DEPRECIATION

Varnit Kaushik(214)

Kumar Saurabh(223)

Abhishek Shaw(210)

Shobhit Goel(240)

Sachin Kumar Gupta(256)

Flow of Presentation Objective

Introduction

Causes of depreciation

Methods of calculating depreciation

Need for depreciation

OBJECTIVE

To understand the basics of depreciation and its application in financial accounting .

DEFINITION

Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes.

Depreciable Assets

• Expected to be used during more than one accounting period.

• Have a limited useful life .• Held by an enterprise for use in 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 .

Depreciation not applicable in

• Forests, plantations and similar regenerative natural resources .

• Wasting assets including expenditure on the exploration for and extraction of minerals, oils, natural gas and similar non-regenerative resources .

• Expenditure on research and development .• Goodwill and other intangible assets .

Tangible Depreciable Property

Purchased property that can be seen or touch• Machinery• Buildings and improvements, fences• Dams, ponds, or terraces• Irrigation systems and water wells• Partial business use

Intangible Depreciable Property

Purchased property that has value that cannot be readily seen or touch

• Computer Software

• Copyrights, patents, etc

Causes of Depreciation

• Internal causes

• External causes

Internal Causes

• Wear and tear

• Depletion

External Causes

• Obsolescence

• Efflux of time

• Accident

METHODS FOR CALCULATING DEPRECIATION

Straight Line Depreciation Method

• Simplest and most commonly used depreciation method .• Calculated by taking the purchase or acquisition price of an

asset subtracted by the salvage value divided by the total productive years .

• The asset can be reasonably expected to benefit the company .

EXAMPLE

= $20,000 per year ($62,500 - $2,500) × 13

Depreciation Accumulated Accumulated UndepreciatedExpense Depreciation Depreciation Balance

Year (debit) (credit) (credit balance) (book value)62,500$

1 20,000$ 20,000$ 20,000$ 42,500 2 20,000 20,000 40,000 22,500 3 20,000 20,000 60,000 2,500

60,000$ 60,000$

9-14

Accelerated Depreciation Method

• An asset loses book value at a faster rate than the traditional straight-line method.

• Companies employ this method when they have assets that they expect to be more productive in their early years.

• Helps companies shield income from taxes as the higher the depreciation expense, the lower the net income.

EXAMPLES

Sum-of-years' Digits Method

• Annual Depreciation is determined by multiplying the Depreciable Cost by a schedule of fractions.•They assume that an asset loses a majority of its value in the first several years of use.

EXAMPLE

Depreciation expense =

(Cost - Salvage value) x Fraction

Fraction for the first year = n / (1+2+3+...+ n)    Fraction for the second year = (n-1) / (1+2+...+n)  

   Fraction for the third year = (n-2) / (1+2+3+...+ n)           ...

Fraction for the last year = 1 / (1+2+3+...+ n)

  n represents the number of years for useful life. 

ABC Ltd. purchased a truck for $65,000 on 1st January 1991. The expected life was 5 years and salvage value $5,000. 

Amount to be written off= $65,000 - 5,000 = 60,000

Sum of years = 1 + 2 + 3 + 4 + 5 = 15

First year depreciation 5/15×60,000=20,000$

Second year depreciation 4/15×60,000=16,000$

Third year depreciation 3/15×60,000=12,000$

Fourth year depreciation 2/15×60,000=8,000$

Fifth year depreciation 1/15×60,000=4,000$

Total depreciation in 5 years 20000+16000+12000+8000+4000=60,000$

Units-of-Production Depreciation Method

• Based on an asset’s usage, activity, or parts produced instead of the passage of time .

• In this method, depreciation during a given year will be very high when many units are produced, and it will be very low when only a few units are produced.

Annual depreciation expense =

(cost of asset – salvage value)*

Actual production/ total estimated production

Formula for Calculating Units-of-Production Depreciation Method

EXAMPLE

Suppose, a printer has original cost $7,000, salvage value $1,000, and is expected to produce 100,000 units.

Depreciation per unit = (7,000−1,000) / 100,000 = .06$

.06× actual production will give the depreciation cost of the current year.

If in any year actual production is 10,000 units, then depreciation for that year is 10,000x.06= 600$

•Ascertainment of True Profit or Loss

-Depreciation must be considered in order to rule out the ambiguity

•Ascertainment of True Cost of Production

-Depreciation must be considered as a part of cost of production else it would result in loss to business.

Need for Depreciation

•True Valuation of Assets-Depreciation helps in displaying true financial position of business .

•Keeping Capital Intact-If excess profit is withdrawal (not considered), working capital would gradually reduce resulting in weak business.

Thank You!!