Accounting for Depreciation –
Meaning of Depreciation
Depreciation may be described as a permanent, continuing and gradual decrease in
the book value of fixed assets. It is based on the cost of assets consumed in a business
and not on its market value.
Depreciable assets are assets which
(i) are expected to be used during more than one accounting period; and
(ii) have a limited useful life; and
(iii) are held by an enterprise for use in the 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.
Useful life is either (i) the period over which a depreciable asset is expected to be
used by the enterprise; or (ii) the number of production or similar units expected to be
obtained from the use of the asset by the enterprise.
Depreciable amount of a depreciable asset is its historical cost, or other amount
substituted for historical cost1 in the financial statements, less the estimated residual
value.
Depletion
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 enterprise is into mining business and purchases a coal mine
for ` 10,00,000. Then the value of coal mine declines with the extraction of coal out of
the mine.
Amortization
Amortisation refers to writing-off the cost of intangible assets like patents, copyright,
trademarks, franchises, goodwill which have utility for a specified period of time. The
procedure for amortisation or periodic write-off of a portion of the cost of intangible
assets is the same as that for the depreciation of fixed assets. For example, if a
business firm buys a patent for ` 10,00,000 and estimates that its useful life will be 10
years then the business firm must writeoff ` 10,00,000 over 10 years. The amount so
written- off is technically referred to as amortisation.
Obsolescence
Obsolescence is another factor leading to depreciation of fixed assets. In ordinary
language, obsolescence means the fact of being “out-of-date”. Obsolescence 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to an existing asset becoming out-of-date on account of the availability of better type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:
• Technological changes;
• Improvements in production methods;
• Change in market demand for the product or service output of the asset;
• Legal or other description.
Need or Objectives for providing Depreciation:-
The following are the need or objectives for providing depreciation:
(i) To find out the correct profit or loss: the profit for any year can be determined
only when all cost of earning revenues have been accounted for. Decrease in the
value of fixed assets or depreciation shows the cost of earning revenue by use of fixed
assets in the accounting year. Depreciation is not optional but compulsory to
determine correct profit or loss.
(ii) To show true and fair view of the financial position: Depreciation, if not charged,
would result in assets being stated at a higher value. As a result of this, the Position
Statement or Balance Sheet would not present a true and fair view of the financial
position.
(iii) Provision for funds out of profits for replacement: Funds should be retained, out
of Profits, for replacement of assets at the end of life of the asset. The amount of
depreciation is debited to Profit and Loss Account, on account of depreciation are
retained in the business as no payment is made like other expenses.
(iv) To ascertain the correct cost of production: Depreciation should be taken into
consideration for calculating the cost of production.
Two Methods of Depreciation:-
The amount of depreciation to be charged for the year is calculated by using various
methods. But the two main methods for calculating depreciation are:
1. Fixed Percentage on Original Cost or Fixed Installment or Straight Line Method.
2. Fixed Percentage on Diminishing Balance or Reducing Installment Method or
Written Down Value Method.
Necessity of providing Depreciation.
The necessity of providing Depreciation:
The following are the necessity of providing depreciation:
(i) To find out the correct profit or loss: the profit for any year can be determined
only when all cost of earning revenues have been accounted for. Decrease in the
value of fixed assets or depreciation shows the cost of earning revenue by use of fixed
assets in the accounting year. Depreciation is not optional but compulsory to
determine correct profit or loss.
(ii) To show true and fair view of the financial position: Depreciation, if not charged,
would result in assets being stated at a higher value. As a result of this, the Position
Statement or Balance Sheet would not present a true and fair view of the financial
position.
(iii) Provision for funds out of profits for replacement: Funds should be retained, out
of Profits, for replacement of assets at the end of life of the asset. The amount of
depreciation is debited to Profit and Loss Account, on account of depreciation are
retained in the business as no payment is made like other expenses
(iv) To ascertain the correct cost of production: Depreciation should be taken into
consideration for calculating the cost of production. If it is not considered the cost of
production will not be correct.
(v) To meet the legal requirements: It is mandatory to charge Depreciation to comply
with the provisions of the Companies Act and the Income Tax Act.
Question – 1
Good Manufactures Ltd. Purchase on 1
October, 2018 a machinery costing Rs. 25,000. A sum of Rs. 1,000 was spent upon its
installation. Depreciation is charged @ 10% p.a. on the Diminishing Balance
Method. The company closes its books every year on 31 March (ignore GST).
