It is the reduction in the value of assets due to usage,
time, wear and tear, technological outdated or obsolescence, depletion, inadequacy, decay or other such factors. All fixed assets except the value of land decreases every year. Gradual decrease in the value of fixed assets is known as depreciation. objectives
To calculate proper profits.
To show the asset at its reasonable value To maintain the original monetary investment of the asset intact. Provision of depreciation results in some incidental advantages also. To provide for replacement of an asset. Depreciation is permitted to be deducted from profits for tax purposes. Causes of Depreciation
Internal causes: wear and tear, disuse,
maintenance, change in production, restriction of production, reduced demand, technical progress & depletion.
External causes: obsolescence and efflux
ion of time Factors in measurement of depreciation
Total cost of asset
Estimated useful service life or economic life The estimated turn-in (residual) value. Rate of depreciation
The rate at which an asset is depreciated in any methods
for computing depreciation. Scrap Value
It is associated with the depreciation of assets used in a
business. It is defined as the expected or estimated value of the asset at the end of its useful life. It is also known as salvage value or residual value. Methods of Depreciation
Straight line method
Reducing balance method Straight line method
In this method, depreciation is calculated by dividing the
total cost of the asset by the life of an asset and if an asset has any salvage value then the same has to be deducted from the original cost of an asset. The amount of depreciation will be same for each year, since depreciation is charged at fixed rate. Formula of Straight line method
Under this method, the same amount of depreciation is
charged every year throughout the life of the asset. The formula = Total cost of acquisition - residual value or scrap value
Estimated life
r =R/C * 100; r = depreciation rate
R = Amount of depreciation, C = Acquisition cost Problems
1) The initial cost of a machine and the scrap value are
Rs.40000and Rs. 4000 respectively. If the life is 9 years. Find the annual depreciation using straight line method. Solution: Depreciation = original cost scrap value life of an asset = 40000-4000 9 = 36000 9 = 4000 2) The cost of the machine is Rs. 17000 its salvage value is Rs. 2000 and its estimated useful life is 5 years. find depreciation under straight line method. Solution: Depreciation= cost of an asset- salvage value estimated life of an asset = 17000-2000 5 = Rs. 3000 per year 3) If office furniture purchased on Jan 2 for Rs. 8100 and estimated useful life of 6 years and a trade-in-value of Rs. 750. what is the book value at the end of the fifth year? Solution: Depreciation= cost of an asset- salvage value estimated life of an asset = 8100 750 6 = 73560 6 = Rs. 1225 per year Depreciation at the end of 5th year
Depreciation = 1225*5 = 6125
Book value at the end of 5th year
Book value= cost of an asset depreciation
= 8100 6125 = 1925 4) Determine the depreciation rate per year for an estimated useful life of (a) 10 years (b) 50 years (c) 8 years (d) 5 years
(e) 16 years (f) 20 years
Solution: Depreciation rate per year =100% estimated life (a) 100/ 10= 10% (b) 100/50 = 2% (c) 100/8 = 12 % or 12.5% (d) 100/5 = 20% (e) 100/16 = 6 % or 6.5% (f) 100/20 = 5% 5) Determine the - (a) depreciation rate (b) yearly depreciation (c) book value after 10 years of building that cost Rs. 100000 on Jan 7 after its estimated useful life of 25 years, the salvage value is Rs. 20000. Solution: (a) depreciation rate = 100% estimated life = 100/25 = 4% (b) Yearly depreciation = ( cost salvage)* depreciation rate per year = (100000 20000) * 0.04 = 80000 * 0.04 = Rs. 3200 per year
(c) Book value after 10 years
depreciation at the end of 10 year = 3200 * 10 = Rs. 32000 Book value = cost depreciation = 100000 32000 = Rs. 68000 Problem .6
What is the amount of depreciation at the end of the
second year, if a piece of equipment was purchased on July 24 for 1300, its estimated useful life is 8 years, and trade in value is 100. Solun: Depreciation= cost of an asset- salvage value estimated life of an asset = 1300 100 8 = 150/year PROBLEM NO.3
Original cost- 1,10,000
Depreciation value- 6000 For 5 years Soln : let d be the rate of yearly depreciation 6000 = 1,10,000 (1-d)^5 (1-d)^5 = 6000/1,10,000 = 6/110 = 3/55 (applying log on both the sides) log (1-d)^5 = log (3/55) 5log (1-d) = log 3 log 5 Prob 3 contd..
150/12= 12.5/month 12.5*5 months=62.5 for first year 62.5*150= 212.5 depreciation at the end of second year. Reducing balance method
In this method, depreciation is charged at fixed rate on the
reducing balance of an asset after deducting depreciation of every year out of the cost of fixed assets.
It is also known as diminishing balance method or written
down value method or declining value method or book value method.
The balance in the asset account will go on decreasing but
will never become zero. Reducing balance method
The Annual amount of depreciation will not remain fixed
or equal.
It gradually decreases since, the current value of the asset
decreases every year. Problems
6. The initial cost of machine is Rs. 15000 and it
has a life of 5 years. Find annual depreciation using sum of the year digit method. Solution: depreciation = n(n+1)/2 = 5(5+1)/2 = 15 first year =5/15 = 0.3333% (0.3333*15000) = 5000 Second year= 4/15= 0.2667% = 4000 Third year= 3/15= 0.2% = 3000 Fourth year=2/15=0.1333 =2000 Fifth year= 1/15=0.0667 = 1000 Problem.1
7. A machine is purchased for Rs. 350000. its subject to
depreciation at the rate of 6% for first three years and thereafter at the rate of 8% for two years. Find value of machine at the end of five years. Solution: c= 350000 rate of depreciation= 6% for three years rate of depreciation = 8% for two years Cost of machine after 5 years = 350000(1-6%)3 (1-8%) 2 = 350000 ( 0.8305) (0.8464)