Depreciation

MEANING:

Depreciation means decrease in the value of fixed assets caused by use of asset,

efflux of time or any other cause. Such annual loss in the value of the asset is

like any other expense and requires equitable spread over the period of the

useful life of the asset.

According to Accounting Standard (AS) - 6 (Revised 1994)

“Depreciation is a measure of the wearing out, consumption or other loss of

value of a depreciable asset arising from use, effluxion of time or obsolescence

through technology and market changes. Depreciation is allocated so as to

charge a fair proportion of the depreciable amount in each accounting period

during the expected useful life of the asset. Depreciation includes amortization

of assets whose useful life is predetermined.”

CHARACTERISTICS OF DEPRECIATION

 Depreciation is always a fall in the value of only fixed assets.

 This fall is always gradual.

 The fall is of permanent character and it cannot be recouped after words.

 The depreciation is a continuous process and it does not matter whether the

assets was put to use during the period or not.

 Depreciation is the fall in the book value of the assets and not in market or

exchange value.

 Depreciation is the result of the use of asset, passage of time and

obsolescence.
Factors or Elements of Depreciation

1. Depletion: Depletion is an accounting concept used most often in mining,

timber, petroleum, or other similar industries. The depletion deduction

allows an owner or operator to account for the reduction of a product's

reserves

2. Amortisation: Amortization refers to expensing the acquisition cost minus

the residual value of intangible assets (often intellectual property such as

patents and trademarks or copyrights) in a systematic manner over their

estimated useful economic lives so as to reflect their consumption, expiration,

obsolescence or other decline in value as a result of use or the passage of time.

3. Obsolescence: Due to technological developments, the asset in use may

become out dated and loose a large part of its value. This fall may also be the

result of changes in tastes and habits of customers, changes in the supply and

location of material resources, etc. in other words, Obsolescence is a term used

with the depreciation.

4. Abnormal Factors: There are some abnormal factors which also lead to

decrease the value of fixed assets. Examples of abnormal factors are: Loss by

fire; flood, earthquake, Theft etc.

CAUSES OF DEPRECIATION

 Wear and Tear due to use of the asset

 Accidents and Expiration of certain legal

 Obsolescence’s

Needs / Objectives / Importance of Depreciation

  To ascertain true profits

 To show true and fair view of financial position

 To provide funds for replacement of assets

 To keep the capital

 To Know the Correct amount of income tax

 Compliance with law

 Matching costs and Revenue:

Methods of Depreciation

1. Straight line method: Straight-line Method of depreciation is the simplest

and most commonly used technique, Under this method the company forecasts

the salvage value (Scrap value) of the asset at the end of the accounting period

during which it will be used to generate revenues (useful life) and will expense

a portion of original cost in equal increments over that period.

2. Diminishing Balance method: It provides a higher depreciation charge in

the first year of an asset's life and gradually decreasing charges in subsequent

years are called accelerated depreciation methods. This may be a more realistic

reflection of an asset's actual expected benefit from the use of the asset: many

assets are most useful when they are new. One popular accelerated method is

the declining-balance method.

ACCOUNTING ENTRIES

(a) For writing off depreciation when provision for depreciation account is not
 maintained-

(i) Depreciation account .. Dr.

To asset account

(Being the entry for providing depreciation on asset)

(ii) Profit and loss account Dr.

To depreciation Account

(Being the transfer of depreciation A/C to profit and loss A/C)

As a result of depreciation the asset appears at its reduced value in the

balance sheet.

(b) In case provision for depreciation account is maintained.

(i) Depreciation account .. Dr.

To provision for depreciation account.

(Being the entry for providing depreciation on asset.)

(ii) Profit and loss account Dr.

To depreciation account.

(Being the transfer of depreciation A/C to profit and loss A/C)

 Under this method, the asset account is not credited with the amount of

depreciation; instead provision for depreciation account is credited.

 The asset appears in the balance sheet at its original cost and it changes

only on its sale, addition or when discarded.

 Provision for depreciation account which effects accumulated depreciation

to date is either shown on the liabilities side of the balance sheet or is

deducted from the value of asset in the balance sheet.

 When an asset is sold, the depreciation to the date of sale is transferred

from provision for depreciation account to the asset account, as a result of

which the fixed asset is brought down to its written down value.

Provision for depreciation account Dr.

To asset Account

The difference between the sale price and the written down value of the asset

is profit or loss on sale. In case the sale price exceeds the written down value of

the asset, there shall be profit on sale. The journal entry is:

(i) Cash / Bank account ..... Dr. Sale price

To asset account

(ii) Asset Account ...............Dr.

To profit and loss account Amount of profit

In case the sale of price of the asset is less than its written down value, there

shall be a loss on sale. The journal entry is:

Cash/Bank Account..............Dr Sale price

Profit and loss account.........Dr Amount of loss.
To asset account ............. Written down value.

Performa of Depreciation Account

Depreciation A/c
Date Particulars Amount Date Particulars
2009 2009
March March
31 By Asset A/c 31 By Profit & loss A/c

2010 2010
March By Asset A/c March By Profit & loss A/c
31 31

2011 By Asset A/c 2011 By Profit & loss A/c

March March
31 31

Provision for Depreciation Account:

Journal Entries:
1. Depreciation A/c Dr.

To Provision for Dep. A/c

(Being depreciation charged on asset)

2. Profit & Loss A/c Dr.

To Depreciation A/c
(Being Depreciation Transferred to Profit and Loss A/c)

Performa of Provision for Depreciation Account

Provision for Depreciation A/c

Date Particulars Amount Date Particulars Amount
2010 2010
March March
31 By Balance c/d 31 By Depreciation A/c

2011 2010
March By Balance c/d April1 By balance b/d
31 2011 By Depreciation A/c
March
31

2011 By Balance b/d

April 1

Asset Disposal Account:

Most commonly this method is used when a part of the asset is sold and
provision for depreciation account exists. Under this method a new account
‘Asset Disposal account’ is maintained. This account may show debit or credit
balance, Debit balance shows Loss and Credit Balance shows Profit.
Asset disposal account is debited with the original cost of asset, being sold, and
credited with amount of Provision for depreciation account. Amount of sale is
also credited to Asset disposal account.
 Performa of Asset Disposal Account

Asset Disposal A/c

Date Particulars Amount Date Particulars Amount
2010 2010
Jan.1 Jan. 1
By Asset A/c By Provision for

Jan.1 Dep. A/c By Bank

Jan.1 (Sale)
By Profit & Loss
By Profit & A/c (Loss on
Loss A/c sale)
(Profit on
sale)