Depriciation by Ronak Mehta

8/3/2019 Depriciation by Ronak Mehta

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Accounting Standards 6

Depreciation Accounting


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Accounting standardsThe accounting standard(AS) 6, Depreciation Accounting,

issued by the ICAI.

This standard was first issued in November 1985 and

made mandatory from 1st April, 1995.


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1) Definition of Depreciation

2) Causes of Depreciation

3) Factors that affect the calculation of Depreciation

4) Methods of Depreciation

a) Straight-line method

b) Reducing balance method

5) Conclusion

Learning Objectives:


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AS-6:DEPRECIATION ACCOUNTINGAccording to Accounting Standard (AS 6)

Depreciation is a measure of the wearingout, consumption or other loss of value of adepreciable asset arising from use effluxion oftime or obsolescence through technology andmarket changes


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Definition of DepreciationIt represents the diminution in value of a fixed asset over a

period of time.

Since depreciation is a provision, it is important to calculatethis figure as accurately as possible.

As a fixed asset has a life of over 1 year and is expected toproduce revenue over a number of years, it is importantto spread the cost of the fixed asset over these years.


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Why do we have to include depreciationin the balance sheet and P & L A/c ?

The depreciation charge in the profit andloss account represents acost of expense and can be viewed asthe cost ofusing the fixed asset overthe period that the profit and loss account

covers.


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1) Physical deteriorationi) Wear and tear When a motor vehicle or

machinery or fixtures and fittings are used, theyeventually wear out.

ii) Erosion, rust, rot and decay Land may beeroded or wasted away by the action of wind, rain, sunand other elements of nature.

Causes of Depreciation


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2) Economic factorsi) Obsolescence: Process of becoming out of date.

For example, replacing a computer with old operating

system with a new computer with XP system.

ii) Inadequacy: Arises when an asset is no longer usedbecause of the growth and changes in the size of thefirm.

For example, a small ferryboat that is operated by a firm ata coastal resort will become entirely inadequate cause ofpopularity, so the firm may replace it with a large

ferryboat.

Causes of Depreciation (cont.)


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3) The time factor (the effluxion of time)Some assets might have a legal life fixed in terms ofyears.

For example, the patents, and leasehold.

Rent some buildings for 10 years.

4) DepletionOther assets are of wasting character, perhaps due to

the extraction of raw materials from them.

For example, Natural resources such as mines, quarries andoil wells come under this heading.

Causes of Depreciation (cont.)


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Factors that affect thecalculation of Depreciation1) Cost of asset(include expenses and capital expenditureincurred eg. The installation fees, the legal fees)

2) Estimated useful l i fe of assetThis is the number of years that the asset is expected to be used

3) Residual or scrap value of the assetThis is the value of the asset at the end of its life.

4) Method of calculating depreciation


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1) STRAIGHT LINE METHOD Amount of depreciation is fixed. Useful to assets whose service remain uniform throughout the year. For

eg: Furniture & fixtures

2) WRITTEN DOWN VALUE METHOD Rate of depreciation is fixed.

3) ANNUITY METHOD Depreciation is calculated from annuity table.

4) SINKING FUND METHOD The amount of depreciation created is invested outside.

5) INSURANCE POLICY METHOD Amount of depreciation of each year is paid as an insurance premium.

Methods of Depreciation


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6) ANNUAL EVALUATION METHOD7) KILOMETRE METHOD

Depreciation calculated on the distance run by the transportation means.

8) LABOUR HOUR RATE METHOD Depreciation is calculated on the basis of labour hour worked.

9) GLOBAL METHOD Depreciation is calculated on the sum of all the assets.

10) PRODUCTION UNIT METHOD Mostly used in mines to calculate the depreciation on production.

11) STATUATORY METHOD Depreciation value/rate is fixed by this method.

Methods of Depreciation (cont.)


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It is a very popular method because its simplicity &consistency.

Straight Line Method


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a) Straight-l ine method (using equation)Straight-line method of depreciation is based on the cost of anasset that is then depreciated, by the same amount, over theestimated useful life of the asset.

