resale value
  • The maintenance cost of asset.


Methods of depreciation
There are different of concepts in depreciation depending on different nature of assets.The types of depreciation methods are summarized below:


Capital/Source of fund

Sinking fund
Insurance policy method
Annuity method


Use base

Mileage method
Depletion service hours method
Working hours method

Time base

Fixed Instalment method or straight line method
Reducing balance method or written down value method
Sum of years digit method
Double declining method

Price base

Repairs provision method
Revaluation method


Some of the important methods of charging depreciation are discussed below:

Straight line method or equal instalment or fixed instalment method

Formula
Depreciation= C-R/N
C=Cost of asset
R= Residual value or expected scrap value
N= Estimated life of asset

Illustration:
Cost of machine Rs.100000 purchased on 01.01.2015 Residual value=Rs.10000 Estimated life =5 years

                                      Machinery Account
Date
Particular
Amount
Date
Particular
Amount
1.1.15
To Machine
100000
12.12.15
By Dep
18000



12.12.15
By Bal C/d
82000

Total
100000


100000
1.1.16
To Bal B/d
82000
12.12.16
By Dep
18000




By Bal C/d
64000

Total
82000


82000
1.1.17
To Bal B/d
64000
12.12.17
By Dep
18000



12.12.17
By Bal C/d
46000

Total
64000


64000
1.1.18
To Bal B/d
46000
12.12.18
By Dep
18000



12.12.18
By Bal C/d
28000

Total
46000


46000
1.1.19
To Bal B/d
28000
12.12.19
By Dep
18000



12.12.19
By BAL C/D
10000

Total
28000


28000
1.1.20
To Bal b/d
10000




Note:
Dep=depreciation
Bal C/d = Balance carried down
Bal b/d = Balance brought down
Depreciation= 100000-10000/5=Rs.18000 p.a.
Accounting period assumed as January to December
At end of the 5th year(i.e. 12.12.19) you can see the balance left over is scarp value Rs.10000/-
Rate of Depreciation is = 18000/100000 x 100= 18%

Diminishing Balance method or written down value method

Depreciation is calculated at a fixed percentage on the written down value (ie. Closing value at the end of the year) So, the depreciation amount will reduced gradually over the life of the asset.
The rate of depreciation is constant but the amount of deprecation for every year will vary.
Let us take illustration same as above, but here the rate of depreciation is prefixed let us assume rate of depreciation is 18%, the estimated life is 10yrs
 Machinery Account
Date
Particular
Amount
Date
Particular
Amount
1.1.15
To Machine
100000
12.12.15
By Dep
18000



12.12.15
By Bal C/d
82000

Total
100000


100000
1.1.16
To Bal B/d
82000
12.12.16
By Dep
14760




By Bal C/d
67240

Total
82000


82000
1.1.17
To Bal B/d
67240
12.12.17
By Dep
12103



12.12.17
By Bal C/d
55137

Total
67240


67240
1.1.18
To Bal B/d
55136
12.12.18
By Dep
9925



12.12.18
By Bal C/d
45211

Total
55136


55136
1.1.19
To Bal B/d
45211
12.12.19
By Dep
8138



12.12.19
By BAL C/D
37073

Total
45211


45211
1.1.20
To Bal b/d
37073



Note:
Dep=depreciation
Bal C/d = Balance carried down
Bal b/d = Balance brought down
Depreciation
1st year 100000x18%=18000/-
2nd year 82000x18%=14760/-
3rd year 67240x18%=12103/-
4th year 55137x18%=9925/-
5th year 45211x18%=8138/-

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