14
DEPRECIATION, PROVISIONS AND
RESERVES
DEPRECIATION
machinery furniture ctc. to run the
land, building,
business requires fixed assets like
A
business. These assets have
passage of
(a) long term value
to the business
like wear and tear, tims.
decreases due to various reasons
(b) value in a phased manner.
obsolescence' ete. chargedto revenue
incurred on such assets has to be year is called depreciation.
Therefore the cost current accounting
asset during the
The expired cost of the fixed
DEFINITIONS decrease in the value of a asset
"Depreciation is the gradual and permanent
R.N. Carter -
from any cause."
loss or dimunition in the value of an asset
J.R. Batliboi, Depreciation
represents
effluxion of time or' fll in the market value."
obsolescence
consequent upon wear and tear, permanent and continuing elimination in the
means a
William Pickles "Depreciation
asset".
quantity, quality or value of an Accounting Standard (AS -6)defines
the
Accountants of India in
Institute of Chartered
wearing out consumption or other loss of a value of a
depreciation as, "a measure of the or obsolescence through
technology and
effluxion of time
depreciable asset arising from useDepreciation is allocated so as to charge a fair proportion of
technology and market changes. period during the expected useful life of the asset.
depreciable amount so each accounting
amortisation of assets whose usefullife is predetermined."
Depreciation includes
AS-6. further defines depreciable assets.
Depreciable assets are assets which
1. are expected to be used during more than one
accounting period
2. have a limited useful life
rental
3. are held by an enterprise for use in production or upply of goods ad services for
to others or for administrator purposes.
4. and not for the purpose of sale in ordinary course of business."
394
DEPRECIATION, PROVISIONS
AAND RESERVES 395
CAUSES OF DEPRECIATION
1. Wear and Tear : Wear and tear means decline in the value of a asset due to its use. The
ats physically detenorated due to use. The more an asset is
example if a machine used. ureater is its weal a
ter.For workS double
on with a machine which works on
singleshift, naturally the depreciation in case ofshiftmachinery
compared working on double shift will be
dvuble.the depreciation in case of asingle shift.
2. Accidental Destruction : Sometime the value of a fixed asset depreciates due to some
Keidentslike fire or natural calamity like flood, earth quakes etc.
3. Natural Decay : Some times, in some regions or areas, natural factors like increases the
nnoisture causing rusting of machines or leakages or softening of walls of buildings.
4, Obsolescence : Sometimes new innovations in the market due to technological
developments render old assets out dated and obsolete.
5. Effluxion of Time : Some assets have limited contractual life like patents, copyrignts,
licences, leases etc. There these assets become value less after the expiry of periodoftheir life.
6. Depletion : Incase of mineral assets,the value is depleted due to extraction of minerals
like incase of coal mines, oil wells ete
7. Expiration of Age : Some assets like animals (livestock) lose their value gradually with
the expiry of their age.
CHARACTERISTICS OF DEPRECIATION
value of a
1, Depreciation refers to a permanent, gradual and continuous decrease in the
fved asset and it continues till the end of the useful life of the asset.
valuation of fixed asset.
2. Depreciation is a process of allocation of expired cost and not of
3,Depreciation is a non-cash expense.
of the business.
4. Depreciation is charged to revenue to find out net profits
calculating depreciation is followed, the
5. Depreciation is a estimate whatever method of
exact amount can never be calculated.
whether the asset is carefully handled or
6. Depreciation is a must i.e., it always takes place
not.
fixed assets only.
7. Depreciation is calculated in respect of
depreciation charged to revenue cannot exceed its depreciable value i.e., cost less
8. Total
Scrap value.
charging depreciation are (a) to write off the expired cost of the asset (b)
9. The objectives of asset at the end of its useful life.
loprovide funds for the replacement of the
sPECTRUM ACCOUNTAN
396
DEPRECIATION
CHARGING
OBJECTIVESOF following reasOns
due to businesscan only be
fixedcalculasset,
ated
in the books the
reconded by
Depreciationis Correct profits earned principle. Unless cost of
calculate4
Know Correct Profits : revenue ie., matching profits cannot be
1. To against the account true
whcn costs are
matched profit and loss
Balance Sheet :
Depreciation has to te
period is charged to the
True Value in show the assets at their re
used during the at their in order to
the Assets balance sheet balance sheet.
