Lets look at

what we did in
the last
class

We started with

ACCOUNTING FOR
DEPRECIATION

 with Learning Objectives

Fixed Assets?
Depreciation?
Depreciation, Depletion, Amortization, and
Impairment?
Methods of Depreciation?
Accounting for Depreciation
Accounting Standards for Depreciation
Presentation and Disclosures?

We tried to understand Fixed

Assets
Fixed Assets are long-term assets and usually,
they have a life more than one year.
Fixed Assets are assets from which benefits are
to accrue in future or it provides a stream of
future benefits.
Fixed asset is an asset held with the intention
of being used for the purpose of producing or
providing goods or services and is not held for
sale in the normal course of business.

We appreciated difference between

Capital Expenditure
vs
Revenue Expenses

Cost of a fixed Assets includes

All those expenses necessary to incur to bring the
asset into operation or to have its commercial
operation.
The CUT-OFF point is the day of operation;
before that all expenses related to an asset have to
be capitalized; and after that all expenses have to
be treated as Revenue Expenses related to the
assets.
Before, Capital Expense

Day of Operation

After,
Revenue Expense

Accounting for Fixed Assets

Purchase and Other Expenses
We also learnt how to make entries for
the purchase of fixed assets and other
related expenses.

Where are they shown in the

books of accounts?

Depreciation

Please note that all fixed assets are

subject to Depreciation except freehold
land.
land

We tried to understand
Depreciation
Depreciation involves:

allocating the cost of tangible

assets to expense in a systematic and

rational manner to periods expected to
benefit from use of its depreciable assets.

We also tried to learn Why

Depreciation?
Fixed Assets are subject to
depreciation and thus, depreciation
needs to be provided so as to
Ensure allocation of original cost of a
fixed asset over its useful life;
Ascertaining the true cost of
operations; and
Providing current valuation of fixed
assets in the Balance Sheet.

Two things are

to be
remembered
about
Depreciation

1. Please disconnect in your mind Physical

Depreciation and Accounting Depreciation.
2. Depreciation is not a SOURCE OF FUND.

Now, lets move with Todays

Agenda

To begin with, lets understand completely the

nature of Depreciation

#1
All fixed assets except land lose their
capacity to provide services with passage
of time. This loss of productive capacity is
recognized

as

Depreciation

Expense

which is taken to Profit and Loss Account.

To begin with, lets understand completely the

nature of Depreciation

#2
The term Depreciation is used broadly in the following 2
senses:
ECONOMIC DEPRECIATION: It is economic loss due to both

1.

physical deterioration and technological obsolescence. It may be

PHYSICAL DEPRECIATION

FUNCTIONAL DEPRECIATION

ACCOUNTING DEPRECIATION: It is a systematic allocation of

2.

cost basis over a period of time. It may be

BOOK DEPRECIATION

TAX DEPRECIATION

Asset Depreciation
Economic Depreciation
the gradual decrease in
utility in an asset with
use and time

Depreciation
Accounting depreciation
The systematic allocation
of an assets value in
portions over its
depreciable lifeoften
used in engineering
economic analysis

Physical
Depreciation

Functional
Depreciation

Book
depreciation

Tax
Depreciation

Our next step

is

How to determine the amount of depreciation

each year so that it can be expensed to Profit
and Loss Account?

What are the

factors
determining the
depreciation
expenses?

Factor #2

Depreciation
Depreciation Expense
Expense Factors
Factors

Initial Cost

Residual Value

Factor #1

Depreciable Cost
Useful Life

1
F
a
c
t
o
r
#3

Factor#4:Method
Methodof
of
Factor#4:
determiningthe
the
determining
amountof
of
amount
Depreciation
Depreciation

Periodic Depreciation
Expense

Factors to Consider in Asset

Depreciation

Depreciable life (How long?)

Salvage value (Disposal value)

Cost basis (Depreciation basis)
Method of depreciation (How?)

Factor #1: Initial Cost

Initial Cost is the cost of
acquisition and including costs
incurred to make the asset
operational.

This cost is also called the

HISTORICAL COST.

Factor #2: Residual Value or Salvage

Value or Disposable Value
Residual Value is the estimated amount that will be
received at the time the asset will be sold or
removed from the services.

It is managements best estimate of what an asset

will be worth at the time of its disposable.

It is to be estimated at the time of determining the

amount of depreciation.

