THE SYSTEM OF ACCOUNTING

WRITTEN BY:

SYED AQEEL RAZA

MASTER OF COMMERCE & POLITICS

DEPRECIATION

The depreciation in accounting is an income tax deduction

that allows recovering the cost of an asset used in a trade or
business or for the production of income under depreciation
expense allowed annually allowance for the wear and tear,
deterioration, or obsolescence of the asset.
Most types of tangible assets except land such as building,
machinery, vehicles, furniture, equipment etc come under
depreciation and likewise, the certain intangible asset like
patent, copyright, computer software etc. is depreciable.
Therefore, the decrease in value of tangible/non-current
assets or the allocation of the cost of assets to the period in
which they are used for accounting or tax purposes comes
under depreciation involves in;
-

Cost of the asset

Expected salvage value/residual value of the asset
Estimated useful life of the asset
The method of calculating the cost over such life.

COST OF ASSETS
Examples of fixed assets are building, furniture, plant and
machinery, office equipment, vehicles, etc. that can be
depreciated when the land is non-current assets but does not
depreciate because of its natural value. The cost of the fixed
asset is declined by depreciation as depreciation expense
which affects revenue and the declined amount is shown by
accumulated depreciation as a contra asset.
The cost of an asset contains purchase price excluding trade
discount, cash discount, and direct expenses like insurance
in transit, transporting, installation charges, the foundation
of the plant, additional part as replacement etc.
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DEPRECIATION
SALVAGE VALUE/RESIDUAL VALUE OF THE ASSET

When the estimated life of an asset is timed out, the

company disposes of and sells it for some reduced amount
which is salvage value based on asset cost, less any
estimated salvage value and if the salvage value is expected
to be quite small, it is generally ignored for the purpose of
calculating depreciation.

ESTIMATED USEFUL LIFE OF THE ASSETS

The depreciation is recognized over the estimated useful life
of an asset and the estimated useful life of an asset is
expected to be productive and on ending useful life of the
asset is expected to be disposed of.

THE METHOD OF COMPUTING DEPRECIATION

There are several methods for calculating depreciation but
most common;
Straight line depreciation

Sum of years digits method

Units of output depreciation
Production hours method
Diminishing/declining balance method
Double-declining balance method

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DEPRECIATION

STRAIGHT LINE DEPRECIATION

The straight line depreciation method is the simplest method
used widely. In this method, an equal portion of the cost of
an asset is allocated to each year or month and may call it
constant annual depreciation.
The annual depreciation according to this method is
calculated as under;
Depreciation =
cost - Salvage/Residual value / useful life.
Or
depreciation = cost-salvage/residual value
Useful life

Assume that on April 2010, a company purchased furniture

at the cost of Rs.100, 000/=. The useful life of the furniture is
estimated for five years. At the end of useful life, the salvage
value or residual value will be Rs.20, 000/=.
Suppose that the furniture includes on list price Rs.
100,000/= at 10% trade discount, 5% cash discount and
direct charges amounting to Rs.3,960/= including insurance
in transit, transportation, labor charges, fixing charges etc.
=

LIST PRICE
LESS: 2% trade discount
Less: 2% cash discount
Add: direct expenses
Net cost of the furniture

100,000
2,000
---------98,000
1,960
--------96,040
3,960
--------100,000
======

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DEPRECIATION

STRAIGHT LINE DEPRECIATION CALCULATION

Depreciation
12,000
Depreciation
= 16,000
Depreciation
= 16,000
Depreciation
= 16,000
Depreciation
= 16,000
Depreciation
4,000

for April 2010; = (100, 000 - 20,000 = 80,000) x 1/5 = 16,000 x 9/12 =
2011;

= (100, 000 - 20,000 = 80,000) x 1/5 = 16,000 x 12/12

2012;

= (100, 000 - 20,000 = 80,000) x 1/5 = 16,000 x 12/12

2013;

= (100, 000 - 20,000 = 80,000) x 1/5 = 16,000 x 12/12

2014;

= (100, 000 - 20,000 = 80,000) x 1/5 = 16,000 x 12/12

Jan-Mar 2015

= (100, 000 - 20,000 = 80,000) x 1/5 = 16,000 x 3/12 =

Sum of years digit method

In this method, the depreciation rate is used as to the life of
an asset is 5 years which fraction is 1+2+3+4+5=15 which
means that 5 years is the remaining life of the asset and 15
is the sum total of its useful life.
Assume that an asset was purchased at Rs.5000/= which
has estimated residual value Rs.500/= and estimated life 5
years. Under the method of sum of year digit method, it is
computed as under;
Depreciation Schedule: Sum of year digits method
Year

Computation

depreciation Accumulated Book Value

Expense
Depreciation
5000

1st
2nd
3rd

5/15 x 4500
4/15 x 4500
3/15 x 4500

1500
1200
900

Cost

1500
1200
900

3500
2300
1400

4th
5th

2/15 x 4500
1/15 x 4500

600
300

600
300

800
500

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DEPRECIATION

Units of output depreciation

In this method, a more equitable distribution of the cost of some assets can be
obtained by dividing the original depreciation cost with the estimated life in units
rather than the year of useful life. This method states the capacity of machinery to
produce units.
Suppose that a machine was purchased at Rs.100,000 when its residual value is
estimated by Rs.10,000 and production capacity by 100,000 units with normal repair
and maintenance. In this method, the depreciation can be made as;
Depreciation rate per unit
Depreciation rate per unit

=
cost salvage value
Estimated life in units
=
100,000 10,000
=
90,000
--------------------------------100,000
100,000