Cost Estimated Disposal Value

Depreciation per annum =

Expected useful life

Example 1:ABC Ltd. Bought a machine at a cost of Rs. 80,000. Themachine has an expected useful life of 5 years and at theend of the 5th year, it can be sold for Rs. 10,000.

Depreciation per annum = Rs. 14,000

Straight Line Method


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Cost Annual

Depreciation

Provision for

Depreciation

NBV

Date of purchase 80,000 80,000

End of 1st year 80,000 14,000 14,000 66,000

End of 2cd year 80,000 14,000 28,000 52,000

End of 3rd year 80,000 14,000 42,000 38,000

End of 4th year 80,000 14,000 56,000 24,000

End of 5th year 80,000 14,000 70,000 10,000

Straight Line MethodDepreciation for 5 years would be:


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Straight Line MethodADVANTAGES1. It is simple to calculate & easy to understand.

2. It can reduce the book value of the asset to zero.

3. The valuation of the asset each year in the balance sheet isreasonably fair.

DISADVANTAGES1. It ignores the fact that the service yielding ability of the asset fallwhile the repairs & maintenance cost increase with the passage of time.

2. If an additional asset is acquired, the amount to be charged asdepreciation needs to be calculated.


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Amount of depreciation goes on declining everyyear.

LIFE OF ASSETS

Reducing Balance Method


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b) Reducing balance methodDepreciation is calculated on a fixed percentage on

the Diminishing Balance of the Asset (the NBV).This results in a higher depreciation charge in the earlieryears of the assets estimated useful life.

Example 2: A machine costs Rs. 50,000 is to bedepreciated at 15% on Reducing Balance Method.

Cost Annual Depreciation Provision for

Depreciation

NBV

Date of purchase 50,000 0 - 50,000

End of 1st year 50,000 50,000 x 15% = 7,500 7,500 42,500

End of 2cd year 50,000 42,500 x 15% = 6,375 13,875 36,125

End of 3rd year 50,000 36,125 x 15% = 5,419 19,294 30,706

End of 4th year 50,000 30,706 x 15% = 4,606 23,900 26,100

End of 5th year 50,000 26,100 x 15% = 3,915 27,815 22,185


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ADVANTAGES:1. Appropriate for assets which lose value quickly in the early year

2. Appropriate for assets which become outdated/obsolete3. Easy calculation.4. Balanced effect on profit or loss account of different years.

DISADVANTAGES:1. Asset is never completed written off

2. Loss of Interest3. Unequal burden of Profit & Loss A/c.

4. For assets which have a short life, the percentage used to calculatedepreciation is very large

Reducing Balance Method


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Double entry records forDepreciationFor Purchase of Fixed Asset

Asset A/c. Dr. xxTo Cash/Bank A/c. xx

For Depreciation of Fixes AssetDepreciation A/c. Dr. xx

To Machinery / Asset A/c. Xx

For Transfer of Depreciation to P & L A/c.P & L A/c. Dr. xxTo Depreciation A/c. xx


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For Selling Asset Depreciation till dateDepreciation A/c. Dr. xx

To Machinery / Asset A/c. xxFor Selling Asset Cash Received

Cash/bank A/c. Dr. xxTo Machinery / Asset A/c. xx

For Profit or loss on sale of AssetMachinery/ Asset A/c. Dr. xxTo Profit on sale of asset A/c. xx

Loss on Sale of asset A/c. Dr. xxTo Machinery A/c. xx

Double entry records forDepreciation


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Double entry records forDepreciationFor Providing Depreciation on Asset

Depreciation A/c. Dr.xx To Provision for Depn. A/c. xx

For Transferr ing Prov. For Depn. On Asset SoldProv. For Depn. A/c. Dr. xx

To Asset Sale A/c. Xx


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For determination of net profit or net loss.

For showing asset at fair and true value in thebalance sheet.

Provision of funds for replacement of assets.

Ascertaining accurate cost of production.

Distribution of dividend out of profit only.

CONCLUSION


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Thank you

Depriciation by Ronak Mehta

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