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INSTRUCTOR:
Prof. (Dr.) Paresh ShahF.I.C.W.A.,Ph.D.(Finance).,F.D.P.(IIMA)
FIXED ASSETS AND
DEPRECIATIONACCOUNTING
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IDENTIFICATION OF FIXED
ASSETS Fixed assets are long-term assets whose
usefulness in the operation of the f irm is
lik
ely to ex
tend beyond one accounti
ngper iod. They are not for resale
It is an expenditure on asset, which is not
written off completely against income in
the accounting period in which it is
incurred
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DETERMINING THE COST OF A FIXED
ASSET OR ACQUISITION COST OF A
FIXED ASSET The gross book value of an asset is the
histor ical cost or the cost at which the
asseti
s actually acqui
red. The cost of an asset compr ises the
purchase pr ice (including import duties
and other taxes or levies) and any directly
attr ibutable cost of br inging the asset to
the wor king status.
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Particulars Amount Rs.
Purchase price of the asset
Add: Import duties
Octroi duties
Loading and Unloading Expenses
Installation and commissioning expenses
Erection Expenses
Technical consultancy fees
Less: Trade Discount
Cost of a Procured fixed asset
DETERMINATION OF COST OF A PROCURED FIXED ASSET
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REVALUATION OF ASSETS
Fixed assets may be restated in value,
with the help of appraisal undertaken by
competent and approved valuers. Suchchange in the value of the assets is called
revaluation.
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DEPLETION COST
Depletion is the portion of the cost of
natural resources that is allocated to
extraction or production of the resourcesover time
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Depletion rate per = Acquisition and Development costs ± Residual value
unit of production Estimated recoverable units
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AMORTISATION COST
The cost of intangible long-term operating
assets is allocated over the life of the
asset to reflect the decline in its service
potentiality.
The allocated cost of services given up
dur ing each per iod of the asset¶s life is
called Amortisation
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Amortisation per per iod
=Cost of an intangible asset
expected life in per iods
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DEPRECIATION EXPENSES
The cost of using long-term operatingasset, which is called depreciation, isrecorded piecemeal as the assets are
used. Depreciation is an allocation of the cost
that is calculated using an asset¶s
acquis
ition cost,
its e
xpected l
ife andexpected residual value, and one of the
several accepted depreciation methods
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DEPRECIATION EXPENSES
The Institute of Chartered Accountants of India def inesdepreciation as follows in accounting standard AS-6 on³Depreciation Accounting´.
³Depreciation is a measure of wear ing out, consumption
or other loss of value of depreciable asset ar ising fromuse, affluxion of time or obsolescence throughtechnology and mar ket changes. Depreciation isallocated so as to charge a fair proportion of thedepreciable amount in each accounting per iod dur ing the
expected useful life of the asset. Depreciation includesamortisation of assets whose useful life is pre-determined´.
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DEPRECIATION EXPENSES
In short, depreciation is the allocated cost
of services given up by a tangible long-
term operating asset (other than land)
during a period of time.
It can be said that amount of depreciation
recorded in books of account is only an
estimate.
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CAUSES OF DEPRECIATION
Wear and Tear
Obsolescence
Effluxion of time Accidents
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OBJECTIVES OF PROVIDING
DEPRECIATION Correct income measurement
True position statements
Funds for replacement
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EFFECTS OF NOT PROVIDING
FOR DEPRECIATION Per iodic expenses will be understated,
Prof its will be overstated;
Asset valuat
ion w
ill be overstated;
Capital depletion will take place;
Cost of production will be understated;
Pr ice determination will be inappropr iate; and
Net worth will be overstated.
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DEPRECIATION IS A PROCESS
OF ALLOCATION Accumulated depreciation is that part of the cost of af ixed asset, which is not recoverable when the asset isf inally put out of use.
The depreciation is the value of the benef it the asset has
provided dur ing a given accounting per iod. Depreciation accounting attempts to allocate in a rational
and systematic manner the difference betweenacquisition cost and estimated residual value (estimatedsalvage value) over the useful life of the asset.
Depreciation accounting is helpful to ascertain the trueprof it the entity, and to present the true f inancial positionof the entity
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DEPRECIATION IS A PROCESS
OF ALLOCATION Original cost of the asset
Salvage values
Useful life Depreciable cost
Written down value
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DEPRECIATION METHODS
The different depreciation methods aim to
allocate the cost of an asset to different
accounting per iod in a systematic and
rational manner. Each method produces a
different pattern of expenses over the
time.
