Depreciation Ppt

Depreciation Depreciation is a measure of the wearing out,

consumption or other loss of value of a depreciable asset arising fromuse,effluxion of time orobsolescence through technology and market

changes.

CharacteristicsIt is the decrease in the value of the asset.Depreciation word is used for the decrease in the

value of tangible fixed asset. Value decreases gradually due to charge of

depreciation.

ApplicabilityThis Statement applies to all depreciable

assets, except :—(i) forests, plantations; (ii) wasting assets, Minerals and Natural Gas;(iii) expenditure on research and development;(iv) goodwill;(v) live stock – Cattle, Animal Husbandry.

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

Causes of Depreciation

By constant use Effect of timeBy expiry of legal rightsAccidentHuman mistakeObsolescenceFall in pricesDepletion

Depreciation Accounting

To ascertain the true & fair profit or loss of the organisation

To reveal the true & fair financial position of the organisation

To provide funds for replacement

To compute the correct tax liability

Contd…The term Depreciation is used broadly in the following 2

senses:

1. ECONOMIC DEPRECIATION: It is economic loss due to

both physical deterioration and technological

obsolescence. It may be… PHYSICAL DEPRECIATION FUNCTIONAL DEPRECIATION

2. ACCOUNTING DEPRECIATION: It is a systematic

allocation of cost basis over a period of time. It may be… BOOK DEPRECIATION TAX DEPRECIATION

Initial Cost Residual Value- =Depreciable Cost

Useful Life

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Periodic Depreciation Expense

2 3 4 5

Facto

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Facto

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Fa

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3Factor#4: Method of

determining the amount of

Depreciation

Factor#4: Method of determining the

amount of Depreciation

Depreciable Amount or CostInitial cost minus resale value is called the

Depreciable amount and it is this amount that has to be allocated as depreciation over the estimated life of an asset.

Depreciable Amount of a depreciable asset is its historical cost, or other amount substituted for historical cost in the financial statements, less the estimated residual value.

This amount is also known as DEPRECIATION DEPRECIATION BASEBASE.

Methods of Depreciation

The following four depreciation methods are acceptable for Financial Accounting purposes:

1. Straight-Line

2. Declining-Balance

3. Sum-of-Years-Digits

4. Units-of-Production

Declining-balance Declining-balance and sum-of-years-digitssum-of-years-digits are known as Accelerated Depreciation Methods.

Straight Line Method (SLM)The Straight-Line-Method provides for the same

amount of depreciation expense for each year of

useful life.

It views a fixed asset as providing its services in

a level stream, that is, service provided is equal

in each year of the asset’s life.

Rate is reciprocal of estimate service life

It charges an expense, an equal fraction of net

cost of assets each year.

Straight-Line MethodStraight-Line MethodStraight-Line MethodStraight-Line Method

Cost – estimated residual value Estimated life

= Annual depreciation

ExampleExampleExampleExample

Original Cost.....………….. Rs.24,000

Estimated Life in years…..5 years

Estimated Residual Value...Rs.2,000


Estimated Life in years…..5 years


Straight-Line MethodStraight-Line MethodStraight-Line MethodStraight-Line Method

Rs. 24,000 – Rs. 2,000 5 years

= Rs. 4,400 annual depreciation

SLM – Depreciation Amount and Book Value

For example, an equipment worth $1m with an estimated life of five years and salvage value of $100,000 would have the following depreciation schedule and asset value after each year as shown below.

Straight-Line MethodStraight-Line MethodStraight-Line MethodStraight-Line MethodThe straight-line method is

widely used by firms because it is simple and it provides a

reasonable transfer of cost to periodic expenses if the asset is

used about the same from period to period.

The straight-line method is widely used by firms because it is

simple and it provides a reasonable transfer of cost to

periodic expenses if the asset is used about the same from period

to period.

ACCELERATED METHODThis method allows companies to write off more

of their assets in the earlier years and less in the later years.

