ABSTRACT

Depreciation is the accounting process of gradually converting unexpired cost of fixed asset

into expenses over a series of accounting period. It is derived from a latin word

‘Depretium’ where ‘De’ means decline and ‘Pretium’ means price. It is the gradual

decline in the book value of fixed asstes, due to their use and allied reasons. In industry long

lived assets or fixed assets wears out over a longer period. Accordingly, the outlay of long

lived asset is spread over several years and annually only a fraction thereof expires. So to find

out the correct profit or the net income of a certain business depreciation is charged.
 INTRODUCTION

Depreciation is the cost of lost usefulness or cost of diminution of service yield from a
use of fixed assets. It is the permanent fall in the value of fixed asset arising through wear and
tear from the use of those assets in the business.

Depreciation is a method of reallocating the cost of a tangible asset over its useful life
span of it being in motion. Businesses depreciate long-term assets for both accounting and tax
purposes. The former affects the balance sheet of a business or entity, and the latter affects
the net income that they report. Generally the cost is allocated, as depreciation expense,
among the periods in which the asset is expected to be used. Methods of computing
depreciation, and the periods over which assets are depreciated, may vary between asset types
within the same business and may vary for tax purposes. These may be specified by law or
accounting standards, which may vary by country. There are several standard methods of
computing depreciation expense, including fixed percentage, straight line, and declining
balance methods. Depreciation expense generally begins when the asset is placed in service.
For example, a depreciation expense of 100 per year for five years may be recognized for an
asset costing 500. Depreciation has been defined as the diminution in the utility or value of an
asset. Depreciation is a non cash expense. It does not result in any cash outflow. Causes of
depreciation are natural wear and tear.

OBJECTIVE: To calculate proper profit, to show the asset at its reasonable value to
maintain the original monetary investment of the asset intact.

METHODOLOGY:

1. Books
2. Website
Causes of deprecation:

 Passage of time: Some assets confer upon their holders the exclusive rights to enjoy
certain privileges for a fixed period of time.
EX: Copyrights, Patent rights, Leases of land
 Depletion of fixed assets: An assets that depletes over time as resources are extracted
from it.
EX: Gold mines, Quarries
 Obsolescence: When new models or efficient tool come into existence then old assets
become out of date.
EX: Cars, Computers
 Physical deterioration: It is cost by physical wear and tear. Like rot, erosion, rust
and decay.
EX: Office furniture, printing machines,

Needs of charging depreciation:

 Determination of net profit or net loss

 Showing assets at fair and true value in the balance sheet
 Provision of funds for replacement of assets.
 Ascertaining accurate cost of production.
 Distribution of dividend out of profit only.
 Avoiding over payment of income tax.

Factors determining depreciation:

 Original cost of the fixed assets i. e,purchase price plus freight and installation expenses.
 Estimated amount of expenditure on repairs during the useful life.
 Estimated useful life of asset after which it will be discarded.
 Estimated residual or scarp value.
 Possibility of obsolescence.
 Interest on investment – the amount invested on purchase of asset, if it had been invested
in some other investment what interest would have been earned.
 Advantages of depreciation:
1. Tax deduction: depreciation is seen as a cost in accounting, so even knowing
that there isn’t a out flowing of cash, it counts as a cost. That is why a lot of
companies accelerate the process of depreciation: because it lowers your taxes.
2. Asset Valuation: Reporting the value of the asset with the depreciation helps a lot
when analysing, knowing that the value with the depreciation is more correct.
3. Timing for rebuying: A lot of investors see the excess amount of depreciation as a
sign that the executive border is not reinvesting the money in the operation. So, for
big companies and people that want to sell their business, the depreciation in the
books helps to see which time is best to reinvest in assets.
Disadvantages of depreciation:

1. Depreciation is not related to usage factors.

2. It ignores the fact that in the later years of the life of the asset, efficiency of the asset
declines.
3. Loss of interest on investment in the asset is not accounted for.

Methods of charging depreciation:

1. Straight line method

2. Written down value method

Straight line method: A common method of reducing the cost, or purchase price, of
assets is straight-line depreciation. This process reduces the cost of an asset by an equal
amount each year over the estimated useful life of the asset, typically a number of years.
Straight-line depreciation is calculated by dividing the depreciable cost of the asset by the
number of years the asset will be used.

Advantages: Straight-line depreciation, also known as the fixed or equal-installment

depreciation method, is the simplest and most widespread form of depreciation used by
businesses. It is suitable for assets that operate uniformly and consistently over the life of the
item. The fixed method is straightforward, uncomplicated, easy to understand and simple to
apply. Each year the same amount of money is taken as a depreciable business expense on the
company's tax return.

