Fixed Assets

Depreciation Methods

1 Straight Line Method 2 Accelerated methods written down value method; sum-of-the years digit method 3 Production unit method 1 Straight Line Method (SLM) SLM distributes the depreciable amount equally over the life of the asset. Assumption : depreciation arises solely from the passage of time and the effect of usage on the service value of the asset is insignificant. Used for assets that depreciate with time , and are little affected by the extent of usage. Eg. building , vehicles etc. Under charge depreciation in the earlier years. A computer costs Rs 1,00,000 and is expected to realize Rs 25,000 at the end of its estimated useful life of three years.

Annual depreciation = [cost residual value] / useful life = [Rs 1,00,000 25,000] / 3yrs = Rs 25,000

Depreciation Schedule: SLM

Year Cost (Rs) (2) 1,00,000 1,00,000 Yearly Depreciation (Rs) (3) 25,000 25,000 Accumulated Depreciation (Rs) (4) 25,000 50,000 Ending Book Value (2-4) (Rs) (5) 75,000 50,000

(1) 1 2

1,00,000

25,000

75,000

25,000

Year 1 Depreciation------------------------Dr 25,000 To Accumulated Depreciation Year 2 Depreciation------------------------Dr 25,000 To Accumulated Depreciation Year 3 Depreciation------------------------Dr 25,000 To Accumulated Depreciation Balance Sheet

25,000

25,000

25,000

Fixed Assets
Computer Gross Block Less Accumulated Depreciation

Year 1
(Rs)

Year 2
(Rs)

1,00,000 25,000

1,00,000 50,000

Net Block

75,000

50,000

2 Accelerated Methods This method provides relatively large amounts of depreciation in the early years of the assets useful life, and smaller amounts in later years. Assumption: certain types of plants and equipments are more efficient when they are new and decline in service as they age. Certain assets lose service value because of rapid technological changes. Charge higher depreciation in the earlier years. a) Written Down Value Method / Diminishing Balance Method depreciation will be computed at a fixed rate on the assets remaining value. The depreciation keeps on decreasing from year to year. This is the only accepted method acceptable for tax purposes. Depreciation Rate = 1 - n (residual value / cost) , n being useful life in years

Depreciation Rate = 1 - 3 25,000/ 1,00,000 = 1 - 30.25 = 1- 0.6299 = 0.3700 or Depreciation Schedule: WDV Year (1) Cost (Rs) (2) Yearly Depreciation (Rs) (3)

37% Ending Book Value (2-4) (5)

Accumulated Depreciation (Rs) (4)

1 2 3

1,00,000 1,00,000 1,00,000

37,000 23,310 14,685

37,000 37,000 23,310 23,310 14,685

37,000 60,310 74,995

63,000 39,690 25,005

Year 1 Depreciation------------------------Dr To Accumulated Depreciation Year 2 Depreciation------------------------Dr To Accumulated Depreciation Year 3 Depreciation------------------------Dr To Accumulated Depreciation Fixed Assets Computer Gross Block Less Accumulated Depreciation Net Block

14,685 Balance Sheet Year 1 Year 2

1,00,000 37,000 63,000

1,00,000 60,310 39,690

2 Revising Estimated Useful Life and Residual Value New developments such as unanticipated physical damage or unforeseen obsolescence would require changing the previous useful life estimate. Q1: Vinod bought a computer for Rs 1,00,000, with an estimated residual value of Rs 10,000.At the time ,it seemed that the computer would be useful for 6 years. After three years of use, he thinks that the computer will last only two more years at the end of which it is expected to realize Rs 5,000.Vinod follows SLM. Calculate the revised depreciation expense from year 4 onwards.
Cost Less Estimated Residual Value Original Depreciable Amount Original Estimated Useful Life (years) Yearly Depreciation Expense [90,000 / 6] Accumulated Depreciation for 3 years [15,000 x 3] Current Book Value of the Asset [1,00,000-45,000] Less Revised Estimated Residual Value Revised Depreciable Amount Revised Useful Life (years) Rs 1,00,000 Rs 10,000 Rs 90,000 6 yrs Rs 15,000 Rs 45,000 Rs 55,000 Rs 5,000 Rs 50,000 2yrs

Revised Yearly Depreciation Expense [50,000 / 2]