What will be the amount of Depreciation for the year ended 31 March 2019, 31
March 2020 and 31 March, 2021?
Methods of Recording Depreciation
In the books of account, there are two types of arrangements for recording
depreciation on fixed assets:
• Charging depreciation to asset account or
• Creating Provision for depreciation/Accumulated depreciation account
Charging Depreciation to Asset account
According to this arrangement, depreciation is deducted from the depreciable cost
of the asset (credited to the asset account) and charged (or debited) to profit and
loss account. Journal entries under this recording method are as follows:
1. For recording purchase of asset (only in the year of purchase)
Asset A/c Dr. (with the cost of asset including installation, freight, etc.)
To Bank/Vendor A/c
2. Following two entries are recorded at the end of every year
(a) For deducting depreciation amount from the cost of the asset.
Depreciation A/c Dr. (with the amount of depreciation)
To Asset A/c
(b) For charging depreciation to profit and loss account.
Profit & Loss A/c Dr. (with the amount of depreciation)
To Depreciation A/c
3. Balance Sheet Treatment
When this method is used, the fixed asset appears at its net book value (i.e. cost less
depreciation charged till date) on the asset side of the balance sheet and not at its
original cost (also known as historical cost).
Creating Provision for Depreciation Account/Accumulated
Depreciation Account
This method is designed to accumulate the depreciation provided on an asset in a
separate account generally called ‘Provision for Depreciation’ or ‘Accumulated
Depreciation’ account. By such accumulation of depreciation the asset account need
not be disturbed in any way and it continues to be shown at its original cost over the
successive years of its useful life. There are some basic characteristic of this method
of recording depreciation. These are given below:
• Asset account continues to appear at its original cost year after year over its entire
life;
• Depreciation is accumulated on a separate account instead of being adjusted in the
asset account at the end of each accounting period.
The following journal entries are recorded under this method:
1. For recording purchase of asset (only in the year of purchase)
Asset A/c Dr. (with the cost of asset including installation, expenses etc.)
To Bank/Vendor A/c (cash/credit purchase)
2. Following two journal entries are recorded at the end of each year:
(a) For crediting depreciation amount to provision for depreciation account
Depreciation A/c … Dr. (with the amount of depreciation)
To Provision for depreciation A/c
(b) For charging depreciation to profit and loss account
Profit & Loss A/c … Dr. (with the amount of depreciation)
To Depreciation A/c
3. Journal Entry for Sale of Assets
Cash/Bank A/c … Dr.
To Asset A/c
4. Journal Entry for Profit on the Sale of Asset
Profit on sale of Asset A/c … Dr
To Profit & Loss A/c
5. Journal Entry for Loss on the Sale of Asset
Profit & Loss A/c … Dr
To Loss on sale of Asset
Question – 2
M/s Singhania and Bros. purchased a plant for ` 5,00,000 on April 01, 2017, and spent `
50,000 for its installation. The salvage value of the plant after its useful life of 10 years is
estimated to be ` 10,000. Record journal entries for the year 2016-17 and draw up Plant
Account and Depreciation Account for first three years given that the depreciation is
charged using straight line method if :
(i) The books of account close on March 31 every year; and
(ii) The firm charges depreciation to the asset account.
Solution
Books of Singhania and Bros.
Journal
Dr. Cr.
Date Particulars L.F Amount ` Amount `
.
2016
Apr. 01 Plant A/c Dr.
To Bank A/c 5,00,000
(Purchased plant for ` 5,00,000) 5,00,000
Apr. 01 Plant A/c Dr. 50,000
To Bank A/c 50,000
(Expenses incurred on installation)
2017
Mar. 31 Depreciation A/c Dr. 54,000
To Plant A/c (Depreciation charged 54,000
on asset)
Mar. 31 Profit and Loss A/c Dr. 54,000
To Depreciation A/c (Depreciation 54,000
debited to profit and loss account)
Plant A/c
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2016 2017
Apr. 01 Bank 5,00,000 Mar. 31 Depreciation 54,000
Balance c/d 4,96,000
Bank 50,000
(Installation
expenses)
5,50,000 5,50,000
2017 2018
Apr. 01 Balance 4,96,000 Mar. 31 Depreciation 54,000
b/d
Balance c/d 4,42,000
4,96,000 4,96,000
2018 2019
Apr. 01 Balance 4,42,000 Mar. 31 Depreciation 54,000
b/d
Balance c/d 3,88,000
4,42,000 4,42,000
2019
Apr. 01 Balance 3,88,000
b/d
Depreciation A/c
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amounts
` `
2017 2017
Mar. 31 Plant 54,000 Mar. 31 Profit and 54,000
2018 2018
Mar. 31 Plant 54,000 Mar. 31 Loss Profit 54,000
2019 2019
54,000 and Loss 54,000
Mar. 31 Plant Mar. 31 Profit & Loss
Workings Notes
(1) Calculation of original cost
(`)
Purchase cost 5,00,000
Add: Installation cost 50,000
Original cost 5,50,000
Salvage value 10,000
Useful life 10 years
5 ,50,000−10,000
(2) Depreciation amount = =54,000 p . a.