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Straight Line Method (SLM) or
Fixed Installment method
nnual depreciation = Cost of the asset ± Residual value
Estimated economical life
Or:
Depreciation per unit output = Cost of asset ± Residual value
Estimated output dur ing the economical life
and Annual depreciation = Depreciation per unit of output x Number of units
produces dur ing an accounting per iod. i.e., year
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1000
A
m
o
u
n
tR
s
.
900
800700
600
500
400
300 Annual Depreciation
200100
0
1 2 3 4 5 6 7 8 9 10
Useful life (years)
Fig. 7.2 Straight Line Method ± Annual Depreciation Charge.
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r = 1 ± n s
c
Where r = Rate of depreciation or a f ixed percentage.
n = Number of years of asset¶s useful life.
s = Salvage Value or residual value.
c = Acquisition cost of the asset
Reducing or Diminishing or Declining
balance Method or wr itten down
value Method (WDV)
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GRAPHICAL PRESENTATION OF REDUCING BALANCE METHOD11/15/2010 22Prof. (Dr.) Paresh Shah
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Double Declining Method
This method charging larger amounts of
depreciation to the early years of an
assets life.
In this method, a constant rate is applied
to the asset balance, i.e., acquisition cost
less accumulated depreciation.
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Usage Method
Usage method of depreciation allocates
the cost of an asset over its expected life
in direct proportion to the actual use made
of the asset , e.g., the miles travelled by a
delivery truck.
Usage depreciation is computed by
multiplying as assets depreciable cost by ausage ratio, as in the following equation.
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Usage depreciation =usage ratio x
acquisition cost less residual value.
Usage ratio = Actual usage dur ing the per iod
Total expected usage
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Machine Hour Method
Where it is practicable to keep a record of
the actual running hours of each machine,
depreciation may be calculated on the
basis of hours that the concerned machine
wor ked
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Depreciation for the per iod =
Depreciable amount x No. of hours machine wor ksEstimated total machine hours
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Production Units Method
Depreciation for the per iod =
Depreciable Amount x Production dur ing the per iod.
Estimated total Production.
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Repair Provision Method
Repairs and maintenance cost over the life
of an asset is to be added to the or iginal
cost of the asset to get a total capital
outlay, which is apportioned over the life of
the asset.
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Revaluation Method
Assets are revalued per iodically and the
decline in their value is considered as
depreciation.
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PROVISION OR FUNDS
METHODS
Annutity Method.
Sinking Fund Method.
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FACTORS INFLUENCING SELECTION
OF DEPRECIATION METHOD
Depreciation has a signif icant effect in
determining the f inancial position and result of
operations of an entity via calculating net income
as well as deduction from taxable income. A combination of more than one method is
sometimes used. In respect of depreciable
assets, which do not have mater ial value,
depreciation is often allocated fully in theaccounting per iod in which it is acquired.
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FACTORS INFLUENCING SELECTION
OF DEPRECIATION METHOD
Disclosure
± The Accounting Standard VI has provided that
depreciation method used, and depreciation
rates or the useful life of the assets, if they are
different from the pr incipal rates specif ied in
the statute gover ing the entity should also be
closed in the f inancial statements along with
the disclosure of other accounting policies.
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METHOD OF RECORDING
DEPRECIATION There are two ways of recording depreciation in
the books, i.e., when no provision for depreciation account is maintained, and whenprovision for depreciation account is maintained.
When no provision for depreciation accountis maintained ± Under this method, depreciation is directly charged to
an asset account, and in the balance sheet, the assetshown at its wr itten-down value (acquisition cost less
depreciation provided to-date.). At the end of theaccounting per iod, depreciation account is closed bytransferr ing it to the income statement or prof it andloss account.
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METHOD OF RECORDING
DEPRECIATION
When provision for depreciationaccount is maintained
± Under this method, depreciation is not directly
charged to the asset account, but credited toµAccumulated Depreciation Account¶ or µProvision for Depreciation Account¶ or µDepreciation Fund Account¶ or µAccumulated
Depreciat
ion Account¶. Deprec
iat
ion accountis closed by transferr ing it to the prof it and
loss account.
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METHOD OF RECORDING
DEPRECIATION
Exchange of Used Asset with NewAsset
± When a new f ixed asset is acquired in
exchange for another old asset (already usedand depreciated) of the same kind or other,the entity is to pay only the difference, i.e., thedifference between the cost of a new asset
and the value of the old asset granted by theseller. This value of old asset is known as³Trade-in-Allowance´, which becomes a partof the cost of the new asset
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DEPRECIATOIN METHOD: IMPACT
ON PROFIT MEASUREMENT
Depending on the method used, a
difference amount is charged for annual
depreciation.
It may also be noticed that over the entire
life of an asset the total amount of
depreciation charge cannot be different.
Thus, the difference is only in terms of
annual apportionment .
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