2. To Show fixed assets in the overstated in the
deducted from the
cost of assets will be to
Depreciation is a nears provide
Ifdepreciation is not charged, the
replacement of assets : life. Since depreciation is a non cash
funds
value. for
3. To
generate funds
at the end of their usefulaccumulated over the working life of the
of fixed asset depreciation gets proper method of
for replacement amount of'annual
the especially when depreciation is
Cxpense, hence to replace the asset
it becomes easy
asset and
Indian Companies Act, 1956 has made. It
selected. of calculate
Requirement : Section 205 depreciation in order to divisible
4. Statutory stock companyto provide for
compulsory for a joint possible without plant,
profits. production : Production is not produeti
ascertain true cost of Therefore,cost of assets used in
5. To labour.
and tools along with materials and otherwise it will lead to understatemen.
machinery, calculation of cost of production
has to be included in the fixing of lower selling price. reduces
production leading to charge against profits, it
ofcost of depreciation is a
liability : Since
6.Saving in income tax
saving income tax. charged against profts
the taxable profits, thus When depreciation is
capital intact : intact.
7. To maintain the thus capital invested in the business remains
distributable profits get reduced and
FACTORS AFFECTING DEPRECIATION
estimated amount which depends on the following factors :
Depreciation is an mones
amount spent by the business on its purchase along withthe
1. Cost of Asset : The import duty etc:
transportation and installation like freight, insurance, Octroi,
spent on its
constitute the total cost of the asset.
the
Value : Sometimes the asset realises some value when it is discarded or sold at
2. Scrap
value is deducted from the cost of the asset to
end of its working life. This estimated scrap
determine the depreciable amount.
is estimated in terms of years
3. Estimated useful life : The working life of the asset
depreciation. This is the mos
months, days, hours output mileage etc to determine the annual
difficult task and technical experts like engineers are required to estimate it.
RECA
TION.PROVISIONS
AND RESERVES 397
AMaintenance of Asset : If the asset is got repaired at regular intervals and is handled
working life gets enhanced. Thus the amount of depreciation to be charged has to
maintenance factor
into account.
5.Legal.Provision :In some cases like joint stock companies, depreciationis the function of
keoaprOViSionsin this regard. Income Tax Act, 1961 also sets out rates of depreciation and
of
nethodfcalculating depreciation in respect of various categories of assets.
6. Rate of Obsolescence : In case class of assets like office appliances, rate of obsolescence
Therefore depreciation is written off at higher rate in case of those assets.
ACCOUNTIYGENTRIES
FOR
DEPRECIATION
Accountingentries for depreciation are recorded in the following two methods :-
, When asset account is shown at net book value. In this method, the following
accounting entries are passed:
For charging depreciation on asset:
Depreciation Account Dr.
To Asset Account
CÀ For transfering depreciation charge to the profit and loss acçount :
Profit and Loss Account Dr.
ToDepreciation Account
II. When asset account is shown at its original cost in the books. In this method, the
following entries are passed :
) For charging depreciation :
Depreciation Account Dr.
To Provision for Depreciation Account
())For transferring depreciatton account totheprofit and loss account :
Profit andLoss Account Dr.
To Depreciation Account
The provision for depreciation accounting willbe shown in the balance sheet as a deduction
from the cost of the concerned asset.
METHODS OF DEPRECIATION
There is not a single method of depreciation which can be used for all types of fixed assets.
Sitability ofamethod depends upon nature of business, type of asset and management's policy.
Following methods are geperally used for providing depreciation on fixed assets :
1. Straight Line Method or Original Cost Method or Fixed Installment Method