Rs 25,000

3 Changing the Depreciation Method The consistency principle requires that enterprises follow the same depreciation method. Q2: Asif bought a car for Rs 5,00,000. The car had an estimated useful life of six years and a residual value of Rs 50,000. Asif follows the SLM of depreciation. At the beginning of the fourth year, he decides to switch to the WDV, he believes that will capture the pattern of consumption of the benefits from the asset. There is no change in the residual value. Calculate the revised depreciation expense as per WDV method.
Cost Less Estimated Residual Value Depreciable Amount Original Estimated Useful Life (years) Yearly Depreciation Expense [4,50,000 / 6] Accumulated Depreciation for 3 years [75,000 x 3] Current Book Value of the Asset [5,00,000-2,25,000] Rs 5,00,000 Rs 50,000 Rs 4,50,000 6yrs Rs 75,000 Rs 2,25,000 Rs 2,75,000

Depreciation Rate
Depreciation Expense for Year 4 [ 2,75,000 x 43.35%]

Rs 43.35%
Rs 1,19,213

Rate of Depreciation as per WDV =1 - n residual value / cost , n being useful life in years = 1 - 3 50,000 / 2,75,000 = 1 - 3 0.181 = 1- 0.5656 = 0.43349 =43.35%

Disposal of Depreciable Assets When an asset becomes obsolete an enterprise either sells it or exchanges it for another asset. Seldom is the disposal value of an asset equal to its carrying amount, so it is usually necessary to recognize a gain or a loss on disposal. Accounting entries differ depending on the manner of disposal of a used asset: (a) discarding ;(b) holding for disposal ;(c) selling ; or (d) exchanging for another asset. Depending on the manner of disposal, the entries must : 1. Record depreciation for the part of the period ending with the date of disposal 2. Remove the cost of the asset and accumulated depreciation from the books 3. Show any receipt or payment of cash 4. Recognize any gain or loss on disposal 5. Recognize any new asset acquired

Q3: Amit Co. acquired a photocopier on April 1, 2006 for Rs 1, 70,000 with an estimated life of eight years and residual value of Rs 10,000. Amit charges straight line depreciation. The company disposes of the photocopier on June 30, 2011 i.e. after using it for five years and three months. The financial year-end is March 31.Just before the disposal , the asset and accumulated depreciation would have appeared in the books as follows: Photocopier a/c To Balance 1,70,000

Accumulated Depreciation Photocopier a/c

By Balance

1,00,000

Depreciation for three months:

{[1,70,000 10,000] / 8} x (3/12) = Rs 5,000

Entry for period April 1 to June 30 2011:

Depreciation----------------------------Dr To Accumulated depreciation photocopier 5,000 5,000

Accumulated Depreciation Photocopier

By Balance

1,05,000

The carrying amount of the asset is Rs 65,000.

(a) Discarding Suppose Amit Co. abandons the photocopier without realizing any amount. It will remove the asset and accumulated depreciation accounts and recognize the asset's carrying amount as loss. Accumulated Depreciation Photocopier -------- Dr 1,05,000 Loss on Discarding of Photocopier ------------ Dr 65,000 To Photocopier 1,70,000 (discarding of photocopier)

(b) Holding for Disposal Suppose the company withdraws the asset from its intended use and plans to sell it later. As before, it will remove the asset and accumulated depreciation accounts and recognize the lower of the asset's carrying amount and estimated net realizable value (i.e. fair value less costs to sell) as a non current asset held for sale. It will recognize the carrying amount of the asset less estimated net realizable value at loss. If the photocopier is estimated to sell for Rs 10,000 after deducting estimated selling cost. Photocopier Held for Sale ----------- Dr 10,000 Accumulated Depreciation Photocopier---------- Dr 1,05,000 Loss on Disposal of Photocopier -------------- Dr 55,000 To Photocopier 1,70,000

( holding photocopier for sale)

(c) Selling - i Suppose Amit Co. sells the photocopier for Rs 50,000 after meeting the selling costs. It will remove the asset and accumulated depreciation accounts, record the net sale proceeds and recognize the difference between the carrying amount of the asset less net sale proceeds as gain or loss. Cash --------------------Accumulated Depreciation Photocopier ----------------Loss on Disposal of Photocopier ----------To Photocopier Dr 50,000 Dr 1,05,000 Dr 15,000 1,70,000

