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Depreciation

Meaning :- Fall in the value and utility of such assets due to their constant use and expiry of time . Definition :- Depreciation may be defined as the permanent and continuing diminution in the quality, quantity or the value of an asset. William Pickles

Features of depreciation
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3. 4.

5.

6.

Depreciation is decline in the value of fixed asset (except land). Such fall is of permanent in nature . Once the value of an asset is reduced as depreciation, it cannot be restored. It is gradual and continuing process. It decreases only the book value of the asset, not the market value. It is used only in the respect of tangible fixed assets. Not used in case of wasting assets. It is a non cash expenses. Not lead to cash outflow..

Causes of depreciation
1.

2.
3. 4. 5. 6. 7.

By By By By By By By

constant use. expiry of time. expiry of legal rights. obsolescence. accident. depletion. permanent fall in market price..

Methods of providing depreciation

1. 2. 3. 4. 5. 6.

7.
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Fixed Instalment Method. Diminishing Balance Method. Annuity Method. Depreciation Fund Method. Insurance Method. Revaluation Method. Depletion Method. Machine Hour Rate Method..

Fixed Instalment Method

This is also known as original cost method, equal instalment method, and straight line method. Under this method depreciation is calculated by deducting the scrap value from the original cost of the asset and then dividing the remaining balance by the no of years of the estimated life. The calculated depreciation is charged annually will reduce the original cost of the asset to zero, or its scrap value.

Original cost of asset estimated scrap value

Yearly Depreciation :Estimated life of asset

For example :-original cost of the asset is 5,00,000. and scrap value is 1,00,000. after estimated life of 10 yrs.

Yearly Depreciation :-

5,00,000 1,00,000 10

= 40,000

Merits of Fixed Instalment Method

1.

2.
3.

Simplicity. Equality of depreciation. Assets can be completely written off..

Demerits of fixed instalment method

1.

2.
3. 4.

5.

Difficulty in computation. Unequal charge against income. Undue pressure in later years. Unrealistic to write off the value of asset to zero. Difficulty in determination of scrap value..

Diminishing Balance Method

It is also known as Reducing Instalment Method, Written Down Value Method. Under this method, as the value of asset goes on diminishing year after year, the amount of depreciation also goes on declining.

For example :-If a machine is purchased for Rs 10,000 and depreciation is to be charged at rate of 10 %.

1st year on Rs. 10,000 @ 10% 2nd year on Rs. 9000 (10,000 -1000 ) = 9000 X10

= 1000 = 900

100
3rd year on Rs. 8100 ( 9000 -900 ) = 7290 X 10 100 = 810

and in the same way so on

Merits of Written Down Method

1.

2.
3. 4.

5.

Easy calculation. Equal charge against income. No undue pressure in later years. Balance of asset is never written off to zero. Approved method by Income Tax Authorities..

Demerits of Written Down Value Method

1.

2. 3.

Asset cannot be completely written off Omission of Interest factor Difficulty in determining the rate of depreciation

Difference between the two methods

Fixed Instalment Equal dep. is charged every year Book value of asset reduced to zero Combined burden on account of depr. and repairs is lighter in earlier years and heavier in later years This method is not approved by Income tax authorities.

1.

1.

2.

2.

3.

3.

Diminishing Balance Method Dep. goes on decreasing every year Book value of asset cannot be zero Combined burden on account of depr. and repair will be almost equal over different years

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4.

This method is approved by Income Tax authorities.