DEPRECIATION

Meaning of Depreciation :

• Depreciation is the measurement of an asset’s valuable loss over time, usage, or obsolescence.

• Depreciation, rather than writing off an asset as a deductible, recognize the asset’s usage over a period.

• As per AS 10, Depreciation is nothing but a charge that is allocated to an asset systematically over its
useful life. Thus, the depreciable amount so charged for an asset in each period is typically recognized
in the profit and loss statement of the business entity.

• Value of such assets decreases with passage of time mainly due to following reasons.
• Wear and tear due to its use in business
• Efflux of time (even when it is not being used)
• Obsolescence due to technological or other changes
• Decrease in market value
• Depletion mainly in case of mines and other natural reserves
As per Schedule II under the Companies Act, 2013

• Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.

• Depreciable amount of an asset is the cost of an asset or other amount substituted for cost (i.e., in case
of revaluation of assets, such revalued amount), less its residual value.

• Useful life of an asset is the period over which an asset is expected to be available for use by an entity,
or the number of production or similar units expected to be obtained from the asset by the entity.

• Thus, there are 3 important factors for computing depreciation:

a. Estimated useful life of the asset

b. Cost of the asset
c. Residual value of the asset at the end of its estimated useful life
 Objectives of providing depreciation

To ascertain To present true To accumulate To ascertain

true results of and fair view of the funds for the true cost of
operations financial position replacement of production
assets
 Factors affecting the amount of depreciation

Cost of asset Expected useful life and utility Estimated residual value
Cost of property, plant and equipment comprises:
• Its purchase price, including non-refundable import duties and purchase taxes, after deducting trade
discounts and rebates.

• Any cost directly attributable to bring the asset to the location and condition necessary for it to be
capable of operating in a manner intended by the enterprise.

• The initial estimate of the costs of dismantling, removing, the item and restoring the site on which
an asset is located.

Examples of directly attributable costs are:

a) cost of employee benefits arising directly from acquisition or construction of an item of property, plant
and equipment.
b) cost of site preparation
c) initial delivery and handling costs
d) installation and assembly costs
e) cost of testing whether the asset is functioning properly, after deducting the net proceeds from selling the
items produced while testing (such as samples produced while testing)
f) professional fees e.g. engineers hired for helping in installation of a machine
 Methods for providing depreciation

Commonly used methods of Depreciation

Straight-line Method Diminishing Balance Method

Results in a constant charge Results in a decreasing charge

over the useful life if the residual value of the over the useful life
asset does not change
Straight line method :
• According to this method, an equal amount is written off every year during the working life of an
asset so as to reduce the cost of the asset to nil or its residual value at the end of its useful life.

• The advantage of this method is that it is simple to apply and gives accurate results especially in case
of leases, and also in case of plant and machinery.

• This method is also known as Fixed Installment Method.

Cost of Asset-Scrap Value

Straight Line Depreciation =
Useful Life

Straight Line Depreciation x 100

Straight Line Depreciation Rate =
Cost of Assets
Reducing or Diminishing balance method or Written down value (WDV) Method

• Under this system, a fixed percentage of the diminishing value of the asset is written off each year so as
to reduce the asset to its residual value at the end of its life.

• The rate of depreciation under this method may be determined by the following formula:

1-n Residual Value

x 100
Cost of Assets

where, n = useful life

Similar to straight line method, in this method also period of use in a particular year e.g. year of
purchase or sale an item of property plant and equipment needs to be considered while computing
the depreciation amount.
 Accounting entries under straight line and reducing balance methods:

Amount of Depreciation is credited to the Asset

Provision for depreciation or Accumulated depreciation
Account every year and the Asset Account is
account is opened
carried at historical cost less depreciation.

Accounting entries : Accounting entries :

Depreciation Account Dr. Depreciation Account Dr.

To Provision for Depreciation Account or To Asset Account
Accumulated Depreciation

Profit and Loss Account Dr. Profit and Loss Account Dr.
To Depreciation Account To Depreciation Account
Example : 1

Jain Bros. acquired a machine on 1st July, 2021 at a cost of Rs. 14,00,000 and spent Rs. 1,00,000 on its
installation. The firm writes off depreciation at 10% p.a. of the original cost every year. The books are
closed on 31st December every year.

Required
Show the Machinery Account and Depreciation Account for the year 2021 and 2022.
 Machinery Account
Date Particulars Amount Date Particulars Amount
2021 2021
July 1 To Bank A/c 14,00,000 Dec. 31 By Depreciation A/c
July 1 To Bank A/c - 1,00,000 10% on ` 15,00,000 for 75,000
Installation 6 months
Expenses Dec. 31 By Balance c/d 14,25,000
15,00,000 15,00,000
2022 2022
Jan. 1 To Balance b/d 14,25,000 Dec. 31 By Depreciation A/c
10% on ` 15,00,000 1,50,000
Dec. 31 By Balance c/d 12,75,000
14,25,000 14,25,000

Depreciation Account

Date Particulars Amount Date Particulars Amount

2021 2021
Dec. 31 To Machinery A/c 75,000 Dec. 31 By Profit & Loss A/c 75,000
2022 2022
Dec. 31 To Machinery A/c 1,50,000 Dec. 31 By Profit & Loss A/c 1,50,000
 Example : 2

Jain Bros. acquired a machine on 1st July, 2021 at a cost of Rs. 14,00,000 and spent Rs. 1,00,000 on its
installation. The firm writes off depreciation at 10% p.a. every year. The books are closed on 31st
December every year.

