KSHITIJ EDUCATION

Specialized Institute for Mathematics, Computer Science & Commerce

9810860991, 9910061580,47008740
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CLASS-XI
DEPRECIATION S
AS-6 (Revised): Depreciation Defined
• Depreciation is “a measure of the wearing out, consumption or other loss of value of depreciable H
asset arising from use, efflux of time or obsolescence through technology and market-change.
Depreciation is allocated so as to charge fair proportion of depreciable amount in each accounting
period during the expected useful life of the asset. Depreciation includes amortisation of assets
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whose useful life is pre-determined”.
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• Depreciation has a significant effect in determining and presenting the financial position and
results of operations of an enterprise. Depreciation is charged in each accounting period by
reference to the extent of the depreciable amount. I
‘Depreciable’ assets are those assets which . J
(i) “are expected to be used during more than one accounting period.
(ii) have a limited useful life; and
(iii) are held by an enterprise for use in production or supply of goods and services, for
rental to others, or for administrative purposes and not for the purpose of sale in the
ordinary course of business.”
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• The amount of depreciation basically depends upon three factors, i.e. Cost, Useful life and Net
realisable value. D
(i) Cost of a fixed asset is “the total cost spent in connection with its acquisition, installation
and commissioning as well as for add item or improvement of the depreciable asset”.
(ii) Useful life of an asset is the “period over which it is expected to be used by the U
enterprise”.

Features of Depreciation
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1. It is decline in the book value of fixed assets.
2. It includes loss of value due to efflux of time, usage or obsolescence. For example, a business A
firm buys a machine for Rs. 1,00,000 on April 01, 2000. In the year 2002, a new version of the
machine arrives in the market. As a result, the machine bought by the business firm becomes
outdated. The resultant decline in the value of old machine is caused by obsolescence. T
3. It is a continuing process.
4. It is an expired cost and hence must be deducted before calculating taxable profits. For example, I
if profit before depreciation and tax is Rs. 50,000, and depreciation is Rs. 10,000; profit before tax
will be:
Profit before depreciation & tax 50,000 O
(-) Depreciation (10,000)
Profit before tax 40,000
5. It is a non-cash expense. It does not involve any cash outflow. It is the process of writing-off the
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capital expenditure already incurred.

Notes : Accountancy XI - Depreciation Page 1

 KSHITIJ EDUCATION
Specialized Institute for Mathematics, Computer Science & Commerce
9810860991, 9910061580,47008740

Depreciation & Depletion

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The term depletion is used in the context of extraction of natural resources like mines, quarries, etc.
that reduces the availability of the quantity of the material or asset. For example, if a business S
enterprise is into mining business and purchases a coal mine for Rs. 10,00,000. Then the value of
coal mine declines with the extraction of coal out of the mine. This decline in the value of mine is
termed as depletion. The main difference between depletion and depreciation is that the depletion is
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concerned with the exhaustion of economic resources, but the depreciation relates to the usage of an
asset. Depletion and depreciation are given similar accounting treatment because both results into I
decline of value of assets over a period of time.

Depreciation & Amortisation T

Amortisation refers to writing-off the cost of intangible assets like patents, copyright, trade marks,
franchises, leasehold mines which have entitlements to use for a specified period of time. The
procedure for amortisation is the periodic write-off of a portion of the cost of intangible assets. It is
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the same as that for the depreciation of fixed assets. For example, if a business firm buys a patent
for Rs. 10,00,000 and estimates that its useful life will be 10 years then the business firm must J
write-off Rs. 10,00,000 over 10 years. The amount so written- off is technically referred to as
amortisation.

