ACCOUNTS HONOURS

DEPRICIATION POLICY

PRESENTED TO:-MAM sangam kapoor

Topics Coveredo Meaning of Depreciationo Why is Depreciation important?o Depreciation is an Estimate o Methods of Depreciationo Depreciation under Companies and

Income Tax Acto Recording of Depreciation

DEFINITIONS OF DEPRECIATIONThe term depreciation is derived from the

Latin words ‘do’ meaning down and ‘pretium’ meaning price. It means putting

down the value of an asset due to wear and tear , passage of time, obsolescence, etc.

According to Malchman and Slavin ‘ Depreciation refers to the process of

estimating and recording the periodic charges to expense due to expiration of the

usefulness of a capital asset”

According to J.N. Carter, “Depreciation is the gradual and permanent decrease in the value of an asset from any cause.”

According to J.R. batiliboi , “Depreciation represents loss or diminution in the value of an asset consequent upon wear and tear , passage of time, obsolescence, or fall in the market value.”

The institute of chartered Accountants of England and Wales has described depreciation as thus :

“ Depreciation represents that part of the cost of fixed assets to its owner which is not recoverable when the asset is fully put out of use by him.

From the above definitions it is clear that depreciation is the gradual , continuing and permanent fall in value of fixed assets .

The main cause for this fall in value are wear and tear, passage of time, obsolescence, or fall in the market value, inadequacies, depletion etc.

In recent editions of English language dictionaries the word depreciation has been described as decline in the value of an asset due to such causes as wear and tear , passage of time, obsolescence and inadequacy.

CHARATERISTICS OF DEPRECIATION

The Depreciation charged on fixed assets has the following features:

Depreciation is always a fall in the value of asset.

This fall is always gradual. The fall is of permanent character and it

cannot be recouped afterwards. The depreciation is a continuous process

and it does not matter whether the asset was put to use during the period or not.

Depreciation is always on fixed assets and not on current or floating assets .

NOTE - Fixed assets are those assets which are of material value not meant for resale and having fairly long life and are used in business . With the exception of LAND all fixed assets have a limited useful life such as plant and machinery ,furniture , motor van and building.

Depreciation is the fall in the book value of the asset not in market or exchange value.

Depreciation is the result of the use of assets, passage of time and obsolescence.

CAUSES OF DEPRECIATION

1. Use of the asset or wear and tear

2. Accident3. Expiration of Certain Legal

Rights4. Obsolescence5. Inadequacy6. Depletion

NEED FOR PROVIDING DEPRECIATION

The providing of depreciation on fixed assets is important because of the following:

To know the true Profit or Loss: The depreciation is an expense though not payable to any outside party and does not involve outflow of funds. But even then when the fixed assets are put to use I the business , the toss in their value must also be acknowledged to know the true profit or losses .as per matching principal of accounting all costs must be recorded whether paid or not which are incurred to earn revenue.

To show true and fair view of financial position: The correct financial position of a business is depicted by balance sheet. While preparing balance sheet it is necessary that fixed assets are shown at figures derived after deducting depreciation from their book values. If not ,fixed assets might be over stated and balance sheet may not show true and fair view of financial position.

To provide funds for replacements of assets .

Depreciation is a source of funds for replacements of assets . After useful life , sufficient funds will be required at the deposal of the firm if proper depreciation provision are made otherwise firm may face financial difficulties for replacement after the assets become useless.

Concept of depreciation accounting

The growing importance of depreciation accounting in the twentieth century may be attributed to several factors as follows:

With the growth of mechanization in production , depreciation has become a sizeable amount affecting the cost of production.

Capital budgeting also needs the determination of proper amount of depreciation . A considerable amount of capital is required for the replacement of old assets at the end of their useful life.

The fluctuations in prices of assets at the end of their useful life.

The technological developments have increased the incidence of obsolescence of assets.

Basic factors in estimating DEPRECIATION

To determine the amount of depreciation of a fixed asset, the following factors are to be taken into consideration:

1. Cost of the asset ; 2. Useful life of the asset ;3. Salvage value ;4. Method of depreciation

Cost of Asset: The cost of the asset includes all reasonable expenses that are incurred to bring the asset in a workable condition.

Useful life of the Asset: The determination of the useful life of an asset is of great importance because it is the useful life over which the whole cost of the asset is to be written off by way of depreciation. The useful serviceable life is estimated either from depreciation rates by income tax authorities or from opinions of engineers or experience with similar assets.

Salvage value : it is the amount that can be recovered from the sale of the asset after the expiry of its useful serviceable life. In those cases where this amount is insignificant, it is ignored altogether but when this amount is quite substantial, the depreciation is calculated on net cost of the asset, that is original cost less salvage value.

