Depreciation accounting.pptx

7/29/2019 Depreciation accounting.pptx

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Fixed Assets andDepreciation Accounting

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Correct perspective of long term

assets or fixed assetsThey have a useful life of more than a year

They are used in the operations of

business

They are not intended for resale to

customers.

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Fixed Assets Accounting

Accounting for fixed assets involves dealing

with following questions:

1. Determination of cost of acquisition of

fixed assets

2. Allocation of cost of fixed assets over its

estimated life

3. Accounting of disposal of fixed assets.

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Cost of acquisition

Cost of a fixed assets comprises its purchase

price, import duties and taxes on purchase and

any other directly attributable costs of bringing

the asset to working conditions for its intendeduse.

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Following expenditures relate to the import of a

chemical plant:

1. Customs duty on the plant

2. Clearing charge paid to the port trust.

3. Demurrage for delay in clearing the

consignment

4. Freight5. Transit Insurance

6. Repairs of some part damaged while the plant

was unloaded at the port.LECTURE 6 5


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Some related aspects

Capitalization of Borrowing Costs: Interest

paid in connection with the loan paid to

acquire any fixed assets is added to the

cost of that particular fixed asset till thepoint of commencement of production. .

Such expenditure will be treated as

revenue expenditure after commencementof production.

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Basket Purchases

Some times a group of fixed assets may be

purchased at a single lump sum price. In

that case the total purchase price would

be allocated among the various assets onthe basis of their relative fair value. This

fair value is usually determined by

professional valuers.

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For example if a firm pays Rs 2,50,000 for a

building as well as land on which it is

situated, how much should be taken as

value of building and how much should betaken as value of land when the expert

valuer fixes the market value of building at

Rs 280000 and that of land as 120000.

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Depreciation

Definition

Difference between Depreciation,

Depletion ,Amortization

Basic Features of Depreciation

Causes of Depreciation

Objectives of providing DepreciationFactors affecting the amount of

depreciation

Methods of Recording DepreciationLECTURE 6 9


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Depreciation

Depreciation is the gradual and permanent

decrease in the value of asset from any

cause: By Carter

Depreciation may be defined as the

permanent and continuous diminution in

the quality, quantity and value of an asset:

By William Pickles

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Features of Depreciation

The term depreciation is used only in

respect of fixed assets

Depreciation is a charge against profits

Depreciation is different from maintenance

Decrease in value of assets is permanent

and perpetual.

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Causes of Depreciation

Wear and tear

Exhaustion

ObsolescenceEfflux of time

Accidents

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Depletion: This term is used in relation to

natural resources such as mines, oil wells

etc

Amortization: This term is usually used in

respect of intangible assets like patent ,

copyrights, goodwill etc.

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Depreciation Accounting

Depreciation accounting is a system of

accounting which aims to distribute cost or

other basic value of a tangible fixed assets

less salvage value (if any) over theestimated useful life of that particular asset

in a systematic and rational manner.

It is process of allocation and not valuation.

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Objectives of Providing

DepreciationAscertainment of true profits

Presentation of true financial position

Replacement of assets

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Factors affecting the amount of

DepreciationCost of the assets

Estimated scrap Value

Estimated useful life

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Cost of the asset: This is the cost

incurred in making asset available for use

at the first instance. This amount is

specific and known at the time ofacquisition of the asset.

Salvage value: This is the expected sales

value of the asset at the end of its usefullife.

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Useful life: It is the period for which the

asset can be used for production.

Depreciable Cost: This is the original cost

of the asset less its salvage value.

Book Value: It is the original cost of the

asset less depreciation to date. This is

also known as WDV .

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Method of recording

DepreciationDepreciation can be recorded in the books

of accounts by two different methods:

1. when a provision of depreciation account

is maintained

2. When a provision of depreciation

account is not maintained.

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Methods for providing

depreciationStraight Line Method or fixed installment method

Reducing Balance Method

Some other methods

Depletion method

Sum of years digits method(SYD) method

Machine Hour rate method

Group Depreciation method

Depreciation or Sinking Fund method

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Fixed Installment method or

Straight line method

According to this method the amount of

depreciation is calculated as follows:

Depreciation= cost of asset- scrap value

Life of asset

Depreciation to be charged can also be expressed

as percentage of cost.

R = D*100C

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For example, an asset has been purchased

for Rs 10,000 and it will have a scrap

value of Rs 1000 at the end of its useful

life of 10 years the amount of depreciationto be charged every year :

Depreciation = 10000-1000

10 years

= Rs 900 each year or 9%

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Merits:

This method is simple to understand and easy to

apply.

