Depreciation can be defined as a continuing, permanent and gradual decrease in the

book value of fixed assets. This type of shrinkage is based on the cost of assets
utilised in a firm and not on its market value.

Features of Depreciation

Following are the 3 principal features of depreciation:

 Depreciation is a decrease in the book value of fixed assets.

 Depreciation involves loss of value of assets due to the passage of time and
obsolescence.

 Depreciation is an ongoing process until the end of the life of assets.

Causes of Depreciation

1. Wear and Tear due to Use or Passage of Time: Wear and tear is nothing
but deterioration and the following decrease in the value of an asset,
resulting from its use in business operations for earning revenue.

2. Expiration of Legal Rights: Some categories of assets lose their value after
the agreement directing their use in business comes to an end after the expiry
of the predetermined period.

3. Obsolescence: Obsolescence is another factor driving to the depreciation of

fixed assets. In common language, obsolescence means being “out-of-date”.
Obsolescence refers to an actual asset becoming outdated on account of the
availability of a better type of asset.

4. Abnormal Factors: Drop in the use of the asset may be caused by abnormal
factors. Namely, accidents due to the earthquake, fire, floods, etc.,
Accidental loss is permanent but not continuing.

Depreciation Formula:

1. Annual amount of depreciation under Straight Line Method

2. Rate of depreciation on original cost

Advantages and Disadvantages of Straight Line Method:

Advantages Disadvantages

1. It is a very simple method of 1. Under this method book value of

calculating depreciation. the asset will be charged more for
maintenance and repair in the final
2. Under this method, Asset can
years as compared to initial years.
be depreciated up to the net
scrap value or zero value. 2. It is difficult to ascertain a suitable
rate of depreciation.
3. Under this method, the same
amount is charged as 3. It is not suitable for assets having
depreciation in Profit & Loss long life and high value.
Account.

Methods of Calculating Depreciation

Straight Line Method (SLM)

Under the depreciation Straight Line Method, a fixed depreciation amount is

charged annually, during the lifetime of an asset. The amount of annual
depreciation is computed on Original Cost and it remains fixed from year to year.
This method is also known as the ‘Original Cost method’ or ‘Fixed Instalment
method’.

Written Down Value Method (WDV)

Under the Written Down Value method, depreciation is charged on the book value
(cost –depreciation) of the asset every year. Under the WDV method, book value
keeps on reducing so, annual depreciation also keeps on decreasing. This method is
also known as ‘Diminishing Balance Method’ or ‘Reducing Instalment Method’.

Straight Line Method vs Written Down Value Method

Straight Line Method Written Down Value Method

Basis of Charging Depreciation

Depreciation is calculated on the Depreciation is calculated on the book

original cost of fixed assets. value of fixed assets.

Amount of Annual Depreciation

The amount of annual depreciation

is fixed for all years of useful life. The amount of depreciation declines year
after year.

Recognition by Income Tax

The Straight Line Method is not The Written Down Value method is
recognised by the Income Tax recognised by the Income Tax
Department. Department.

Cost of Depreciation and Repairs

The combined cost on account of The combined cost on account of
depreciation and repairs is lower in depreciation and repairs remains, more or
the initial years and higher in the less, equal throughout the life of the
later years. asset.

Different methods of calculating depreciation

(a) Straight line method

(b) Diminishing or decline balance method
(c) Sum of the years digits method
(d) Sinking Fund method
(e) Annuity Method
(f) Revaluation Method
(g) Product unit method

Salvage/ scrap value is book value at the end of its life of n years. i.e. 𝑩𝒕 𝒏

Method (𝐷 ) Depreciation amout (𝐵 ) Book value of the asset at the

at the end of time period t end of time period t
Straight line 𝑷−𝑭 𝑷−𝑭
𝑫𝒕 = 𝒕 𝑩𝒕 = 𝑷 − 𝒕
method 𝒏 𝒏

Diminishing 𝑫𝒕 = 𝑲 (𝟏 − 𝑲)𝒕 𝟏
𝑷 𝑩𝒕 = (𝟏 − 𝑲)𝒕 𝑷
or decline
balance
method

Sum of the 𝒏 − (𝒕 − 𝟏) 𝒏 − (𝒕 − 𝟏) 𝒏−𝒕

years digits 𝑫𝒕 = (𝑷 − 𝑭) 𝑫𝒕 = (𝑷 − 𝑭)
𝒏(𝒏 + 𝟏)/𝟐 (𝒏 + 𝟏) 𝒏
method
Straight line method:

A company has purchased equipment whose cost is 100000 and has an

estimated life of eight years .The estimated salvage value of the equipment is
20000.From from Straight line method find depreciation at the end of each year
upto life of 8 years.

