Amity Business School Depreciation means a fall in the value of an asset. Every Fixed Asset is liable to lose its value ,once it begin to be used for production purpose Accounting Concept of Depreciation Accounting concept of depreciation means to distribute the cost of fixed asset over its estimated life in a reasonable manner. Amity Business School Plant Assets Natural Resources Intangible Assets Depreciation Depletion Amortization Amity Business School 1. Wear and tear wearing out of the asset on account of its constant use is called wear & tear. 2. Lapse of time With passage of time there is reduction in the value of fixed assets . 3. Obsolescence Due to acquisition of an improved model which is more economic and works more quickly then the existing machine will become obsolete. Causes of Depreciation Amity Business School Objective of Charging Depreciation 1. To Ascertain the Profit or Loss Properly 2. To show the Asset at its proper Value 3. To Retain out of Profit Funds for Replacement Basic Factors Consider for calculating the Depreciation 1. Original cost of the Asset 2. Scrap Value at the End of its Life 3. Estimated effective or Commercial life or legal life which ever is shorter Amity Business School Methods of Depreciations 1. Straight Line Method or Fixed installment Method 2. Diminishing Balance or Written Down Value Method 3. Annuity Method 4. Sinking Fund Method 5. Sum of the Digits Method 6. Insurance policy Method 7. Revaluation Method
Amity Business School Straight Line Method Under this method, an equal portion (amount) of the cost of the Asset is allocated as Depreciation to each accounting year over a period of its effective life. This is done so to reduce the value of the asset equal to zero or its salvage or scrap value This method is based on the assumption that depreciation is the Function of Time Rather than of use and service potential of the Asset It is also called as Fixed or Equal instalment method Amity Business School The Annual depreciation charge will be computed as follows Annual Depreciation = Cost of Asset + Erection charges Scrap Value
Estimated life of the Asset Question 1 A machine is purchased for Rs 50000 & Rs 5000 is incurred as erection charges. The machine has a life of 5 years with a salvage value of Rs 10,000. Compute the annual depreciation.
Question 2 A firm bought a machinery for Rs 38000 on 1 st January 2009 and its life was Estimated to be 8 years. Its estimated scrap value at the end of the period was Rs 6000. Calculate the amount of depreciation. Amity Business School Ram & Sons acquired a machine on 1 st July 2008 at a cost of Rs 14000 and spent Rs 1000 on its installation. The firm write off depreciation at 10% on the original Cost every year. The Books are closed on 31 st December every year. Show the Machinery Account & Depreciation Account for three years. Question 3. Question 4. On 1st January 2000, Z Ltd purchased a plant costing Rs 41000 and spent Rs 4000 On its erection. The estimated effective life of the plant is 10 year with scrap value of Rs 5000. Calculate depreciation on the SLM for three years. Amity Business School Advantages of Fixed installment method It is easily understandable & is simply to apply. Amount of depreciation does not vary from year to year. Under this method the book value of asset is reduced either to zero or scrap value as the case may be. Amity Business School Disadvantages of fixed installment method It does not reflect correct charge on a/c of depreciation where effective utilization of asset varies from year to year. It does not recognize the reality that as an asset becomes older the amount spent for repairs. Sometime in this method, book value of asset become zero but yet the assets are used in the business. Amity Business School Written Down Value Method Under this Method depreciation is charged at fixed rate on the reducing balance (i.e. cost less depreciation) every year. Advantages of diminishing balance method Simple to understand Easy to follow Ensures a fairly even charge to profit and loss A/c Disadvantages Value of an asset cannot be brought down to zero There is a difficult task to ascertain the proper rate of depreciation