(sale of photocopier at a loss of Rs 65,000-50,000 = Rs 15,000)

(c) Selling - ii If the asset is sold for an amount greater than its carrying amount, a gain will result. If the net sale proceeds are Rs 90,000. Cash ---------------------Dr 90,000 Accumulated Depreciation Photocopier ---------------------Dr 1,05,000 To Photocopier 1,70,000 To Gain on Disposal of Photocopier 25,000 (sale of photocopier at a gain of Rs 90,000-65,000= Rs 25,000 )

(c) Selling -iii If the net sale proceeds equal the carrying amount of the asset, no gain or loss arises. In that case it will remove the asset and accumulated depreciation accounts and record the net sale proceeds.

Cash --------------------Accumulated Depreciation Photocopier ---------------To Photocopier (sale of photocopier at carrying amount)

Dr 65,000 Dr 1,05,000 1,70,000

(d) Exchanging for Another Asset - i Suppose Amit company exchanges the photocopier with a fair value of Rs 75,000 and cash amount of Rs 25,000 for a scanner with a fair value of Rs 1,00,000. Assume that the cash flow configuration of the two assets is different. So the transaction has commercial substance. Amit will record the scanner at its fair value of Rs 1,00,000 and the gain on the exchange of Rs 10,000, the difference between the fair value and carrying amount of photocopier. Scanner ------------------------ Dr Accumulated Depreciation Photocopier -------------- Dr To Cash To Photocopier To Gain on Disposal of Photocopier 1,00,000 1,05,000 25,000 1,70,000 10,000

(Exchange of photocopier for scanner at a gain of Rs 10,000)

(d) Exchanging for Another Asset - ii Suppose Amit company exchanges the photocopier with a fair value of Rs 75,000 and cash of Rs 25,000 for a new photocopier with a fair value of Rs 1,00,000.On the face of it there is a gain of Rs 10,000.But the transaction lacks commercial substance because Amit`s cash flow configuration is not expected to change as a result of the exchange . In effect, the company is in the same position as it was before the transaction, and there is no gain really. So it recognizes the asset received at the carrying amount of the asset given up, adjusting for cash paid. Photocopier (new) -----------------------Accumulated Depreciation Photocopier ----------------To Cash To Photocopier (exchange of photocopier for a new photocopier) Dr 90,000 Dr 1,05,000 25,000 1,70,000

In other words, the cost of the asset received is reduced by the amount of notional gain

Revaluation of Property Plant and Equipment Enterprises can choose either the historical cost model or the revaluation model for property ,plant and equipment. Under the historical cost model , the asset appears at its cost less any accumulated depreciation and accumulated impairment losses. Under the revaluation model , the asset appears at its fair value at the date of the revaluation less any accumulated depreciation and accumulated impairment losses. Revaluation Reserve An increase in an asset's carrying amount arising from revaluation goes directly to equity under the heading Revaluation Reserve.

Q4: Victor company bought a plant on January 1, 2009 for Rs 15,000 with an estimated useful life of 5 years and depreciated it using the SLM. Assume that on Dec 31,2011,the purchase price of a new plant is Rs 25,000.If the existing plant is revalued what will be the treatment in the books of account? On Dec 31,2011,the plant would appear in the balance sheet as: Cost Less Accumulated Depreciation [15,000 x 3/5] Carrying Amount
On Revaluation:

Rs 15,000 9,000 6,000

Current Purchase Price Less Accumulated Depreciation [25,000 x 3/5]

25,000 15,000

Carrying Amount

10,000

Journal entry to record the revaluation:

Plant --------------------------Dr To Accumulated Depreciation on Plant To Revaluation Reserve 10,000 6,000 4,000

The credit of Rs 6,000 to Accumulated depreciation is the backlog depreciation for three years for the difference between depreciation based on revaluation and on cost

IFRS
a) Depreciation Expense ---------------------- Dr Rs 5,000 Rs 5,000

To Accumulated Depreciation on Plant

b)

Revaluation Reserve ------------------------------ Dr To Profit and Loss A/c

Rs 2,000 Rs 2,000

 Thank You