Depreciation Accounting

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• DEPRECIATION ACCOUNTING
• (AS-6)

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Concept

• decrease in the value or the expired portion of
  the cost of fixed asset is called as
  Depreciation.
• a process of allocating the cost of a fixed asset
  over its estimated useful life in a rational and
  systematic manner.
• AICPA- a system of accounting which aims to
  distribute the cost or other basic value of
  tangible capital assets less salvage (if any)
  over the estimated useful life of the unit (which
  may be a group of assets) in a systematic and
  rational manner. It is a process of allocation
  and not of valuation

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Depreciable Assets

• expected to be used during more than one
  accounting Depreciable period
• have a limited useful life
• held by an enterprise for Assets 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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Causes

• Wear Tear Time effluxion
  (Passage of time)
• Obsolescence (Technological changes)
• 
  Depletion (Natural resources)

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Objectives

• Calculating Net Profit/Loss Correct financial
  position
• Funds for Replacement correct cost of
  production
• Tax benefit Legal requirements.
• 
  ( Companies Income Tax Act)
•  

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Notes of Depreciation

• Depreciation a Non-Cash expense
• a charge against profit
• Depreciation a Source of Fund for replacing the
  asset
• Depreciation is calculated using the Cost of the
  fixed asset (Market Value is ignored)

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Interchangeable terms of Depreciation

• Depreciation is for Fixed Asset
• Amortization is for Intangible Fictitious
  assets
• Depletion is for Natural Resources or Wasting
  Assets.

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Factors to calculate Depreciation

• Cost of asset including Capital expenses for
  installation, commissioning, trial run etc.
• Estimated useful life of the asset
• Estimated scrap value (if any) at the end of
  useful life of the asset
• Also called as Salvage Value, Residual Value,
  Terminal Value
• Note The Cost of the asset Less Estimated Scrap
  Value is called as Depreciable Value which is
  to be written off during the useful life

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Methods of charging Depreciation

• Straight Line Method
  Written Down Value method
• Annuity Method Sinking Fund
  Method
• Sum of years digits method Machine hour method
• Production units method

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Straight Line Method

• Also called as Fixed Instalment, Original
  Cost Method
• The depreciable value is written off over the
  useful life reduced to Nil.
• An equal amount is charged as depreciation in PL
  A/c.
• Assumption The usage/utility of the asset is
  equal in every accounting period.

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Straight Line Method

• Depreciation Amount Cost Scrap Value
• Useful
  Life
• Depreciation rate Depreciation Amount 100
• Cost of Asset
• Applicable for assets that have insignificant
  repairs maintenances.

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Written Down Value Method

• Also called as Reducing Balance, Diminishing
  Balance or Fluctuating Instalment method
• Annual depreciation decreases every year
• The asset Reduced value never touches Zero
• Depreciation rate

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Written Down Value Method

• Depreciation is high, when repairs are
  negligible.
• As repair increases, Depreciation gets lesser.
• Income Tax Act mandates WDV method
• Part C of Schedule II (Companies Act, 13)
  specifies depreciation rates (SLM/WDV)
• Schedule XIV (Companies Act,1956)
• First Year-Depreciation same (under SLM/WDV)
• Subsequent years- Lesser Depreciation as per WDV

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Sum of years digits method

• Variation of the Reducing Balance Method
• Depreciable Value (Original Cost Less Scrap
  Value) multiplied by
• The number of years (including present year) of
  remaining life of the asset
• Total of all digits of
  the life of the asset (in years)

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Annuity Method

• This method includes the factor of interest on
  capital employed
• Asset A/c Dr.
• To Interest A/c
• Depreciation is charged on the assets original
  cost the interest(opportunity cost)
• Depreciation is constant over the years
  (calculated using the annuity table)
• Note Depreciation Debited to PL A/c,
  Interest Credited to PL A/c
• Generally used for long term leases which
  involves capital outflow.