Causes of Depreciation
These have been very clearly spelt out as part of the definition of depreciation E
in the Accounting Standard 6 and are being elaborated here.
(a) Wear and Tear due to Use or Passage of Time : Wear and tear means deterioration, in an
assets value, arising from its use in business operations for earning revenue. It reduces the D
asset’s technical capacities to serve the purpose for, which it has been meant. Another aspect
of wear and tear is the physical deterioration. An asset deteriorates simply with the passage
of time, even though they are not being put to any use. This happens especially when the
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assets are exposed to the vagaries of nature like weather, winds, rains, etc.
(b) Expiration of Legal Rights : Certain categories of assets lose their value after the C
agreement governing their use in business comes to an end after the expiry of pre-
determined period. Examples of such assets are patents, copyrights, leases, etc. whose utility
to business is extinguished immediately upon the removal of legal backing to them. A
(c) Obsolescence : Obsolescence is another factor leading to depreciation of fixed assets. In
ordinary language, obsolescence means the fact of being “out-of-date”. Obsolescence T
implies to an existing asset becoming out-of-date on account of the availability of better type
of asset. It arises from such factors as: (i) Technological changes (ii) Improvements in
production methods (iii) Change in market demand for the product or service output of the I
asset & (iv) Legal or other description.
(d) Abnormal Factors: Decline in the usefulness of the asset may be caused by abnormal
factors such as accidents due to fire, earthquake, floods, etc. Accidental loss is permanent
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but not continuing or gradual. For example, a car which has been repaired after an accident
will not fetch the same price in the market even if it has not been used. N

Notes : Accountancy XI - Depreciation Page 2

 KSHITIJ EDUCATION
Specialized Institute for Mathematics, Computer Science & Commerce
9810860991, 9910061580,47008740

What is the need for providing Depreciation ?

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The need for providing depreciation in accounting records arises from conceptual, legal, and
practical business consideration. These considerations provide depreciation a particular significance S
as a business expense.
(i) Matching of Costs and Revenue: The rationale of the acquisition of fixed assets in
business operations is that these are used in the earning of revenue. Every asset is bound
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to undergo some wear and tear, and hence lose value, once it is put to use in business.
Therefore, depreciation is as much the cost as any other expense incurred in the normal I
course of business like salary, carriage, postage and stationary, etc. It is a charge against
the revenue of the corresponding period and must be deducted before arriving at net
profit according to ‘Generally Accepted Accounting Principles’. T
(ii) Consideration of Tax: Depreciation is a deductible cost for tax purposes. However, tax
rules for the calculation of depreciation amount need not necessarily be similar to current
business practices.
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(iii) True and Fair Financial Position: If depreciation on assets is not provided for, then the
assets will be over valued and the balance sheet will not depict the correct financial J
position of the business. Also, this is not permitted either by established accounting
practices or by specific provisions of law.
(iv) Compliance with Law: Apart from tax regulations, there are certain specific legislations
that indirectly compel some business organisations like corporate enterprises to provide
depreciation on fixed assets. E
State whether the following statements are true or false:
(i) Depreciation is a non-cash expense. D
(ii) Depreciation is also charged on current assets.
(iii) Depreciation is decline in the market value of tangible fixed assets.
(iv) The main cause of depreciation is wear and tear caused by its usage. U
(v) Depreciation must be charged so as to ascertain true profit or loss of the business.
(vi)
(vii)
Depletion term is used in case of intangible assets.
Depreciation provides fund for replacement.
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(viii) When market value of an asset is higher than book value, depreciation is not charged.
(ix) Depreciation is charged to reduce the value of asset to its market value. A
(x) If adequate maintenance expenditure is incurred, depreciation need not be charged.

Factors Affecting the Amount of Depreciation

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The determination of depreciation depends on three parameters, viz. cost,estimated useful life and
probable salvage value. I
Cost of Asset : Cost (also known as original cost or historical cost) of an asset includes invoice
price and other costs, which are necessary to put the asset in use or working condition. Besides the
purchase price, it includes freight and transportation cost, transit insurance, installation cost, O
registration cost, commission paid on purchase of asset add items such as software, etc. In case of
purchase of a second hand asset it includes initial repair cost to put the asset in workable condition.
For example, a photocopy machine is purchased for Rs. 50,000 and Rs. 5,000 is spent on its
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transportation and installation. In this case the original cost of the machine is Rs. 55,000 (i.e. Rs.
50,000 + Rs.5,000 ) which will be written off as depreciation over the useful life of the machine.