Required
Show the Machinery Account on diminishing balance method for the year 2021 and 2022.
 Machinery Account

Date Particulars Amount Date Particulars Amount

2021 2021
July 1 To Bank A/c 14,00,000 Dec. 31 By Depreciation A/c 75,000
July 1 To Bank A/c - 1,00,000 (` 15,00,000 x 10% x
6/12) for 6 months
Dec. 31 By Balance c/d 14,25,000
15,00,000 15,00,000
2022 2022
Jan. 1 To Balance b/d 14,25,000 Dec. 31 By Depreciation A/c 1,42,500
(` 14,25,000 x 10%)
Dec. 31 By Balance c/d 12,82,500
14,25,000 14,25,000
Depreciation Account
Date Particulars Amount Date Particulars Amount
2021 2021
Dec. 31 To Machinery A/c 75,000 Dec. 31 By Profit & Loss A/c 75,000
2022 2022
Dec. 31 To Machinery A/c 1,42,500 Dec. 31 By Profit & Loss A/c 1,42,500
Sum of years of digits method
It is a variation of the “Reducing Balance Method”. In this case, the annual depreciation is calculated by
multiplying the original cost of the asset less its estimated scrap value by the fraction represented by:

The number of years (including the present year) of remaining life of the asset
Total of all digits of the life of the asset (in years)

Suppose the estimated life of an asset is 10 years; the total of all the digits from 1 to 10 is 55 i.e.,
10 + 9 + 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1, or by the formula:

n (n+1) = 10×11 = 55
2 2
The depreciation to be written off in the first year will be 10/55 of the cost of the asset less estimated
scrap value; and the depreciation for the second year will be 9/55 of the cost of asset less estimated
scrap value and so on.

The method is not yet in vogue; and its advantages are the same as those of the Reducing Balance
Method.
 Example : 3
M/s Akash & Co. purchased a machine for 10,00,000. Estimated useful life and scrap value were 10
years and 1,20,000 respectively. The machine was put to use on 1.1.2017.

Required
Show Machinery Account and Depreciation Account in their books for 2022 by using sum of years
digits method.

In the books of M/s Akash & Co.

Machinery Account
Date Particulars Amount Date Particulars Amount
2022 2022
Jan. 1 To Balance b/d (w.n.2) 3,60,000 Dec. 31 By Depreciation A/c 80,000
(w.n.3)
Dec. 31 By Balance c/d 2,80,000
3,60,000 3,60,000
2023
Jan.1 To Balance b/d 2,80,000
 Depreciation Account

Date Particulars Amount Date Particulars Amount

2022 2022
Dec. 31 To Machinery A/c 80,000 Dec. 31 By Profit and Loss A/c 80,000
80,000 80,000

Total of sum of digit of depreciation for 2017-21

10+9+8+7+6 40
( 10,00,000 – 1,20,000 ) = 8,80,000 × = 6,40,000
55
10(10+1)
2
Written down value as on 1-1-2022
10,00,000 – 6,40,000 = 3,60,000

Depreciation for 2022

(10,00,000 – 1,20,000) × 5
= 80,000
55
Machine Hour Method :
• Where it is practicable to keep a record of the actual running hours of each machine,
depreciation may be calculated on the basis of hours that the concerned machine worked.

• The machine hour rate of the depreciation, is calculated after estimating the total number of
hours that machine would work during its whole life; however, it may have to be varied from
time to time, on a consideration of the changes in the economic and technological conditions
which might take place, to ensure that the amount provided for depreciation corresponds to that
considered appropriate in the changed circumstances.

• Schedule II to the Companies Act 2013 which prescribes estimated useful life of different
assets for companies also recognizes this method to some extent.

• It prescribes that depreciation should be charged using estimated useful life suggested in it;
however, in certain category of plant and machinery it prescribes charging higher amount of
depreciation if these assets are used for 2 shifts or 3 shifts
 Example : 4

A machine was purchased for Rs. 30,00,000 having an estimated total working of 24,000 hours. The
scrap value is expected to be Rs. 2,00,000 and anticipated pattern of distribution of effective hours is
as follows :

Year
1 – 3 3,000 hours per year
4 - 6 2,600 hours per year
7 - 10 1,800 hours per year

Required
Determine Annual Depreciation under Machine Hour Rate Method.
Statement of annual depreciation under machine hours rate method

Year Annual Depreciation

1-3 3,000 × ( Rs. 30,00,000 – Rs. 2,00,000) = Rs. 3,50,000

24,000

4-6 2,600 × ( Rs. 30,00,000 - Rs. 2,00,000) = Rs. 3,03,333

24,000

7 - 10 1,800 × ( Rs. 30,00,000 – Rs. 2,00,000) = Rs. 2,10,000

24,000
Production Units Method

Under this method depreciation of the asset is determined by comparing the annual production with
the estimated total production. The amount of depreciation is computed by the use of following
method:

Production during the period

Depreciable Amount x
Estimated total production

The method is applicable to machines producing product of uniform specifications.

