DEPRECIATION BASICS AND DIFFERENT TYPES OF METHODS

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means continuing decrease in the value of an asset due to normal wear and tear, Obsolescence (out of fashion or outdated).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 5^th 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

1^st year 100000x18%=18000/-

2^nd year 82000x18%=14760/-

3^rd year 67240x18%=12103/-

4^th year 55137x18%=9925/-

5^th year 45211x18%=8138/-