10
Question – 3
M/s. Dalmia Textile Mills purchased machinery on April 01, 2016 for ` 2,00,000 on credit from M/s
Ahuja and sons and spent ` 10,000 for its installation. Depreciation is provided @10% p.a. on
written down value basis. Prepare Machinery Account for the first three years. Books are closed on
March 31, every year.
Solution
Books of Dalmia Textiles mills Machinery Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2016 2017
Apr. 01 Bank 2,00,000 Mar. 31 Depreciation 21,0001
Bank 10,000 Balance c/d 1,89,000
2,10,000 2,10,000
2017 2018
Apr. 01 Balance b/d 1,89,000 Mar. 31 Depreciation 18,9002
Balance c/d 1,70,100
1,89,000 1,89,000
2018 2019
Apr. 01 Balance b/d 1,70,100 Mar. 31 Depreciation 17,0103
Balance c/d 1,53,090
1,70,100 1,70,100
2020 Balance b/d 1,53,090
Working Notes
1. Calculation of the amount of depreciation (`)
Original cost on 01.04.2016 2,10,000 (i.e. 2,00,000 + 10,000)
Less: Depreciation for 2016-17 (21,000)
WDV on 01.04.2017 1,89,000
Less: Depreciation for 2017-18 (18,900)
WDV on 01.04.2018 1,70,100
Less: Depreciation for 2018-19 (17,010)
WDV on 01.04.2017 1,53,090
Question – 4
Depreciation under WDV- Purchase and Sale of Asset
A Ltd. purchased on 1st April, 2019 a machinery for Rs. 2,91,000 and incurred Rs.
9000 for installation. On 1st October another machinery for Rs. 1,00,000 was
purchased. On 1st October 2020 the machinery purchased on 01/04/2019 having
become useless was sold for Rs. 1,93,000 and on that day a new machinery was
purchased for Rs. 2,00,000.
Depreciation was provided on 31st March each year @ 10 percent p.a on written
Down Value.
You are required to prepare machinery account.
Solution:
In the Books of A Ltd.
Machinery A/c
Dr. Cr.
Amount Amount
Date Particulars Date Particulars
(`) (`)
2019 2020
April To Bank A/c 2,91,000 March 31 By Depreciation A/c 35000
1 To Bank A/c 9,000 [depreciation on
1 [Installation Charge] asset sold ]
To Bank A/c 1,00,000 31 By Balance c/d 3,65,000
Oct. 1 4,00,000 4,00,000
2020
April 1 To Balance b/d 2020
3,65,000 Oct. 1 By Depreciation A/C
13,500
Oct. 1 To Bank A/c (sold on Machinery)
2,00,000
[New Machine
1 1,93,000
Purchased] By Bank A/c
1 By Profit & Loss A/c 63,500
2021
March 31 By Depreciation A/c 19,500
[WN-1]
March 31 2,75,500
By Balance c/d
5,65,000 5,65,000
Working Note 1:
Calculation of Book Value of Machine
Machine-1 Machine2 Machine-3
Particulars (`) (`) (`)
Cost 3,00,000 1,00,000 2,00,000
Depreciation for 2019-20 (30,000) (5000)
Written Down Value 2,70,000 95,0000
Depreciation for 2020-21 (13,500) (9,500) (10,000)
Written Down Value Sale 2,56,500 85,500 1,90,000
Proceeds (1,93,000)
63,500
Loss on Sale
Question – 5
On 1st January, 2003 a Company purchased a plant for ` 20,000. On 1st July in the
same year, it purchased additional plant worth ` 8,000 and spent ` 2,000 on its
erection. On 1st July, 2004, the plant purchased on 1st jan., 2003 having become
obsolete, was sold off for ` 12,500. On 1st October, 2005, fresh plant was purchased
for ` 28,000 and on the same date, the plant purchased on 1st July, 2003 was sold at `
6,000.