Example : 5

A machine is purchased for Rs. 20,00,000. Its estimated useful life is 10 years with a residual value of
Rs. 2,00,000. The machine is expected to produce 1.5 lakh units during its life time. Expected
distribution pattern of production is as follows:

Year Production
1-3 20,000 units per year
4-7 15,000 units per year
8-10 10,000 units per year

Required
Determine the value of depreciation for each year using production units method.
Statement showing depreciation under production units method

Year Annual Depreciation

20,000 × ( Rs. 20,00,000 - Rs. 2,00,000) = Rs. 2,40,000

1-3
1,50,000

15,000 × (Rs. 20,00,000 - Rs. 2,00,000 ) = Rs. 1,80,000

4-7
1,50,000

10,000 × (Rs. 20,00,000 - Rs. 2,00,000) = Rs. 1,20,000

8-10
1,50,000
Depletion Method :

• Depletion is the allocation of the cost of wasting natural resources such as oil, gas, timber, and
minerals to the production process.

• This method is used in case of mines, quarries etc. containing only a certain quantity of product.

• The depreciation rate is calculated by dividing the cost of the asset by the estimated quantity of
product likely to be available to be extracted.

• Annual depreciation will be the quantity extracted multiplied by the rate per unit.
 Example : 6

M/s Surya & Co. took lease of a quarry on 1-1-2019 for ` 1,00,00,000. As per technical estimate the total
quantity of mineral deposit is 2,00,000 tonnes. Depreciation was charged on the basis of depletion
method. Extraction pattern is given in the following table:

Year Quantity of Mineral extracted

2019 2,000 tonnes
2020 10,000 tonnes
2021 15,000 tonnes

Required
Show the Quarry Lease Account and Depreciation Account for each year from 2019 to 2021.
 Quarry Lease Account
Date Particulars Amount Date Particulars Amount
2019 2019
Jan. To Bank A/c 1,00,00,000 Dec. 31 By Depreciation A/c 1,00,000
[(2,000/2,00,000)×`1,00,00,000]
Dec. 31 By Balance c/d 99,00,000
1,00,00,000 1,00,00,000
2020 2020
Jan. 1 To Balance b/d 99,00,000 Dec. 31 By Depreciation A/c 5,00,000
Dec. 31 By Balance c/d 94,00,000
99,00,000 99,00,000
2021 2021
Jan. 1 To Balance b/d 94,00,000 Dec. 31 By Depreciation A/c 7,50,000
Dec. 31 By Balance c/d 86,50,000
94,00,000 94,00,000
 Depreciation Account

Date Particulars Amount Date Particulars Amount

2019 2019

Dec. 31 To Quarry lease A/c 1,00,000 Dec. 31 By Profit & Loss A/c 1,00,000

1,00,000 1,00,000
2020 2020

Dec. 31 To Quarry lease A/c 5,00,000 Dec. 31 By Profit & Loss A/c 5,00,000

5,00,000 5,00,000
2021 2021

Dec. 31 To Quarry lease A/c 7,50,000 Dec. 31 By Profit & Loss A/c 7,50,000

7,50,000 7,50,000
Example : 7

A firm purchased on 1st January, 2020 certain machinery for Rs. 5,82,000 and spent Rs. 18,000 on its
erection. On July 1, 2020 another machinery for Rs. 2,00,000 was acquired. On 1st July, 2021 the
machinery purchased on 1st January, 2020 having become obsolete was auctioned for Rs. 3,86,000 and
on the same date fresh machinery was purchased at a cost of Rs. 4,00,000.

Depreciation was provided for annually on 31st December at the rate of 10 per cent p.a. on written down
value.
Calculate Depriciation and show its impact on P&L and Balance sheet
Working Note:

Machine Machine Machine

I II III
Rs. Rs. Rs.
Cost 6,00,000 2,00,000 4,00,000

Depreciation for 2020 (60,000) (10,000)

Written down value 5,40,000 1,90,000

Depreciation for 2021 (27,000) (19,000) (20,000)

Written down value 5,13,000 1,71,000 3,80,000

Sale Proceeds (3,86,000)

Loss on Sale 1,27,000

 Example : 8

On April 1, 2019 Shubra Ltd. purchased a machinery for ` 12,00,000. On Oct 1, 2021, a part of the machinery
purchased on April 1, 2019 for ` 80,000 was sold for ` 45,000 and a new machinery at a cost of ` 1,58,000 was
purchased and installed on the same date. The company has adopted the method of providing 10% p.a.
depreciation on the written down value of the machinery.

Required : Show the necessary ledger accounts for the years ended 31st March, 2020 to 2022 assuming that
(a) Provision for Depreciation Account’ is not maintained
(b) Provision for Depreciation Account is maintained.