Notes : Accountancy XI - Depreciation Page 3

 KSHITIJ EDUCATION
Specialized Institute for Mathematics, Computer Science & Commerce
9810860991, 9910061580,47008740

Estimated Net Residual Value: Net Residual value (also known as scrap value or salvage value for
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accounting purpose) is the estimated net realisable value (or sale value) of the asset at the end of its
useful life. The net residual value is calculated after deducting the expenses necessary for the S
disposal of the asset. For example, a machine is purchased for Rs. 50,000 and is expected to have a
useful life of 10 years. At the end of 10th year it is expected to have a sale value of Rs. 6,000 but
expenses related to its disposal are estimated at Rs. 1,000. Then its net residual value shall be Rs. H
5,000 (i.e. Rs. 6,000 – Rs. 1,000).
Depreciable Cost: Depreciable cost of an asset is equal to its cost (as calculated above less net
residual value. In the above example, the depreciable cost of machine is Rs. 45,000 (i.e., Rs. 50,000
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– Rs. 5,000.) It is the depreciable cost, which is distributed and charged as depreciation expense
over the estimated useful life of the asset. In the above example, Rs. 45,000 shall be charged as T
depreciation over a period of 10 years. It is important to mention here that total amount of
depreciation charged over the useful life of the asset must be equal to the depreciable cost. If total
amount of depreciation charged is less than the depreciable cost then the capital expenditure is I
under recovered. It violates the principle of proper matching of revenue and expense.
Estimated Useful Life: Useful life of an asset is the estimated economic or commercial life of the J
asset Useful life depends upon the following factors : (a) Pre-determined by legal or contractual
limits, e.g. in case of leasehold. (b) asset, the useful life is the period of lease.(c) The number of
shifts for which asset is to be used.(d) Repair and maintenance policy of the business organisation.
(e) Technological obsolescence.(f) Innovation/improvement in production method.(g) Legal or
other restrictions.
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Straight Line Method: This is the earliest and one of the widely used methods of
providing depreciation. This method is based on the assumption of equal usage of the D
asset over its entire useful life. It is called straight line for a reason that if the amount of
depreciation and corresponding time period is plotted on a graph, it will result in a straight line. It is
also called fixed installment method because the amount of depreciation remains constant from year
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to year over the useful life of the asset.
The depreciation amount to be provided under this method is computed by using the following C
formula:
AquisitionCost of asset −Scrap Value of asset
Depreciation per year=
Estimated Useful Life of the Asset∈ years A
Advantages of Straight Line Method
1. It is very simple, easy to understand and apply. Simplicity makes it a popular method in
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practice
2. Asset can be depreciated up to the net scrap value or zero value. Therefore, this method I
makes it possible to distribute full depreciable cost over useful life of the asset
3. Every year, same amount is charged as depreciation in profit and loss account. This makes
comparison of profits for different years easy; O
4. This method is suitable for those assets whose useful life can be estimated accurately and
where the use of the asset is consistent from year to year such as leasehold buildings. N
Limitations of Straight Line Method
Although straight line method is simple and easy to apply it suffers from certain limitations which
are given below.

Notes : Accountancy XI - Depreciation Page 4

 KSHITIJ EDUCATION
Specialized Institute for Mathematics, Computer Science & Commerce
9810860991, 9910061580,47008740

1. This method is based on the faulty assumption of same utility of the asset in different
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accounting years;
2. With the passage of time, work efficiency of the asset decreases and repair and maintenance S
expense increases. Hence, under this method total amount charged against profit on account
of depreciation and repair taken together will not be uniform throughout the life of the asset,
rather it will keep on increasing from year to year. H
Written Down Value Method
Under this method, depreciation is charged on the book value of the asset. Since book value keeps
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on reducing by the annual charge of depreciation, it is also known as reducing balance method. This
method involves the application of a pre-determined proportion/percentage of the book value of the T
asset at the beginning of every accounting period, so as to calculate the amount of depreciation. The
amount of depreciation reduces year after year.
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Advantages of Written Down Value Method
Written down value method has the following advantages: J
1. This method is based on a more realistic assumption that the benefits from asset go on
diminishing with the passage of time. Hence, it calls for proper allocation of cost because
higher depreciation is charged in earlier years when asset’s utility is more as compared to
later years when it becomes less useful
2. It results into almost equal burden on profit or loss account of depreciation and repair
expenses taken together every year
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3. Income Tax Act accept this method for tax purposes
4. As a large portion of cost is written-off in earlier years, loss due to obsolescence gets D
reduced
5. This method is suitable for fixed assets, which lasts for long and which require increased
repair and maintenance expenses with passage of time. It can also be used where U
obsolescence rate is high.