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Sinking Fund Method

• For replacing the fixed asset at the end of its
  life, just accumulating the depreciation is not
  enough
• This annual depreciation (calculated using
  Sinking Fund table)
• is transferred to a sinking fund account a same
  amount investment is done (government securities)
• Every subsequent year the annual depreciation
  the interest earned is reinvested the Investment.
• Last year of the old assets life, the securities
  are sold for replacing the asset

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Sinking Fund Method(Depreciation Reserve Fund)

• The book value of the old asset, at the time, is
  transferred to the Sinking Fund Account.
• Amount realised on sale of the old asset, as well
  as the profit or loss on sale of securities is
  transferred to the Sinking Fund Account
• Surplus of Sinking Fund A/c to General Reserve
• Deficit to PL A/c

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Journal Entries Sinking Fund

• Depreciation A/c Dr. Bank A/c Dr
• To Sinking Fund A/c
  To Sinking Fund Investment A/c
• Profit and Loss Account Dr.
  Sinking Fund Investment A/c Dr.
• To Depreciation A/c To Sinking
  Fund A/c
• 
  
  (Reverse if loss)
• Sinking Fund Investment A/c Dr.
  Sinking Fund A/c Dr
• To Bank A/c To Asset A/c
• Bank A/c Dr. Sinking Fund
  A/c Dr.
• To Interest on Sinking Fund Investment A/c
  To General Reserve A/c
• Interest on Sinking Fund Investment A/c Dr.
  PL A/c Dr.
• To Sinking Fund A/c To
  Sinking Fund Account
• Note Similarly Insurance Policy method is
  used, where annual depreciation is deposited as
  annual premium, on maturity the assured sum is
  used for replacement of asset.

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Production Units Method

• Used by the Manufacturing industries
• Depreciation depends mainly on the actual units/
  output produced in a particular year.
• Depreciation (Original Cost Scrap Value)
  Units produced in the year
• 
  Total Estimated output (Entire Life)

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Machine Hour Method

• Used by the Manufacturing industries
• Depreciation depends mainly on the actual machine
  hours used in a particular year.
• Depreciation (Original Cost Scrap Value)
  Machine hours run in the year
• 
  Total Machine hours(Entire Life)

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Depletion method

• Used for mines, quarries etc
• The depreciation rate is calculated by dividing
  the cost of the asset by the estimated quantity
  of product likely to be available.
• Annual depreciation will be the quantity
  extracted multiplied by the rate per unit.

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Methods-Recording of Depreciation

• Asset A/c
  Provision for Depreciation A/c
• Also called as
  Accumulated Depreciation A/c
• Depreciation is charged from the Asset A/c itself
• Depreciation A/c Dr.
• To Asset A/c
• Depreciation is accumulated in a separate
  A/c
• 
  Depreciation A/c - Dr.
• 
  To Provision for
  Depreciation A/c

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Asset Method

• Only Asset A/c is prepared
• The Purchase of Asset, Depreciation charged, Sale
  of asset, its profit/loss its closing balance
  (Book value/WDV) are shown in the Asset A/c.
• In the Balance Sheet, the asset is shown at the
  Net Book Value (Gross Value Depreciation)

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Accumulated Depreciation

• The Asset A/c Provision for depreciation A/c
  are separately maintained
• In the Asset A/c, the Purchase, Sale its
  Profit/loss are recorded
• ( the account shows the Original cost of the
  asset)
• The depreciation is accumulated in the separate
  Accumulated Depreciation A/c
• When the asset is sold, corresponding accumulated
  depreciation on it, is to be closed.
• Accumulated Depreciation A/c- Dr.
• To Asset A/c

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Asset Disposal A/c

• Asset Disposal A/c can be prepared for the asset
  which is being disposed
• Assets sale, its profit/loss are recorded
• The opening balance of the asset (in the year of
  sale) is transferred to Asset Disposal A/c
• This A/c can be prepared with either of the
  method used for depreciation

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Profit/Loss on asset

• Profit or loss on sale of assets Sale price of
  asset - Book value/WDV of the asset on the date
  of sale
• Book value of the asset on the date of sale
  Original cost of the asset Total depreciation
  on the asset till that date
• The profit/loss is transferred to PL A/c
• If asset is sold over Cost (Sales Original
  Cost) Capital Reserve
• Profit till Cost PL A/c

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Illustration

• A firm purchased on 1st January, 2015 certain
  machinery for 58,200 and spent 1,800 on its
  erection. On July 1, 2015 another machinery for
  20,000 was acquired. On 1st July, 2016 the
  machinery purchased on 1st January, 2015 having
  become obsolete was auctioned for 38,600 and on
  the same date fresh machinery was purchased at a
  cost of 40,000. Depreciation was provided for
  annually on 31st December at the rate of 10 per
  cent p.a. on written down value. Prepare the
  necessary accounts.

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Change in method of depreciation

• As per Consistency concept , the Accounting
  policy should be consistently applied.
• Change is allowed when
• Required by the Statute
• Required by Accounting Standard
• Change result in better true fair view of
  financial statements
• Change in the depreciation method of the asset is
  applied retrospectively.

