Depreciation

Meaning

It is the reduction in the value of assets due to usage,

time, wear and tear, technological outdated or
obsolescence, depletion, inadequacy, decay or other such
factors.
All fixed assets except the value of land decreases every
year.
Gradual decrease in the value of fixed assets is known as
depreciation.
objectives

To calculate proper profits.

To show the asset at its reasonable value
To maintain the original monetary investment of the
asset intact.
Provision of depreciation results in some incidental
advantages also.
To provide for replacement of an asset.
Depreciation is permitted to be deducted from
profits for tax purposes.
Causes of Depreciation

Internal causes: wear and tear, disuse,

maintenance, change in production,
restriction of production, reduced demand,
technical progress & depletion.

External causes: obsolescence and efflux

ion of time
Factors in measurement of depreciation

Total cost of asset

Estimated useful service life or economic life
The estimated turn-in (residual) value.
Rate of depreciation

The rate at which an asset is depreciated in any methods

for computing depreciation.
Scrap Value

It is associated with the depreciation of assets used in a

business.
It is defined as the expected or estimated value of the
asset at the end of its useful life.
It is also known as salvage value or residual value.
Methods of Depreciation

Straight line method

Reducing balance method
Straight line method

In this method, depreciation is calculated by dividing the

total cost of the asset by the life of an asset and if an asset
has any salvage value then the same has to be deducted
from the original cost of an asset.
The amount of depreciation will be same for each year,
since depreciation is charged at fixed rate.
Formula of Straight line method

Under this method, the same amount of depreciation is

charged every year throughout the life of the asset.
The formula = Total cost of acquisition - residual
value or
scrap value

Estimated life

r =R/C * 100; r = depreciation rate

R = Amount of depreciation, C = Acquisition cost
Problems

1) The initial cost of a machine and the scrap value are

Rs.40000and Rs. 4000 respectively. If the life is 9 years. Find the
annual depreciation using straight line method.
Solution: Depreciation =
original cost scrap value
life of an asset
= 40000-4000
9
= 36000
9
= 4000
2) The cost of the machine is Rs. 17000 its salvage value is
Rs. 2000 and its estimated useful life is 5 years. find
depreciation under straight line method.
Solution: Depreciation= cost of an asset- salvage value
estimated life of an asset
= 17000-2000
5
= Rs. 3000 per year
3) If office furniture purchased on Jan 2 for Rs. 8100 and
estimated useful life of 6 years and a trade-in-value of Rs.
750. what is the book value at the end of the fifth year?
Solution: Depreciation= cost of an asset- salvage value
estimated life of an asset
= 8100 750
6
= 73560
6
= Rs. 1225 per year
Depreciation at the end of 5th year

Depreciation = 1225*5
= 6125

Book value at the end of 5th year

Book value= cost of an asset depreciation

= 8100 6125
= 1925
4) Determine the depreciation rate per year for an estimated
useful life of
(a) 10 years (b) 50 years (c) 8 years (d) 5 years

(e) 16 years (f) 20 years

Solution: Depreciation rate per year =100%
estimated life
(a) 100/ 10= 10% (b) 100/50 = 2%
(c) 100/8 = 12 % or 12.5% (d) 100/5 = 20%
(e) 100/16 = 6 % or 6.5% (f) 100/20 = 5%
5) Determine the -
(a) depreciation rate (b) yearly depreciation
(c) book value after 10 years of building that cost
Rs. 100000 on Jan 7 after its estimated useful life of
25 years, the salvage value is Rs. 20000.
Solution: (a) depreciation rate = 100%
estimated life
= 100/25
= 4%
(b) Yearly depreciation
= ( cost salvage)* depreciation rate per year
= (100000 20000) * 0.04
= 80000 * 0.04
= Rs. 3200 per year

(c) Book value after 10 years

depreciation at the end of 10 year = 3200 * 10
= Rs. 32000
Book value = cost depreciation
= 100000 32000
= Rs. 68000
Problem .6

What is the amount of depreciation at the end of the

second year, if a piece of equipment was purchased
on July 24 for 1300, its estimated useful life is 8
years, and trade in value is 100.
Solun: Depreciation= cost of an asset- salvage value
estimated life of an asset
= 1300 100
8
= 150/year
PROBLEM NO.3

Original cost- 1,10,000

Depreciation value- 6000
For 5 years
Soln : let d be the rate of yearly depreciation
6000 = 1,10,000 (1-d)^5
(1-d)^5 = 6000/1,10,000 = 6/110 = 3/55
(applying log on both the sides)
log (1-d)^5 = log (3/55)
5log (1-d) = log 3 log 5
Prob 3 contd..

5log(1-d) = 0.47712 1.74036

5log(1-d) = -1.26324
log(1-d) = -0.25264
= +1-1-0.25264
= -1.747352
Log(1-d) = 1.747352
(1-d) = antilog (1.747352)
1-d = 0.55885
d=0.44115 i.e 44.11%.
Contind

End of second year depreciation

150/12= 12.5/month
12.5*5 months=62.5 for first year
62.5*150= 212.5 depreciation at the end of second
year.
Reducing balance method

In this method, depreciation is charged at fixed rate on the

reducing balance of an asset after deducting depreciation
of every year out of the cost of fixed assets.

It is also known as diminishing balance method or written

down value method or declining value method or book
value method.

The balance in the asset account will go on decreasing but

will never become zero.
Reducing balance method

The Annual amount of depreciation will not remain fixed

or equal.

It gradually decreases since, the current value of the asset

decreases every year.
Problems

6. The initial cost of machine is Rs. 15000 and it

has a life of 5 years. Find annual depreciation using sum of the year digit method.
Solution: depreciation = n(n+1)/2
= 5(5+1)/2
= 15
first year =5/15 = 0.3333%
(0.3333*15000)
= 5000
Second year= 4/15= 0.2667%
= 4000
Third year= 3/15= 0.2%
= 3000
Fourth year=2/15=0.1333
=2000
Fifth year= 1/15=0.0667
= 1000
Problem.1

7. A machine is purchased for Rs. 350000. its subject to

depreciation at the rate of 6% for first three years and thereafter
at the rate of 8% for two years. Find value of machine at the end
of five years.
Solution: c= 350000
rate of depreciation= 6% for three years
rate of depreciation = 8% for two years
Cost of machine after 5 years
= 350000(1-6%)3 (1-8%) 2
= 350000 ( 0.8305) (0.8464)

= 350000 (0.70301984)
= 245911.05