Demerits:

1. This method does not takes into account the

effective utilization of assets

2. Total charge for the use of assets goes onincreasing from year to year thought he asset

might have been used uniformly from year to

year.

. LECTURE 6 23


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Diminishing Balance Method

This method is also called as Reducing

balance method.According to this method

depreciation is charged on the book value

of assets each year.

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For example if the cost of an asset is Rs

20000 and the rate of depreciation is10%,

the amount of depreciation to be charged

in the first year will be Rs 2000.

In the second year depreciation will be

charged at 10% on the book value of

asset( Rs 18000) and so on.

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Advantages:

Total charge for the use of assets remain

constant each year.This method is also simple to understand

and easy to use.

Demerits: It is difficult to calculate therate of depreciation

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Depletion Method

This is also known as productive output method.

According to this method the charge of

depreciation will be based on the following

factors:1. Total amount paid

2. Total estimated quantities of output available

3. Actual quantity taken out during the accountingyear.

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For example if a mine is purchased for Rs

20,000 and it is estimated that the total

quantity of mineral in the mine is 40,000

tonnes, the rate of depreciation per tonnwould amount to 50 paise per tonn. In

case the output in a year amounts to

10,000 tonnes, the amount of depreciationto be charged to Profit and loss account

would be Rs 5000.

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Suitability: this method is suitable where the life

of the asset can be estimated in terms of output.

Eg. Ore deposit, oil deposit

Advantages: Here the amount of depreciation iscorrelated to the productive use of asset

Disadvantages: It requires making of a

reasonably correct estimate of the amount of

likely output otherwise amount charged by way

of depreciation will not be correct.

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Sum of years digits method

This method is on the pattern of Diminishing

Balance Method. The depreciation is

calculated according to the following

formula:Remaining life of asset(including current year)* cost

Sum of all the digits of the life of the asset in years

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For examples, if the cost of an asset is Rs 10,000 and it

has an effective life of 5 years, the amount of

depreciation to be written off each year will be:

1st year = __ 5_____ *10,000

1+2+3+4+5

= 5 *10000 =Rs 3,333

15

2nd year = _4__ * 10,000 = Rs 2,666

15

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Machine hour rate method

Also known as Service hours method. This

method takes into account the running

time of asset for the purpose of calculating

depreciation. Amount of depreciation iscalculated as follows:

Original cost of asset- scrap Value

Life of asset in hours

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For example, if a machine having a scrap value of Rs 1000

is purchased for Rs 20,000 and has an effective life of 10

years of 1,000 hours each, the amount of depreciation

per hour will be computed as follows:

Depreciation = original cost- scrap value

Life of asset in hours

Rs 10000- Rs 1000 =

10,000 hours

Re .90

If the machine runs for 600 hours the amount of

depreciation will be 540,( Re 0.90*600)

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Advantages: This method has the

advantage of correlating the charge for

depreciation to the actual working time.

Disadvantages: This method can only be

used in case of assets whose life can be

measured in terms of working time.

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Group Depreciation Method or

Block Depreciation methodUnder this method all assets, generally

having similar average life expectancy are

grouped together as a single block.

Depreciation is charged for the group in total

and not item by item.

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Depreciation or Sinking Fund

Method.According to this method, the amount

charged by way of depreciation is invested

in certain securities carrying a particular

rate of interest. The amount received asinterest is also invested along with the

annual amount charged by way of

depreciation. At the end of the life of theasset, securities are sold away and money

realized is used to purchase of a new

asset. LECTURE 6 36


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Selection of a suitable

depreciation methodAS 6 does not specifies the method of allocation

used by the management.

Ideally method chosen should go according to

the concept of periodic matching of cost andrevenue.

Practically the factors like simplicity, savings in

record keeping costs, tax laws and legal

requirement influence the choice of method.

Companies Act, 1956 permits to choose

between SLM and WDV method.

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Change in the method of

depreciationTwo different situations:

1. Change in the method of depreciation

may be desired from the current year on

wards(prospective change).

2. Change in the method of depreciation

may be desired from a back date

(retrospective Change).

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Accounting for disposal of fixed

assetsWhen assets becomes useless, they are

scrapped(discarded), sold or exchanged

for new assets.

On disposal, the cost as well as

accumulated depreciation is removed from

the books.

Disposal value is very rarely equal to itsbook value , so gain or loss on disposal

needs to be recognized.

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Depreciation accounting.pptx