Depriciation - Final

7/31/2019 Depriciation - Final

1/29

DEPRECIATION

By

Ibrahim Mulla

Sunay Khaire

Shilpi Jajodia

Vikas Chhabria


2/29

Definition

The allowance for WEAR and TEAR ofany Capital Asset either caused due tousage or passage of time.

Amount ofdecreasing value in a capitalasset allowed to be deducted from abusiness tax return.

Cost Recovery.


3/29

What Can Be Depreciated?

You can DEPRECIATEASSETS only if it meetsthe following requirements: It is used in business or held for the production

of income.

It must be expected to last for more than oneyear. In other words, it must have a useful lifethat extends substantially beyond the year itwas placed in service.

It is Assets that wears out, decays, gets used up,

becomes obsolete, or loses value from naturalcauses.

Depreciable Assets can be either tangible orintangible.


4/29

Tangible Depreciable Asset

Purchased assets you can see or touch.

Livestock (purchased).

Machinery.

Buildings and improvements, fences. Dams, ponds, or terraces.

Irrigation systems and water wells.

Partial business use.

-You can claim depreciation on the part of a vehicle

used in the business (ex - 1/2 business value of a

truck).


5/29

Intangible Depreciable Asset

Purchased assets that has value that you

cannot readily see or touch.

Computer Software.

Copyrights, patents, trademarks etc.


6/29

What Cannot Be Depreciated?

Assets placed into service and disposed ofin the same year.

Land (land can never be depreciated).

Inventory. You cannot depreciate property held for resale

in the normal course of business.

Leased property. The value of the lease is already showing up as

a rental expense. Raised Market Livestock (Because there is

no cost to recover).


7/29

When Depreciation Begins & Ends?

Begins

When you place the assets in service.

When it is ready and available for a specific use in thebusiness.

Example When it was bought for the business.

Ends

When the cost of the item has been recovered or when it

is retired from service, whichever happens first.

Example

When it is sold or is not longer useable.


8/29

Factors In Computing Depreciation

Cost (Historical Cost, Original Cost )

All costs viz acquisition, installation ( wages),transportation, legal expenses for registration ofsale/ lease agreement, improvement, additions etcwhich are incurred before the asset is brought intouse. May include training cost.

Useful Life

Estimate of the expected life based on need for

repair, service life, and vulnerability to obsolescenceviz. lease period, level of use, degree ofmaintenance and technological development.USEFUL LIFE IS SHORTER THAN PHYSICAL LIFE (trueeven for human beings).


9/29

Factors In Computing Depreciation

Salvage / Residual Value

Estimate of the assets realizable value at

the end of its useful life/ commercialuse.

Other Relevant Factors

Replacement cost

Provision ofCompanies Act , Income TaxAct.


10/29

Recurring Costs

Recurring costs such as licenses and

insurance for an asset are NOTincluded

with the assetinstead, they are charged

as EXPENDITURE.


11/29

Depreciable Amount

Depreciable amount means historical costless estimated residual value.

Example

Cost of Asset is $5,00,000, ERV is $25,000. Then,The Depreciable Amount will be $5,00,000 $25,000 i.e. $4.75,000.

The depreciable amount of a depreciableasset should be allocated on a systematicbasis to each accounting period during theuseful life of the asset.


12/29

Depreciation on

Addition/Extensions

Any addition or extension which becomes anintegral part of the existing asset should bedepreciated over the remaining useful life of thatasset. The depreciation on such addition or

extension provided at the rate applied to theexisting asset.

Where an addition or extension retains a separateidentity and is capable of being used after the

existing asset is disposed of, depreciation shouldbe provided independently on the basis of anestimate of its own useful life.


13/29

Causes Of Depreciation

Time Element Lease, patents, copyrights lose their value or

effectiveness. Amortization is a better word for

the gradual fall in their values.

Abnormal Events

Accident, fire, natural calamity may reduce

effectiveness.


14/29

Methods of Depreciation

Fixed / Equal Installments OR Straight LineMethod A fixed portion of the cost of a fixed asset is

allocated and charged as periodic depreciation.

Using this method, depreciation is measured only bytime.

Depreciation amount is the same for each year ofthe assets useful life.

Such depreciation becomes an equal amount ineach period.

Depreciation = (V-S)/n , Where,- V= Cost of the Asset.

- S= Residual value or the expected scrap value.

- n= estimated life of the asset.


15/29

Straight-Line Method Example

= Depreciation per year(Cost Salvage value)

Years of useful life

= $5,900($30,000 $500)5


16/29


Reducing / Diminishing Balance Method OR

Written Down Value Method

Depreciation is calculated at a fixed percentage

on the original cost in the first year. But insubsequent years it is calculated at the same

percentage on the written down values

gradually reducing during the expected working

life of the asset.

The rate of allocationis constant (usually a fixed

percentage) but the amount allocated for every

year gradually decreases.


17/29


Sum ofYears Digit Method It is a revised form ofReducing Balance Method.

Here also the working life of an asset has to be pre-estimated and Total Depreciation is considered as Cost ofthe Asset () Residual or Scrap Value.

The amount ofannual depreciation goes on decreasingwith the use.

For calculating depreciation, the denominator becomesthe sum of the digits representing the life of the asset.Thus if an asset has a life of5 years, the denominatorshould be 1+ 2 + 3 + 4 + 5 or 15.