Limitations of Written Down Value Method

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1. As depreciation is calculated at fixed percentage of written down value, depreciable cost of
the asset cannot be fully written-off. The value of the asset can never be zero; A
2. It is difficult to ascertain a suitable rate of depreciation.

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Notes : Accountancy XI - Depreciation Page 5

 KSHITIJ EDUCATION
Specialized Institute for Mathematics, Computer Science & Commerce
9810860991, 9910061580,47008740
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Straight Line Method

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For each asset calculate D
Cost of asset : It is actual cost of the asset plus all the expenses incurred in bringing the asset to
working condition. U
Calculate yearly depreciation : In straight line method the yearly depreciation is fixed and
constant throughout the life of the asset. If the asset is used for a period of less than a year during
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the period the proportionate depreciation is charged.
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Rate of Dep
Fi xed Depreciation=Acquisition Cost of Asset X
100
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No of Months asset is us ed
DepreciationCharged during the year=¿ Depreciation X
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Depreciation is provided for the period an asset is used in business in an year as a percentage of cost
of acquisition of asset. O
The Journal entry of Depreciation is passes when (i) accounting year comes to an end or (ii) asset is
sold.
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Notes : Accountancy XI - Depreciation Page 6

 KSHITIJ EDUCATION
Specialized Institute for Mathematics, Computer Science & Commerce
9810860991, 9910061580,47008740

In the following questions calculate Acquisition cost of the asset and the depreciation to be charged
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in first three years ending on 31st March 2009, 2010, 2011 on the asset @10% p.a. using straight
line method S
Answer should be in following format
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Months Value of asset in Depreciation Value of asset at the
Year Asset used beginning of year or charged during end of year or when it is I
in the year when it is purchased the year sold
2008-9 T
2009-
10
2010-
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11
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1. On 1st April 20008, purchased a machine for Rs.1,00,000 and spent 20,000 on its erection.
2. On 1st July 2008, purchased a Delivery van for Rs. 60,000. On 1st January 2009 Rs.5000 was
spent on its repairs.
3. On 1st October 2008, purchased a Plant for Rs.2,00,000. It was sold on 31st March 2011. E
4. On 1st April 2008, purchased a machinery for Rs.80,000 and the same machinery was sold
on 31st March 2011. D
5. On 1st April 2008, purchased a machinery for Rs.80,000 and the same machinery was sold
on 31st December 2010.
6. On 1st April 2008, purchased a machinery for Rs.80,000 and the same machinery was sold
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on 30th September 2010.
7. On 1st May 2008 purchased a machinery for Rs. 1,20,000 and the same machinery was sold C
on 1st August 2010.
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Diminishing Balance Method
For each asset calculate T
Calculate yearly depreciation : In reducing balance method the yearly depreciation is calculated as a
percentage of the value of the asset at the beginning of the year or its acquisition cost. The
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depreciation gets reduced year on year. If the asset is used for a period of less than a year during the
period the proportionate depreciation is charged. O
Rate of Dep No of Months
Depreciation=Opening Value of Asset X
100
X
12
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Depreciation is provided for the period an asset is used in business in an year as a percentage of cost
of acquisition of asset.

Notes : Accountancy XI - Depreciation Page 7

 KSHITIJ EDUCATION
Specialized Institute for Mathematics, Computer Science & Commerce
9810860991, 9910061580,47008740

The Journal entry of Depreciation is passes when (i) accounting year comes to an end or (ii) asset is
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sold.
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Repeat the above process for diminishing Balance Method.

Calculation of profit & loss on account of sale of the asset. H

Profit(loss) = Amount Received by sale of asset – Depreciated value of asset on date of sale.
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Calculate profit/loss in each of the above questions.
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Notes : Accountancy XI - Depreciation Page 8