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Change in method of depreciation

• Depreciation is to be compared under both the
  methods from the Date of purchase
• If the depreciation under old method is
• gt Depreciation under new method, then excess
  (surplus) depreciation is taken back (Credited in
  PL A/c)
• If the depreciation under old method is
• lt Depreciation under new method, then short
  (deficit) depreciation is charged(Debited in PL
  A/c)
• Prospectively (from date of change), the new
  method is applied
• (to be applied on revised WDV- if new method is
  WDV)

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Illustration

• A firm purchased on 1st January, 2014 certain
  machinery for 52,380 and spent 1,620 on its
  erection. On January 1, 2014 another machinery
  for 19,000 was acquired.
• On 1st July, 2015 the machinery purchased on 1st
  January, 2014 having become obsolete was
  auctioned for 28,600 and on the same date fresh
  machinery was purchased at a cost of 40,000.
• Depreciation was provided annually on 31st
  December at the rate of 10 per cent on written
  down value. In 2016, however, the firm changed
  this method of providing depreciation and adopted
  the method of providing 5 per cent per annum
  depreciation on the original cost of the
  machinery with retrospective effect.

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Change in Useful Life

• a periodical review of useful life should be done
• In case of revision, WDV should be depreciated
  over remaining life
• (as per the revision)

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Revaluation of asset

• As per AS-6, upward/downward revaluation of asset
  may be done. (on the reduced balance)
• Depreciation is charged on the revalued asset
  over the remaining estimated useful life

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Treatment of Revaluation

• In case Asset revalued upward, the revaluation
  profit credited to Revaluation Reserve A/c
• Asset A/c Dr.
• To Revaluation Reserve A/c
• When subsequently revalued downward, Revaluation
  loss debited/charged from Revaluation Reserve
  (to the extent available), otherwise from PL A/c
• Revaluation Reserve A/c Dr
• PL A/c - Dr.
• To Asset A/c
• For downward revaluation for the first time,
  Revaluation loss charged to PL A/c
• PL A/c Dr.
• To Asset A/c

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Provision for repairs renewals

• An estimated expenditure is debited to Profit and
  Loss Account and credited to Provision for
  Repairs and Renewals Account
• PL A/c Dr.
• To Prov. For Repairs A/c
• The actual expenses are taken from the Provision
  A/c
• Prov. for repairs A/c Dr.
• To Repairs A/c
• Balance in Provision A/c is transferred to Asset
  A/c

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MCQs

• Q.1. Original cost of a machine Rs. 1,30,000,
  Salvage value Rs. 4,000, Useful life 6 years,
  Depreciation for the 1st year under sum of year's
  digit method will be

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MCQs

• Q.2. What would be treatment when plant and
  machinery is sold for Rs. 1,40,000 whose cost is
  Rs. 1,00,000 and WDV is Rs. 40,000

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MCQs

• Q.3. A new machine costing 1 lakh was purchased
  by a company to manufacture a special product.
  Its useful life is estimated to be 5 years and
  scrap value at 10,000. The production plan for
  the next 5 years using the above machine is as
  follows
• Year 1 5,000 units
• Year 2 10,000 units
• Year 3 12,000 units
• Year 4 20,000 units
• Year 5 25,000 units
• The depreciation expenditure for the 3rd year
  will be

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MCQs

• Q.4. Method of depreciation - SLM Rate of
  depreciation-20 Year ending on 31st March every
  year. 1-04-04 Purchased second hand machinery for
  Rs.80,000 1-04-04 Spent Rs.20,000 on its repairs
  Find out the profit or loss on sale of machinery
  if machinery is sold on 30-09-2006 for Rs.45,000

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MCQs

• Q.5. If depreciation is charged on an asset by
  Straight line and Reducing balance methods, what
  will be the respective amount of depreciation in
  subsequent years?

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MCQs

• Q.6. Which method of charging considers that the
  business besides losing the original cost of the
  asset also loses interest on the amount used for
  buying the asset?

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MCQs

• Q.7. For charging depreciation, on which of the
  following assets, the depletion method is
  adopted?

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MCQs

• Q.8. The portion of the acquisition cost of the
  asset, yet to be allocated is known as

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MCQs

• Q.9. Which of the following expenses is not
  included in the acquisition cost of a plant and
  equipment?

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MCQs

• Q.10. In the case of downward revaluation of an
  asset which is for first time revalued, the
  account to be debited is