Solution:

P=100000

F=20000

n=8 years

Salvage/Scrap value is the Book Value is the value of asset at the end of
life i.e at the end of estimated life 8 years

Depreciation per year= (P-F)/n=(100000-20000)/8=10000

(𝐷 ) Depreciation (𝐵 ) Book value of the

amout at the end asset at the end of time
of time period t period t
𝑷−𝑭 𝑷−𝑭
t 𝑫𝒕 = 𝒕 𝑩𝒕 = 𝑷 − 𝒕
𝒏 𝒏
0 0 100000
1 10000 90000
2 20000 80000
3 30000 70000
4 40000 60000
5 50000 50000
6 60000 40000
8 80000 20000
Decline or Diminishing balance method of depreciation

A company has purchased equipment whose cost is 100000 and has an

estimated life of eight years. The estimated salvage value of the equipment is
20000. From decline or diminishing balance method of depreciation find
depreciation at the end of each year upto life of 8 years.

Solution:

P=100000; F=20000; n=8 years

From Straight line method:

Salvage value is the value of asset at the end of life i.e at the end of estimated life 8
years.
t
Bt= (1-K) *P  20000=(1-K)8*100000 1-K=0.8178 K=0.1822

(𝐷 ) Depreciation amout (𝐵 ) Book value of the

at the end of time period t asset at the end of time
period t

t 𝑫𝒕 = 𝑲 (𝟏 − 𝑲)𝒕 𝟏 𝑷 𝑩𝒕 = (𝟏 − 𝑲)𝒕 𝑷

0 --- 100000
1 18220.000 81780

14900.316 66879.68
2
12185.478 54694.21
3
9965.284 44728.92
4

5 8149.609 36579.31

6 6664.751 29914.56

7 5450.433 24464.13

8 4457.364 20006.76
Sum of year’s digits method of depreciation:

A company has purchased equipment whose cost is 100000 and has an estimated
life of eight years. The estimated salvage value of the equipment is 20000. From
sum of year’s digits method of depreciation find depreciation at the end of each
year up to life of 8 years

Solution:

P=100000 ; F=20000; n=8 years

Salvage value (Book Value) is the value of asset at the end of life i.e. at the
end of estimated life 8 years
(𝐷 ) Depreciation amout (𝐵 ) Book value of the asset at the
at the end of time period t end of time period t

𝒏 − (𝒕 − 𝟏) 𝒏 − (𝒕 − 𝟏) 𝒏−𝒕
t
𝑫𝒕 = (𝑷 − 𝑭) 𝑫𝒕 = (𝑷 − 𝑭)
𝒏(𝒏 + 𝟏)/𝟐 (𝒏 + 𝟏) 𝒏

100000
0
17777.778 82222.22222
1
15555.556 66666.66667
2
13333.333 53333.33333
3
11111.111 42222.22222
4
8888.889 33333.33333
5
6666.667 26666.66667
6
4444.444 22222.22222
7
2222.222 20000
8

Theory Questions:
Q.1- What are the other concepts similar to depreciation?

Answer:

Depletion  The term ‘Depletion’ is used with regard to the ‘Natural

Resources’ like oil wells, Mines etc.

 When natural resources are extracted and their stock value

is reduced. This reduction is termed as depletion.

Amortisation  The term ‘Amortisation’ is used with regard to ‘Intangible

Assets’.

 Amortisation refers to writing off the cost of intangible

assets like patents, copyright, trademarks, franchises, etc.

Obsolescence  It refers to a decline in the value of assets due to innovation

or improved techniques, changes in the taste or fashion of
the existing asset.

Q.2- State the objectives of depreciation.

Answer:

Objectives of  To ascertain the correct cost of production

Depreciation
 To retain funds for a replacement.

 To ascertain the correct Profit or Loss.

 To show a true and fair view of the financial

position.
Q.3- List the factors required for calculating the amount of depreciation.

Also give the components of original cost.

Answer:

(a) Factors/elements  The original cost of the assets.

required to calculate
 Estimated residual value or scrap value.
depreciation
 The estimated useful life of the assets.

(b) Original cost Original cost =

Purchase price + Freight + Installation cost +

Any other expenses incurred before the asset is put to

use for the first time.

 In the case of second-hand assets, even

expenses incurred on repair & overhauling,
before putting it to use, are also included in the
original cost.