Disadvantages: Most pieces of office equipment, machinery and other items purchased do
not perform exactly the same each year. As assets age they become less efficient. Repair
costs usually increase over time. Straight-line depreciation does not account for the loss of
efficiency or the increase in repair expenses over the years and is, therefore, not as suitable
for costly assets such as plant and equipment. The functional life span of some assets cannot
clearly be estimated. The straight-line depreciation method should not be used when the
useful life of an asset is unpredictable.

Written down value method: Written down value or the reducing balance method of
depreciation is a method in which depreciation is calculated at a fixed percentage on the
original cost in the first year. However in the subsequent years, depreciation is calculated at
the same fixed percentage but on the written down values gradually reducing during the
expected working life of the Asset due to charge of depreciation.

Advantages:

1. This method is simple to understand and easy to operate. A separate calculation need
not be made in respect of every addition to the main asset.
2. The amount of annual depreciation reduces with the reducing balance of the asset.
3. The amount of depreciation is higher in the earlier years when the machine is efficient
and the cost of repairs is low. In later years amount of depreciation becomes lower
and the amount of repairs increase due to extended use and wear & tear of the
Asset. Thus the total charge for depreciation and repairs together remains more or
less uniform over the years. This helps in eliminating huge variations in
annual profits or losses.
4. This method takes care of the obsolescence problem related to the assets as the major
part of depreciation is charged in the earlier years. Due to this feature replacement
of the assets before the end of its estimated useful life becomes easy and feasible.

Disadvantages:

1. Under this method the book value of an asset cannot be reduced to zero.
2. The rate of depreciation has to be very high if the written down value is to be brought
down to its estimated scrap value.
3. This method is not suitable for an asset having a very short life. The calculation of the
rate of the depreciation becomes very difficult and creates problems in this case.
 Comprehensive problems on depreciation:

A firm purchased plant and machinery on 1st April, 2012 for Rs. 50000. Depreciation is
written off at the rate of 10 % per annum. Prepare journal entries and show plant and
machinery account and depreciation account for 3 years under both the straight line method
and written down value methods. The firm closes its book on 31st December each year.

Solution

Journal entries for plant &machinery account under straight line method

Date Particulars Ledger Debit(Rs.) Credit(Rs.)

folio
2012 Apr. 1 Machinery a/c dr. 50000
To bank a/c 50000
2012 Dec. 31 Depreciation a/c dr. 3750
To machinery a/c 3750
2012 Dec 31 Profit and loss a/c dr. 3750
To depreciation a/c 3750
2013 Dec 31 Depreciation a/c dr. 5000
To machinery a/c 5000
2013 Dec 31 Profit and loss a/c dr. 5000
To depreciation a/c 5000
2014 Dec 31 Depreciation a/c dr. 5000
To machinery a/c. 5000
2014 Dec 31 Profit and loss a/c. Dr 5000
To depreciation a/c 5000
:

Journal entries for plant and machinery account under written down value method:

Date Particulars Ledger Debit(Rs.) Credit(Rs.)

folio
2012 Apr. 1 Machinery a/c dr. 50000
To bank a/c 50000
2012 Dec. 31 Depreciation a/c dr. 3750
To machinery a/c 3750
2012 Dec 31 Profit and loss a/c dr. 3750
To depreciation a/c 3750
2013 Dec 31 Depreciation a/c dr. 4625
To machinery a/c 4625
2013 Dec 31 Profit and loss a/c dr. 4625
To depreciation a/c 4625
2014 Dec 31 Depreciation a/c dr. 4163
To machinery a/c. 4163
2014 Dec 31 Profit and loss a/c. Dr 4163
To depreciation a/c 4163
 Plant and machinery account:

Date Particulars Fixed Reduci Date Particulars Fixed Reducing

instalm ng instalme balance
ent instalm nt method
method ent method
method
2012 To bank a/c. 50000 50000 2012 By depreciation 3750 3750
Apr. Dec a/c
1 31 By balance c/d 46250 46250
50000 50000 50000 50000
2013 To bal b/d 46250 46250 2013 By depreciation 5000 4625
Jan 1 Dec. a/c
31 By balance c/d 41250 41625
46250 46250 46250 46250
2014 To balance 41250 41625 2014 By depreciation 5000 4163
Jan. 1 b/d Dec. a/c
31 By balance c/d 36250 37462
41250 41625 41250 41625

Depreciation account

Date Particulars Fixed Reducing Date Particulars Fixed Reducing

instalment instalment instalment balance
method method method method
2012 To plant 3750 3750 2012 By profit 3750 3750
Dec 31 & Dec 31 & loss a/c
machinery
a/c
3750 3750 3750 3750
2013 To plant 5000 4625 2013 By profit 5000 4625
Dec 31 & Dec 31 & loss a/c
machinery
a/c
5000 4625 5000 4625

2014 To plant 5000 4163 2014 By profit 5000 4163

Dec 31 & Dec 31 & loss a/c
machinery
a/c

5000 4163 5000 4163

Conclusion