Depreciable Amount or Cost

Initial cost minus resale value is called the
Depreciable amount and it is this amount that has
to be allocated as depreciation over the estimated
life of an asset.
Depreciable Amount of a depreciable asset is
its historical cost, or other amount
substituted for historical cost in the financial
statements, less the estimated residual value.
This amount is also known as DEPRECIATION
BASE.
BASE

Factor #3: Estimated Life or Useful

Life
The assets estimated life is a measure of the service
potential that the current user may expect from the asset.
Many times, an asset physical life is taken as estimated life.
Useful life is either (i) the period over which a depreciable
asset is expected to be used by the enterprise; or (ii) the
number of production or similar units expected to be obtained
from the use of the asset by the enterprise.
Useful life of an asset should be determined based on
1.

Expected use of the asset

2.

Expected physical wear and tear

3.

Expected commercial or technical obsolescence

4.

Legal or other limits on the use of the asset.

Factor #4: Methods of

Depreciation
The following four depreciation methods are
acceptable for Financial Accounting purposes:

1. Straight-Line

2. Units-of-Production

3. Declining-Balance

4. Sum-of-Years-Digits

Straight-line is far more widely used than other

methods.
Declining-balance and sum-of-years-digits are
known as Accelerated Depreciation Methods.

Straight Line Method (SLM)

The Straight-Line-Method provides for
the same amount of depreciation
expense for each year of useful life.

Straight-Line
Straight-Line Method
Method
Cost estimated residual value
Estimated life
= Annual depreciation

Example
Example
Original
Original Cost.......
Cost....... Rs.24,000
Rs.24,000
Estimated
55 years
Estimated Life
Life in
in years..
years..
years
Estimated
Estimated Residual
Residual Value...
Value... Rs.2,000
Rs.2,000

Straight-Line
Straight-Line Method
Method
Rs. 24,000 Rs. 2,000
5 years
= Rs. 4,400 annual depreciation

Straight-Line
Straight-Line Rate
Rate
Rs.24,000 Rs.2,000
= Rs.4,400
5 years

Rs.4,400
= 18.3%
Rs.24,000

SLM Depreciation Amount and

Book Value

Straight-Line
Straight-Line Method
Method
The
The straight-line
straight-line method
method isis widely
widely used
used
by
by firms
firms because
because itit isis simple
simple and
and itit
provides
provides aa reasonable
reasonable transfer
transfer of
of cost
cost to
to
periodic
periodic expenses
expenses ifif the
the asset
asset isis used
used
about
about the
the same
same from
from period
period to
to period.
period.

Units-of-Production
Units-of-Production Method
Method
Cost estimated residual value
Estimated life in units, hours, etc.
= Depreciation per unit, hour, etc.

Example
Example
Original
Original Cost.......
Cost....... Rs.24,000
Rs.24,000
Estimated
10,000
Estimated Life
Life in
in hours..
hours..
10,000
Estimated
Estimated Residual
Residual Value...
Value... Rs.2,000
Rs.2,000

Units-of-Production
Units-of-Production Method
Method
Rs.24,000 Rs.2,000
10,000 hours
= Depreciation
per per
unit,hour
hour, etc.
= Rs.2.20

Units-of-Production
Units-of-Production Method
Method
The
The units-of-production
units-of-production method
method isis
more
more appropriate
appropriate than
than the
the straightstraightline
line method
method when
when the
the amount
amount of
of
use
use of
of aa fixed
fixed asset
asset varies
varies from
from
year
year to
to year.
year.

Declining-Balance
Declining-Balance Method
Method
Formula
Formula to
to calculate
calculate the
the
Depreciation
Depreciation Rate
Rate
ESTIMATED RESIDUAL VALUE
RATE OF DEPRECIATI ON = 1 COST OF ASSET
n

Rs. 2,000
RATE OF DEPRECIATI ON = 1 = 39.16%
Rs. 24,000
5

DBM Depreciation Amount and

Book Value

Physical Depreciation

Physical Depreciation occurs

from wear and tear while in use
and from the action of the
weather and environmental
conditions.

Functional Depreciation
Functional Depreciation occurs when a
fixed asset is longer able to provide
services at the level for which it was
intended, e.g., personal computer; that is
to say, when an asset life is mentioned in
terms of its usage, then we have a concept
of Functional Depreciation.

Book Depreciation
Book Depreciation is provided as per the
prevailing accounting standards and the
necessary law of land.

Tax Depreciation
Tax Depreciation is provided as per the
prevailing taxation laws.
laws