Amity Business School

Amity Business School

MBA Class of 2015,
Semester I

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.
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Plant
Assets
Natural
Resources
Intangible
Assets
Depreciation Depletion Amortization
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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
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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
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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

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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
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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.
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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.
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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.
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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.
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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