DEPRECIATION

Salient features Depreciation is a measure of wearing out.

It reduces the book value of the asset but not its market value. It is a measure of loss of value of asset. Depreciation is a continuing process because the book value is reduced either with the use of the asset or with the passage of time. It takes place gradually unless there is a quick physical deterioration or obsolescence due to technological developments. It is not the process of valuation of asset, it is a process of allocation of cost of the asset to the useful life of asset. The term depreciation is used only for tangible fixed assets.
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The other related word with the depreciation:Depletion: Depletion is used in respect of the extraction of natural resources like quarries, mines, etc., that reduces the availability of quantity of the material or asset.
Obsolescence: Obsolescence refers to decrease in usefulness caused on account of the asset becoming out of date, old fashioned, etc. The fact remains that obsolescence is regarded as one of the causes of Depreciation Amortization: It refers to writing off the proportionate value of the intangible such as goodwill, copyright, patents, etc.
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Basis of providing depreciation

(i) Original cost of the asset includes all expenses

including freight, erection charges, up to the point

it is ready for use. (ii) Estimated residual or scrap value at the end of its life.

(iii) Estimated useful, commercial or legal life, whichever is shorter.

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Depreciation

Straight Line Method Or

Fixed Installment Method

Written Down Value Method Or Diminishing Balance Method

Machine hour Rate

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Straight Line Method

1. Depreciation = Cost Estimated scrap value Number of year of expected life

WDV
2. Depreciation = 1-n Net Residual Value Acquisition Cost

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Straight Line Vs. WDV method

1. The amount of depreciation in the Straight Line Method remains same whereas in the other case it is more during the earlier year as compared to later years of the life of the asset. 2. In the case of Straight Line Method, the value of asset on expiry of its life become zero or equal to the salvage value whereas in the case of WDV method the value of assets never become zero. 3. In the case of fixed asset the overall charge for use of the asset cost on increasing and in the case of WDV it remains almost same considering the impact of depreciation and the repairs.
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Capital Expenditure Vs. Revenue Expenditure

Expenditure incurred
for acquiring of fixed asset Increases earning capacity Expenditure incurred for maintaining the existing fixed asset Helps in maintaining the existing earning Benefits restricted only to the accounting period e.g. wages, printing stationary,staff welfare, repair & maintenance, entertainment expenses, sales promotion expenses, interest expenses, interest etc.

Benefits are available for more than one year

e.g. land, building, plant & machinery, furniture & fixtures, office equipment, vehicles etc.

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Valuation of Inventory
Value of Inventory is the value lower of the two

Cost (Purchase Price + Freight Duties + Other Expenditure) ADD Cost of Conversion (Direct Labour + Variable Production Overheads + Allocated Fixed Overhead) ADD Other cost in bringing the inventory to their present condition

Estimated Selling Price in the ordinary course of business LESS Estimated cost of Completion LESS Estimated cost necessary to make the sale

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Method of Valuation

First In First Out (FIFO)

Last In Fast Out (LIFO)

Weighted Average Method

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