ENGINEERING

ECONOMICS,
ESTIMATION &
COSTING
Prof. S.J.Kumbhar
Asst. Professor
Civil Engineering Department
Sardar Patel College of Engineering

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 DEPRECIATION
•The term depreciation refers to the reduction in or
loss of quality or value of a fixed asset through wear
and tear, effusion of time, obsolescence through
technology and market changes or from any other
cause.
•Depreciation takes place in case of all fixed assets
with certain possible exceptions e.g. land and
antiques etc, although the process may be invisible
or gradual. Depreciation does take place irrespective
of regular repairs and proper maintenance of assets.

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•“Depreciation Accounting is a system of
accounting which aims to distribute the cost
or other basic value of tangible capital
assets, less salvage value (if any) over the
estimated useful life of unit (which may be
a group of assets) in a systematic and
rational manner.
•It a process of allocation, not that of
valuation. Depreciation for the year is the
portion of the total charge under such a
system that is allocated to the year.
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 Depreciation, Depletion, Obsolescence
and Amortization

•Depreciation: Depreciation is concerned with charging

the cost of man made fixed assets to operation (and
not with determination of asset value for the balance
sheet). In other words, the term depreciation is used
when expired utility of physical asset (building,
machinery, or equipment) is to be recorded.
• Depletion: This term is applied to the process of
removing an available but irreplaceable resource such
as extracting coal from a coal miner or oil out of an oil
well.
•Depletion differs from depreciation in that the former
implies removal of a natural resource, while the latter
implies a reduction in the service capacity of an asset.
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•Amortization: The process of writing off intangible
assets is termed as amortization. The intangible
assets like patents, copyrights, leaseholds and
goodwill are recorded at cost in the books of
account. Many of these assets have a limited
useful life and are, therefore, written off.
•Obsolescence: It refers to the decline in the useful
life of an asset because of factors like (i)
technological advancements, (ii) changes in the
market demand of the product, (iii) legal or other
restrictions, or (iv) improvement in production
process. 5
 CAUSES OF
•
DEPRECIATION
The depreciation occurs because of the following:
1.Constant use: The constant use of assets results into their
wear and tear, which in turn reduces their working capacity.
Hence, a decrease in the value of assets may be seen due
to reduced capacity. The value of assets like, machinery,
furniture, etc., declines with the constant use of them.
2.Passage of Time: Many fixed assets lose their value with
the passage of time. This holds true in case of intangible
fixed assets such as patents, copyrights, lease hold
properties etc. The term amortization is generally used to
indicate the reduction in the value of such assets.
3. Depletion: Depletion also causes decline in the value of
certain assets. This is true in case of wasting assets such as
mines, oil wells and forest-stands. On account of continuous
extraction of minerals or oils, these assets go on declining
in their value and finally they gets completely exhausted.
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4. Obsolescence: There may not be any physical
deterioration in the asset itself. Despite of this there
may be reduction in the utility of an asset that results
from the development of a better method, machine or
process. For example, an old machine which is still in
good working condition may have to be replaced by a
new machine because of the later being more
economical as well as efficient. In fact, new inventions,
developments in production processes, changes in
demand for product or services, etc. make the asset out
of date.
5. Accidents: An asset may get reduction in its value if
it meets an accident.
6. Permanent fall in the Market Value: Certain
assets may get permanent fall in their value and this
decline in their value is treated as depreciation. For
example, a permanent decline in the market value of
securities and investment may be assumed as
depreciation 7
 NEED FOR PROVIDING
DEPRECIATION
1. To Ascertain the Profits or Losses: The true profits or losses
could be ascertained when all costs of earning revenues have
been properly charged against them. Fixed assets like building,
plant and machinery, furniture, motor vehicles etc are important
tool in earning business income. But the cost of the fixed asset
is not charged to profit and loss of the accounting period in
which the asset is purchased. Therefore, the cost of the fixed
asset less its salvage value must be allocated rationally to the
periods that receive benefit from the use of the asset. Thus,
depreciation is an item of business expense and must be
provided for a proper matching of costs with the revenue.
2. To show the Asset at its Reasonable Value: The assets
decrease in their value over a period of time on account of
various reasons such as passage of time, constant use,
accidents, etc. Therefore, if the depreciation is not charged then
the asset will appear in the balance sheet at the over stated
value. This practice is unfair as the balance sheet would fail
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to
present the true financial position.
3. Replacement of assets: Business assets
become useless at the expiry of their life and,
therefore, need replacement. The cash
resources of the concern are saved from being
distributed by way of dividend by providing for
depreciation. The resources so saved, if set
aside in each year, may be adequate to replace
it at the end of life of the asset.
4. To Reduce Income Tax: If tax is paid on the
business income without providing for
depreciation then it will be in excess to the
actual income tax. This is a loss to the
business. Thus, for calculating tax, depreciation
should be deducted from income similar to the
other expenses as depreciation is a chargeable
expense and results in tax benefit. 9
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•Straight Line Method: This is also known as fixed
installment method. Under this method the depreciation is
charged on the uniform basis year after year. When the amount
of depreciation charged yearly under this method is plotted on a
graph paper, we shall get a straight line. The formula for
calculating depreciation charge for each accounting period is:

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•Diminishing Balance Method: This is
also known as Written down value method [WDV].
Under the diminishing balance method depreciation
is charged at fixed rate on the reducing balance (i.e.,
cost less depreciation) every year. Thus, the amount
of depreciation goes on decreasing every year.
•Under this method also the amount of depreciation is
transferred to profit and loss account in each of the
year and in the balance sheet the asset is shown at
book value after reducing depreciation from it.
•For example, if an asset is purchased for Rs. 10,000
and depreciation is to be charged at 20% p.a. on
reducing balance system then the depreciation for
the first year will be Rs. 2000. In the second year, it
will Rs. 1600 (i.e. 20% of 8000), in the third year Rs.
1280 (i.e. 20% of 6400) and so on.
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•SUM OF YEAR DIGIT METHOD
• The sum of years’ digits method is a form of accelerated
depreciation that is based on the assumption that the
productivity of the asset decreases with the passage of time.
Under this method, a fraction is computed by dividing the
remaining useful life of the asset on a particular date by the
sum of the year’s digits. This fraction is applied to the
depreciable cost of the asset to compute the depreciation
expense for the period. Sum of years’ digits method
attempts to charge a higher depreciation expense in early
years of the useful life of the asset because the asset is most
productive in early years of its life. Also the asset loses much
of its productive efficiency in early years

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