The biggest benefit of this method is the tax benefit.

By writing off more assets against revenue, companies report lower income and thus pay less tax.

Contd…

Stream of benefits provided by a fixed asset may not be level. Rather the benefits provided maybe great in first year of assets life and least in last year.

This is because the assets mechanical efficiency tends to decline with age, because maintenance cost increases with age.

Thus earlier periods would benefit more than later period and depreciation method will reflect this.

Two Types

1. Double declining balance method2. Sum-of-the-years digit

In both these methods, we write off approx. 2/3rd of assets cost in first half of its estimated life.

Double declining Balance Method

This is where the depreciation expense doubles the straight line depreciation expense of the first year. The same percentage is then applied to the non depreciated amount in the subsequent years.

Here each year depreciation is found by applying rate to the net book value of the asset as of the beginning of that year.

Contd…

This is stated % of straight line rate. Thus for an asset with a useful life of 10 years, Straight line rate = 10%

200% declining balance would use a rate of 20%. Similarly 150 % declining balance would use a rate of 15%.

The 200% declining balance method is called Double declining balance method because the deprecation rate is double the straight line rate.

DDB in year 1 = 2/n * (Total Acquisition Cost – Accumulated Depreciation)

where n = number of years

DDB in year 2 and beyond = 2/n * (Asset Value on Balance Sheet)

Sum-of-years-digits

Here the number 1,2,3,4….n are added where

N= estimated years of useful life

Sum = n(n+1) / 2For n=10, SYD = 55

Depreciation rate each year is fraction where denominator is the sum of these digits and numerator for the first year is N, second year is (N-1), then (N-2) and so on.

That is, 10/55, 9/55, 8/55 and so on….

Straight Line v/s Accelerated Depreciation

Assume company XYZ is just starting out as a business and they bought several new computers for their staff. The purchase value of the computers is $10,000

Computers do not have a long useful life, but five years is realistic and adequate. So, n=5

Computers also deteriorate in value much quicker in the first year than the later years so an accelerated depreciation method is more than satisfactory. At then end of five years, computers are generally worthless so the salvage value will be $0.

Contd…One of the benefits to accelerated

depreciation is the reduction of taxes, but another point of great benefit is if the equipment requires maintenance.

Accelerated depreciation will offset the increasing maintenance cost and essentially equalizes the combined charges of both maintenance and depreciation.

The graph below is a simplified view of how the accelerated depreciation and maintenance cost works out to give a straight line total expense

If the straight line method was used, the depreciation would be constant and the maintenance cost would increase which would increase the total expenses.

To see this side by side, we get the following table using the same assumptions as before but with the added maintenance expenses.

At the beginning of the life, the accelerated method obviously costs more but towards the later stages of the useful life, the expenses become much less.

In the example with maintenance cost included, just after one year, the depreciation expense is already close to equal to the straight line method. By year three, the expense is much less compared to the straight line method, and so more revenue can be recognized without any improvements in business.

The straight line method on the other hand does not alter the performance of the business. It can be seen as a revenue smoothing method.

Depreciation Red Flags

For the investing part of depreciation, it depends on the type of company. If you are looking at a rapid tech company where assets lose most of the value within the first year, needs to be replaced regularly, and costs a lot to maintain, the accelerated method is the right choice.

This brings us to the big red flag related to depreciation.

By depreciating assets too slowly, the company is using aggressive accounting. Sounds contradictory, but the result is that earnings are being manipulated by being artificially inflated.

This is true for amortization and writing off any other asset such as impaired assets and/or obsolete inventory.

When you go through the financial statements, check what type of accounting method is used.

Then compare it to a competitor and see whether it is inline with industry standards and suitable for the business model.

Units of production methodIn this method, depreciation is charged

according to actual usage of the asset i.e. high depreciation is charged when there is high activity and less depreciation is charged when there is low activity.