Depreciation= (Remaining Life of the Asset x Depreciable Amount)

Sum of the Years Digit

- Where, Depreciable Amt = Cost of Asset Estimated Scrap Value

- Sum of the Years Digit = n(n+1)/2

- n = estimatedlife of the asset


18/29

Sum of Years Digit Method Example

If an asset costs $50,000, it has a residual

value of$5,000 and working life of5 years,

the depreciation will be:

1st year 5/15 of (50,000 5,000) or $15,000; 2nd year 4/15 of (50,000 5,000) or $12,000;

3rd year 3/15 of (50,000 5,000) or $9,000;

4th year 2/15 of (50,000 5,000) or $6,000;

5th year 1/15 of (50,000 5,000) or $3,000


19/29


Double Declining Balance Method Depreciation is charged at a fixed rate and it is

calculated on the written down value of anasset brought forward on the opening date ofan accounting year.

The Rate of Depreciation becomes the doubleof the rate under fixed installment method.

It may be illustrated as follows:- Original Cost of an Asset 2,20,000, Scrap Value

(Estimated) 20,000 ,Working Life (Estimated) 5 years

Total Depreciation= $ 2,20,000 $ 20,000 =$ 2,00,000

- Annual Depreciation

= $ 2,00,000 /5 =$ 40,000

- Rate of Depreciation under Straight Line Method= $ 40,000 100

= $2,00,000, = 20%


20/29

Double Declining Balance Method

Example

1st

YearLess 40%

Opening cost

Depreciation

$2,20,000

$88,000

2nd

YearLess 40%

Opening bal

Depreciation

$1,32,000

$52,800

3rd

YearLess 40%

Opening bal

Depreciation

$79,200

$31,680

4th

YearLess 40%

Opening bal

Depreciation

$47,520

$19,008

5th

YearLess 40%

Opening (-)

Depreciation

Scrap Value

$28,512

$8,512

$20,000


21/29


= Cost per Unit(Cost Salvage value)

Total units of Activity

= $0.295 per mile($30,000$500)

10000 miles

Depreciation if truck driven 15000 miles in 2010

Expense = (Cost per mile) x (# miles)

= 0.295 x 15000

= $4,425 Depreciation

Mileage Method/ Working Hours/ Service

Hours Method


22/29


Sinking Fund Method Annual depreciation is considered as a source of

providing the replacement cost of an asset. It becomes ameans ofmaintaining capital.

D = C X i .

(1+i)n

- 1- D = Depreciation- C = Cost of the asset

- I = Rate of Depreciation

- n = Life of the asset

No investment is made in the last year as the investments are tobe soldout.

Sinking Fund Account may be called Depreciation Fund Accountalso. It is to be shown on the liability side of Balance Sheet.

Sinking Fund Investments Account may be called DepreciationFund Investments Account also. It is to be shown on the Assetside of the Balance Sheet.

Annual Contribution (charged in lieu of annual depreciation)

= Original Cost x Present Value of Re. 1 at given interest rate.


23/29

Sinking Fund Method Example

Cost of an Asset $40,000, Life:4 years, Depreciation 10%p.a.

Under Sinking Fund Method:

Annual Depreciation = C x i .

(1+i) n -1

= $40,000 x 10

(1+10) 4 -1

= $8619

This amount shall be invested at the end of years 1,2and 3. The amount ofinvestment shall fetch 10%

interest p.a. which will lead to accumulation of$40,000at the end of the 4thyear.

The amount of$8,619 shall not be invested at the endof the 4th year.


24/29


Annuity Method Cost of an asset is considered to be an

investment. Such investment would earninterest if invested outside the business.

D = C i (1+i)n

(1+i)n -1

- D = Depreciation

- C = Cost of the asset- I = Rate of Depreciation

- n = Life of the asset


25/29

Annuity Method Example

Creation Of Internal Reserve Example:

Cost of an Asset $40,000, Life:4 years,Depreciation 10% p.a.

Under Annuity Method:

Depreciation = 40000X 10%X1.4641 = $12,6191.4641-1

In case ofAnnuity Method, the amount of$12,619 shallnot be invested outside the business.

It shall have to be taken as an yearly appropriation. Thetotal amount to be appropriated over a period of4 years= $12,619 x 4 = $50,476.

Cost of Capital = Total Appropriation - Actual Cost of theAsset = $50,476 - $40,000 = $10,476.

S mmar of Wisdom


26/29

Summary of WisdomDepreciation for asset includes tangible and intangible assets

True

False

Cost of insurance or renewal of license is part of depreciation

True

False

We can depreciation extension or deletion of asset, which becomes

an integral part of the asset.

True

False

Depreciation on an asset effect profit and loss of the company firm

True

False

S f i d


27/29

To compute depreciation on an asset, we should

know the three items form the below list.

Original total cost of the asset.

Cost of replacement for the asset.

Estimated useful economic life of the asset.

Estimated scrap or residual value of the asset.

Gradual fall in the value or effectiveness with time of

the intangible asset is also termed as

Immortalize

Amortize

EMI

Degradation.

Summary of Wisdom

S f Wi d


28/29

This method of depreciation is also termed as

Source of replacement cost

Sinking fund method

Single line method

Double declining method

Reducing balance method

This method of depreciation is also termed as

Investment

Annuity method

Single line method

Double declining method

Reducing balance method

Summary of Wisdom


29/29

THANK YOU!!

Depriciation - Final

Documents

Transcript of Depriciation - Final