0.90 Paisa per unit/depreciation expenses

DATA FOR DEPRECIATION BY UNITS OF OUTPUT METHOD

COST OF DEPRECIABLE ASSET
LESS: ESTIMATED SCRAP VALUE
TOTAL AMOUNT TO BE DEPRECIATED
ESTIMATED USEFUL LIFE IN UNITS
DEPRECIATION EXPENSE PER UNNIT =

100,000
10,000
90,000
100,000
90,000/10000 = 0.90 PAISA

SCHEDULE OF DEPRECIATION ON MACHINERY

Life

Depreciation
Value

Units
Rate

depreciation Accumulated Written down

Produced
Expense Depreciation


1
2
3
4
5
6
46000
7
32500
8
23500
9
10000

Cost
100000
0.90
8000
7200
7200
92800
0.90
0.90
0.90
0.90
0.90

8000
8000
11000
10000
15000

7200
7200
9900
9000
13500

14400
21600
31500
40500

0.90

15000

13500

67500

0.90

10000

9000

76500

0.90

15000

13500

90000

54000

85600
78400
68500
59500

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DEPRECIATION
PRODUCTION HOURS METHOD

In this method, plant or machinery is depreciated by hourly

underestimated life in hours.
Suppose that; Machine cost Rs.30000, salvage value Rs.10,
000, estimated life for 50,000 hours with normal
maintenance
Production hours rate =
cost scrap value
Estimated life in hours
Production hours rate =

30000 10000 = 20000

50000
50000

0.40

SCHEDULE OF DEPRECIATION
Life

1
2

Depreciation Hours
depreciation Accumulated Written down
Rate/hour
worked
Expense Depreciation
Value
Cost
30000
0.40
5000
2000
2000
28000
0.40

5000

2000

4000

26000

3
4
5
6
18000
7
16000
8
14000
9
10000

0.40
0.40
0.40
0.40

5000
5000
5000
5000

2000
2000
2000

6000
8000
10000
2000

24000
22000
20000
12000

0.40

5000

2000

14000

0.40

5000

2000

16000

0.40

10000

4000

20000

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DEPRECIATION
DIMINISHING/DECLINING BALANCE METHOD

In this method a certain percentage is determined to fix rate

of calculating the depreciation on any asset which applied to
the total cost of asset of the amount kept in balance year
wise or in other words the rate will be applied to the total
cost of asset and in the second year the same rate will be
applied to the total cost reduce the first year depreciation
and so on.
Assume that if the cost of an asset is Rs.100, 000 and the
fixed percentage applicable to this asset 10%, the
depreciation will be as shown in schedule;
SCHEDULE OF ASSET DEPRECIATION
Life

Rate
Depreciation

Depreciation Accumulated Written down

Expense Depreciation
Value

Cost
100000
1
10%
10000
10000
90000
2
10%
9000
19000
81000
3
10%
8100
27100
72900
4
10%
7290
34390
65610
5
10%
6561
40951
59049
6
10%
5905
46856
53144
7
10%
4214
51070
48930
8
10%
4893
55963
44037

DOUBLE DECLINING/DIMINISHING BALNAE METHOD

The double declining balance method also known as diminishing balance
method is the same method as declining or diminishing balance

method but in this method the percentage as of diminishing

balance method will be double to calculate depreciation of
an asset. If the rate of depreciation is not known the straight
line method help to find out the rate with the formula;
Amount of yearly depreciation
Depreciation amount

x 100

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DEPRECIATION

The rate will be multiplied by 2 to make it rate double which

will be applied in this method to depreciate an asset;
Suppose that a company purchased equipment which cost to
Rs.200000 and estate its life for 10 years and salvage value
Rs.20000 and used them used double declining balance
method for this equipment.
COMPUTATION OF DEPRECIATION
STEP 1
Straight line depreciation = Cost-Salvage value =
Estimate life in year

per year

200000-20000

Depreciation per year

= 200000

20000 depreciation

10

10

STEP 2
COMPUTATION OF RATE OF DEPRECIATION
Depreciation per year
Depreciable cost

x 100

20000 x 100
200000

rate of depreciation

2000000
200000

= 10%

STEP 3
DOUBLE RATE
Depreciation rate

10%

x 2

20% double rate

STEP 4
COMPUTATION OF DEPRECIATION
Cost
First year depreciation @ 20%
W.D. Value
2nd year depreciation @ 20%
W.D. value

200000
-20000
180000
-36000
144000

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DEPRECIATION

The depreciation expense account is debited and the

accumulated depreciation account was credited. The
accumulated depreciation is a contra account to non-current
asset or the conversion value account of an asset from
where the amount reduced from an asset migrates into it
which appears in the balance sheet as a deduction from the
original purchase price of an asset.
On disposing of an asset, the fixed asset account in which
the asset was originally recorded is credited and debit the

account accumulated depreciation which will remove the

amount shown in shown in balance sheet.
If an asset not fully depreciated at the time of its disposal, it
will be recorded as a loss on un-depreciated portion and on
the sale of the asset, the loss will be reduced.
A taxpayer must use Form 4562, Depreciation
Amortization, to report depreciation on a tax return.

and

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WRITERS VIEW
Suppose that the life of an asset is expected
for ten years and was purchased one hundred
thousand rupees but after ten years it sells one
hundred twenty-five thousand rupees when the

life of it was ten years and is would be scraped

according to depreciation rules but increase in
rates even though scraped tells us that the
asset will work for further years and if sells
give profit. So, it comes to mind that the
depreciation is allowed to reduce income by
income tax to businessman to save income tax
and does not mean to live because the
depreciation expense reduces to gross profit
and after ten years the depreciation expense
relief would be ended. If the value of the asset
comes to income and/or remains in business
will give benefit to it but do not apply on
depreciation.
Therefore, the depreciation is the relief to
operate the business reducing income which
saves income tax.
WRITTEN BY:

SYED AQEEL RAZA

MASTER OF COMMERCE & POLITICS