Depreciation is provided at 10% per annum on original cost on 31st December every
year. Show the plant account for 2003 to 2005.
Solution
Plant Account
Dr. Cr.
Date Particulars J.F. ` Date Particulars J.F. `
2003 2003
Jan. 01 To Cash 20,000 Dec. 31 By Depreciation A/c
July 01 A/c To 8,000 (i) for a year 2,000
Cash A/c (ii) for six months 2,500
To Cash 2,000 500 By Balance c/d
A/c (i) 18,000
(expenses) 9,500 27,500
30,000 30,000
2004 2004
Jan. 1 To Balance b/d July 1 By Cash A/c (sale) 12,500
(i) 18,000 Dec. 31 By Depreciation A/c (i) 1,0001
(ii) 9,500 27,500 July 1 By Profit & Loss A/c 4,5001
By Depreciation A/c (ii) 1,000
Dec. 31 By Balance c/d
(₹9,500 - ₹1,000) 8,500
27,500 27,500
2005 2005
Jan. 1 To Balance b/d (ii) 8,500 6,000
Oct. 1 By Cash A/c (sale)
Oct. 1 To Cash A/c (iii) 28,000 Oct. 1 By Depreciation A/c (ii) 7502
Oct. 1 1,750
By Profit & Loss A/c (loss)
Dec. 31
By Depreciation A/c (iii)
(28,000x10/100x3/12) 700
Dec. 31 By Balance c/d
(₹28,000-₹700) 27,300
36,500 36,500
Question – 6
On October 1, 2008, the Akash Transport Company purchased a Truck for ` 8,00,000.
On April 1, 2010, this Truck was involved in an accident and was completely
destroyed and ` 6,00,000 were received from Insurance Company in full settlement.
On the same date another Truck was purchased by the company for ` 10,00,000. The
company writes off 20% depreciation p. a. on written down value method. Give the
Truck Account from 2008 to 2010.
Question – 7
Provision for Depreciation Account
GFG Ltd. acquired a machine for ₹1,80,000 on October 01, 2021, and spent ₹20,000
for its installation. The firm writes off depreciation at the rate of 10% on the original
cost every year. Record necessary journal entries for the year 2021-22 and draw up
necessary for the first three years given that:
(i) The book of accounts closes on March 31 every year; and
(ii) The firm maintains provision for depreciation account.
Question – 8
On April 01, 2010, Bajrang Marbles purchased a Machine for ₹ 1,80,000 and spent ₹
10,000 on its carriage and ₹ 10,000 on its installation. It is estimated that its working
life is 10 years and after 10 years its scrap value will be ₹ 20,000.
(a) Prepare Machine account and Depreciation account for the first four years by
providing depreciation on straight line method. Accounts are closed on March 31st
every year.
(b) Prepare Machine account, Depreciation account and Provision for depreciation
account (or accumulated depreciation account) for the first four years by providing
depreciation using straight line method. Accounts are closed on March 31st every
year.
Question – 9
Reliance Ltd. purchased a second hand machine for ₹ 56,000 on October 01, 2011 and
spent ₹ 28,000 on its overhaul and installation before putting it to operation. It is
expected that the machine can be sold for ₹ 6,000 at the end of its useful life of 15
years. Moreover an estimated cost of ₹ 1,000 is expected to be incurred to recover the
salvage value of ₹ 6,000. Prepare machine account and Provision for depreciation
account for the first three years charging depreciation by fixed installment method.
Accounts are closed on March 31, every year.
Question – 10
Azad Ltd. purchased furniture on October 01, 2014 for ₹ 4,50,000. On March 01,
2015 it purchased another furniture for ₹ 3,00,000. On July 01, 2016 it sold off the
first furniture purchased in 2014 for ₹ 2,25,000. Depreciation is provided at 15% p.a.
on written down value method each year. Accounts are closed each year on March 31.
Prepare furniture account and accumulated depreciation account for the years ended
on March 31, 2015, March 31, 2016 and March 31, 2017. Also give the above two
accounts if furniture disposal account is opened.
