NAME: MAYANK
ROLL NO.:181210029
ASSIGNMENT-2
The monetary value of an asset in an organization is not constant. Its value
decreases over time due to multiple factors, some of them being:
1. Usage of asset
2. Wear and Tear
3. Obsolescence
For example,
If an organization buys machinery for packing purpose for 20 Lakhs,
with the constant use of the machine, it will be degraded and its value
would decrease.
If someone buys a car for 10 Lakhs, and they want to sell that same
vehicle after using it for a year, they would get an amount lower than 10
Lakhs.
All these are fine examples of depreciation in the value of the asset.
Some methods of calculating the depreciation are:
1. Straight Line
In this method, the value of the asset decreases linearly over time until it
reaches salvage value.
Annual Depreciation Value= Cost of Asset - Salvage
ValueUseful life of Asset
Salvage value is the value or the cost of asset at the end of its useful life
Cost price of asset is price at which asset purchased
Useful life is the number of years where the asset is used before attaining
salvage value
Example:
If an organization buys a machine for ₹2 Lakh, the estimated salvage
value is ₹40,000 and its useful lifetime is of 5 years, then Total
Depreciation Expense is described as:
Total Depreciation Expense= 2,00,000-40,0005=₹32,000
Depreciation Rate=32,0001,60,000*100=20%
2. Sum of the Years’ Digit Method
This is a form of accelerated deprecation method. It works on the principle
that the productivity of any machinery is highest when it is new. This
method imposes higher depreciation for the early years and lower
depreciation for the later ones.
Depreciation Expense= Remaining useful lifeSum of the
years'digits*Depreciable Cost
Example:
If an organization purchases a machine at ₹1,60,000 and has a useful life
of 5 years, and then is sold at ₹10,000, then depreciation would be
computed as:
Total Depreciation=₹1,50,0005 Useful years→1+2+3+4+5=15
Therefore, for the first year,
Depreciation= 515*Total Depreciation=515*₹1,50,000=₹50,000
Second year,
Depreciation= 415*Total Depreciation=415*₹1,50,000=₹40,000
Similarly, for the 3rd, 4th and 5th years, the depreciation is of ₹30,000,
₹40,000 and ₹50,000 respectively.
3. Declining Balance Method
This is an accelerated depreciation method in which the depreciation
expense under the declining balance is calculated by applying the
depreciation rate to the book value of the asset at the start of the period.
There are different variants of the declining balance method, 150%
declining balance method, 200% declining balance method and so on.
The percentage is called the accelerator and it reflects the degree of
acceleration in the depreciation.
Declining Balance Depreciation= AcceleratorUseful Life*Cost-
Accumulated Depreciation
Example:
An asset costs ₹20,000 and has an estimated useful life of 5 years and
salvage life of ₹4,500. Its depreciation for the first year using double
depreciation rate is:
Double Depreciation Rate= 15=0.2=20%
Declining Balance Rate=2*20%=40%
Depreciation=40% *₹20,000=₹8,000
4. Annuity Method
In this method, the purchase of an asset is considered an investment of
capital on which a certain rate of interest is earned. The cost of the asset
and the interest are written down annually by equal installments until the
book value of the asset is reduced to NIL.
The annual charge by the way of depreciation is found out from the
annuity tables. The annual charges for the depreciation will be credited to
the asset account and debited to the depreciation account, while interest
will be debited from the asset account and credited to the interest account.
The disadvantage of this method is that it is a severely complicated
method to calculate depreciation.
Secondly, the burden on profit and loss accounts goes on increasing over
time, and the amount of interest decreases as the years pass by.
Therefore, this method is best suited to those assets which require
considerable investments and do not require frequent increments.
5. Sinking Fund Method
This method of depreciation is used when an organization wishes to set
aside a sufficient amount of cash to pay for a replacement asset when the
current asset reaches the end of its useful life. As depreciation is incurred,
a matching amount of cash is invested, the interest proceeds that are
deposited into this fund are also invested.
By the time, a replacement asset is needed, the funds needed to make an
acquisition are accumulated in the associated fund. This approach is
widely used in industries, which usually have a large fixed asset base,
which allows them to constantly provide for future asset replacement in a
highly organized manner.
It is most applicable for long-established industries where it is most likely
that the same assets will have the need to be replaced, over and over
again.
However, the sinking fund method requires the use of a separate asset
replacement fund for each asset, so it can result in an unusually complex
amount of accounting. Also, the replacement cost of the asset may have
changed over its life, so the funded amount may exceed or be short of
actually purchase amount in some cases.
