Depreciation
Copyright 2011 John Wiley & Sons, Inc. 12-1
Definition
The monetary value of an asset decreases over
time due to use, wear and tear or obsolescence.
This decrease is measured as depreciation.
The equipment, building and other material objects
comprising a manufacturing plant require an initial
investment that must have a payback and this is
done by charging depreciation as a manufacturing
expense.
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Types
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Depreciable asset
In general all assets or property with limited useful
life of more than 1 year that is used in a trade or
business, or held for the production of income, is
depreciable.
In short, all fixed capital investment, not including
land is depreciable.
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Non-depreciable asset
Land is non-depreciable, since it has an unlimited
useful life. If land has a limited useful life, as in
case of quarry or mines, then it is acceptable to
depreciate over its useful life.
Inventories held for future sale are not depreciable.
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Purpose of charging depreciation
1. To ascertain true profit of the business.
2. To show the true presentation of financial position
3. To provide fund for replacement of assets
4. To show the asset at it’s reasonable value in the
balance sheet.
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Factors affecting depreciation
1. The original cost of the asset
2. The useful life of the asset
3. Estimated scrap/ salvage value of the asset at the
end of its life
4. Selecting an appropriate method of depreciation
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When depreciation Begins and Ends
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Some Definitions
Current Value:
The current value of an asset is the value of the asset
in its condition at the time of valuation.
Book Value:
It is the difference between the original cost of asset
and all the depreciation charged up to a time.
Salvage Value:
It is the net amount of money obtained from the sale
of used asset or property over and above any charges
involved in removal and sale.
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Some Definitions
Service Life:
The period over which the use of a property is
economically feasible is known as the service life.
Recovery Period:
The period over which deprecation is charged is the
recovery period and this is established by tax codes.
Market Value:
The price which could be obtained for an asset if it
were placed on sale in the open market is designated
as the market value.
The use of this term conveys the idea that if the asset
is in good condition and that a buyer is readily
available the market value may be greater than book
value.
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Some Definitions
Replacement Period:
The cost necessary to replace an existing property at
any given time with one at least equally capable of
rendering the same service is known as the
replacement value.
Depletion Cost:
Capacity loss due to material actually consumed is
measured as depletion.
Depletion cost equals the initial cost times the ratio of
amount of material used to original amount of material
purchased.
This type of depreciation is particularly applicable to
natural resources, such as stands of timber or mineral
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Estimated service life of equipment
Items Life in years
Office furniture, fixtures, 10
machines, equipment
Aircraft 6
Automobile 3
Buses 9
General Purpose trucks 4-6
Railroad cars 15
Tractor 4
Trailers 6
Water transport equipment 18
Buildings (apartments, banks, 40-60
factories, hotel, stores,
warehouses)
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Methods
Straight Line Method
Declining Balance Method
Double-Declining Balance Method
Sum of Year Digit Method
Sinking Fund Method
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Straight Line Method
In the straight line method for determining
depreciation, it is assumed that the value of the
asset or property decreases linearly with time.
Equal amounts are charged for depreciation each
year throughout the entire service life of the asset..
Mathematically,
V VS
d
N
Where, d =Annual depreciation of the asset
V = Original Value of the asset
VS Salavage value of the asset
N Service life of the asset
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Examples:
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Examples
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Examples
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Declining Balance Method
The fixed percentage or declining-balance factor
remains constant through the entire service life of
the property, while the annual depreciation is
different in each year.
The depreciation per annum is equal to net book
value into a constant percentage which is given
here by rate percent.
Annual depreciation of the asset Net Book Value % Rate
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Declining Balance Method
Depreciation at the end of 1st yr V f
Book Value at the end of 1st yr V Vf V (1 f )
Depreciation at the end of 2nd yr V (1 f ) f
Book Value at the end of 2nd yr V (1 f ) V (1 f ) f
V (1 f )(1 f ) V (1 f ) 2
So,
Book Value at the end of a th year V (1 f )a
Book Value at the end of N th year V (1 f ) N
VS V (1 f ) N
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Declining Balance Method
VS V (1 f ) N
1
VS N
f 1
V
This is fixed % decrease rate
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Examples
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Examples
Q. The value of an equipment is Rs 80000. Its scrap
value is Rs 10000. If the fixed % factor for depreciation
is 8%. Determine the service life.
Q. The value of an equipment is Rs 30000. If the fixed
% factor for depreciation is 12% annually and the
service life is 6 years. Find out the salvage value.
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Sum of year digit Method
The following equation is used to determine
depreciation every year with SYD method.
N (a 1)
depreciation after end of a year th
N V Vs
a
1
Where, V = Original Value of the asset
VS Salavage value of the asset
N Service life of the asset
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Examples
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Examples
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Solution
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Problem
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Sinking Fund Method
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