Zero depreciation is charged if the system is idle for the whole period

This method is similar to Straight line method except that, life of an asset is estimated in terms of no. of operations or no. of machine hours instead of no. of years.

Ex – A truck cost – 60,000$And it provides services for 3,00,000 miles.

So depreciation value would be charged at the rate of

60,000/ 3,00,000 = 20 cents per mile

So depreciation expense in a year in which the truck travelled 50,000 miles would be, $10,000.

Units-of-Production Units-of-Production MethodMethod


(Cost – estimated residual value)

Estimated life in units, hours, etc.

= Depreciation per unit, hour, etc.

×No. of Units Produced

ExampleExampleExampleExample


Estimated Life in hours….. 10,000



Estimated Life in hours….. 10,000


Rs.24,000 – Rs.2,000

10,000 hours

= Depreciation per unit, hour, et

= Rs.2.20 per hour



The units-of-production method is more

appropriate than the straight-line method

when the amount of use of a fixed asset varies

from year to year.

The units-of-production method is more

appropriate than the straight-line method

when the amount of use of a fixed asset varies

from year to year.

Units-of-ProductionUnits-of-ProductionUnits-of-ProductionUnits-of-Production

Physical Depreciation …Physical Depreciation occurs

from wear and tear while in use

and from the action of the

weather and environmental

conditions.

Functional DepreciationFunctional Depreciation occurs when a fixed

asset is longer able to provide services at the

level for which it was intended, e.g., personal

computer; that is to say, when an asset life is

mentioned in terms of its usage, then we have a

concept of Functional Depreciation.

Book Depreciation

Book Depreciation is provided as per the

prevailing accounting standards and the

necessary law of land.

Tax Depreciation

Tax Depreciation is provided as per the

prevailing taxation lawstaxation laws.

Minimum DepreciationThe Department of Company Affairs has clarified that

the rates contained in Schedule XIV to the Company Act, 1956 should be viewed as the minimum rates, and, therefore, company cannot charge depreciation at rates lower than specified in the Schedule in relation to the assets. However, if on technical evaluation, higher rate of depreciation are justified, the higher rates should be applied.

Where rates other than Schedule XIV rates are applied, Appropriate disclosers in the notes to the accounts would be required

Depreciation on Items Below Rs. 5000

As per Schedule XIV of the Companies Act, individual items of fixed assets below Rs. 5000/- should be depreciated at 100%. For Exp,

An item of furniture such as a chair or table is capable of being used independently, therefore each chair or table will have to be provided 100% depreciation if its individual value does not exceed Rs. 5000. The 100% provision cannot be avoided by arguing that the furniture can be used only as a set, i.e. a set of chairs, which in aggregate cost more than Rs. 5000.

In case of Plant and Machinery:

Where the aggregate actual cost of individual items of plant and machinery costing Rs. 5000 or less constitutes more than 10% of total actual cost of plant and machinery, normal Schedule XIV rates should be used. (Note number 8 of Schedule XIV of the Companied Act, 1956)

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Query

Info ltd. Has acquired on a 999 year lease a huge piece of land for Rs. 999 lakhs from the Government. The land along with any construction thereon will revert to the Government after 999 years. Since the said period is very long and is akin to owning the land, Info Ltd does not wish to amortize the consideration. Is that acceptable under Indian GAAP.

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ResponseAS- 19 “Leases” does not apply to lease

agreement to use lands. AS 6 ‘ Depreciation Accounting”, does not apply to land unless it has a limited useful life for the enterprise. In other words, if the life of land is limited than AS 6 would apply. In the given case, 999 years though very long is still limited. Therefore, AS 6 would apply. Therefore each year Info Ltd will have to charge Rs. 1 lakh to the income statement as amortization expenses.

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T H A N K Y O U !!!

- Kanika Monga (140)- Nishant Sharma (189)- Karan Batheja (190)

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Depreciation Ppt

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