Depreciation is the value of wear and tear of a fixed assetSuch a value is calculated as:

Cost of the Fixed Asset — Estimated Scrap ValueEstimated Life of the Asset

Depreciation is an Estimate

METHODS OF DEPRECIATION

1. Fixed installment or straight line method

2. Diminishing balance method3. Annuity method4. Depreciation fund method5. Insurance Policy method6. Depletion method7. Machine Hour Rate method

FIXED INSTALMENT OR STRAIGHT LINE METHOD

Fixed installment method is also know as straight line method or original cost method. Under this method the expected life of the asset or the period during which a particular asset will render service is the calculated. The cost of the asset less scrap value, if any, at the end f its expected life is divided by the number of years of its expected life and each year a fixed amount is charged in accounts as depreciation. The amount chargeable in respect of depreciation under this method remains constant from year to year. This method is also know as straight line method because if a graph of the amounts of annual depreciation is drawn, it would be a straight line. FORMULA: Annual Depreciation = [(Cost of Assets - Scrap Value)/Estimated Life of Machinery]

MERITS OF FIXED INSTALMENT METHOD:

1. SIMPLE: It is very easy method of providing depreciation and the calculations are very simple.

2.ASSET IS FULLY WRITTEN OFF: life. According to this method, the asset account is written off fully at the end of its working 3. KNOWLEDGE OF TOTAL DEPRECIATION CHARGED: The amount of total depreciation charged to profit and loss account can be easily ascertained by multiplying the annual instament of depreciation with the number of years , the machine has been used.

4. SUITABLE FOR FIXED LIFE ASSET: This method is very suitable for those assets which have a fixed working life e.g. furniture etc.

DEMERITS:

1. INTEREST ON CAPITAL: The interest on capital invested in fixed assets is ignored under this method also, with the result profits are overstated.

2. NO FUNDS FOR REPLACEMENT: This method does not solve the problem of availability of funds at the time of replacement of assets.

3. ASSET IS NOT REDUCED TO ZERO: The value of asset under this method is never reduced to zero.

4. RATE OF DEPRECIATION: It is difficult to calculate the rate of depreciation under this method.

1.

Depriciation a/c Dr. TO Asset a/c(Being depriciation charged to asset)

Profit and loss a/c Dr. To depriciation a/c (Being the dpriciation charged transferred to P/L a/c.

Same entries are to be passed each year during the life of asset and at the end of last year following entry would be passed. Bank a/c Dr. To asset a/c (Being the scrap of asset sold)

Journal Entries:The journal entries that will have to be made under this method are very simple. The journal entries will be as under:

On 1st January 1991 X purchased a machinery for $21,000. The estimated life of the machine is 10 years. After it its break up value will be $1,000 only. Calculate the amount of annual depreciation according to fixed installment method (straight line method or original cost method) and prepare the machinery account for the first three years.

Dr. Cr.

DATE PARTICULARS AMT. DATE PARTICULARS AMT. 1/1/91 To Bank a/c 21000 31/12 By machinery a/c 2000 By balance c/d 19000 21000 21000

1/1/92 To bal . b/d 19000 31/12 By depriciation a/c 2000 By balance c/d 17000 19000 19000

1/1/93 To bal b/d 17000 31/12 By depricition a/c 2000 By balance c/d 15000 17000 17000

EXAMPLEMachinery Account

Machinery Account

DEPRECIATION FUND METHOD

Depreciation fund method is also know as sinking fund method or amortization fund method. Under this method, a fund know as depreciation fund or sinking fund is created. Each year the profit and loss account is debited and the fund account credited with a sum, which is so calculated that the annual sum credited to the fund account and accumulating throughout the life of the asset may be equal to the amount which would be required to replace the old asset. In order that ready funds may be available at the time of replacement of the asset an amount equal to that credited to the fund account is invested outside the business, generally in gilt-edged securities. The asset appears in the balance sheet year after year at its original cost while depreciation fund account appears on the liability side.

31 December PARTICULARS £

Original machine cost 75,0002013 Depreciation in 2013 (40% cost) 30,000

Written down value at 31 December 20X3 45,000

2014 Depreciation in 2014 (40% of WDV @ 31 December 2013) 18,000

Written down value at 31 December 2014 27,000

2015 Depreciation in 2015 (40% of WDV @ 31 December 2014) 10,800

Written down value at 31 December 2015 16,200

2016 Depreciation in 2016 (40% of WDV @ 31 December 2015) 6,480

Written down value at 31 December 2016 9,720

2017 Depreciation in 2017 (40% of WDV @ 31 December 2016) 3,888

Written down value at 31 December 2017 5,832

EXAMPLE