Depreciation

Depreciable assets are physical objects that retain their size and
shape but that eventually
wear out because obsolete. They are not physica1ly consumed, as are
assets such as supplies, but nonetheless their economic usefulness
diminishes over time. Examples of depreciable assets include buildings
and all types of equipment, fixtures, furnishings—and even
railroad tracks. Land, however, is not viewed as a depreciable asset, as it
has an unlimited
useful life. .
Each period, a portion of a depreciable asset’s usefulness expires.
Therefore, a corresponding portion of its cost is recognized as
depreciation expense.
Depreciation is a measure of the wearing out, consumption or other loss
of value of a depreciable asset arising from use, efflux ion of time or
obsolescence through technology and market changes. Depreciation is
allocated so as to charge a fair proportion of the depreciable amount in
each accounting period during the expected useful life of the asset.
Depreciation includes amortization of assets whose useful life is
predetermined. The depreciation method applies to all depreciable assets,
except the following items to which special considerations apply:—

• Forests, plantations and similar regenerative natural resources;

• Wasting assets including expenditure on the exploration for and
extraction of minerals, oils, natural gas and similar non-
regenerative resources;
• expenditure on research and development;
• goodwill;
• Live stock.
This statement also does not apply to land unless it has a limited useful
life for the enterprise.

Depreciable assets are assets which

• Are expected to be used during more than one accounting period;

and
• Have a limited useful life; and
• Are held by an enterprise for use in the production or supply of
goods and services, for rental to others, or for administrative
purposes and not for the purpose of sale in the ordinary course of
business.

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Depredation Is Only an Estimate

‘The appropriate’ amount of deprecation expense is only an estimate.

After all we cannot look at a building or a piece of equipment and
determine precisely how much of its economic usefulness has expired
during the current period.
The most widely used means of estimating periodic depreciation expense
is the straight line method of depreciation under the straight line
approach, an equal portion of the asset’s cost is allocated to depreciation
expense in every period of the asset’s estimated useful ‘life. The formula
for computing depreciation expense by the straight-line method is:

Depreciation expense (per period) = Cost of the asset

----------------------
Estimated useful life

The use of an estimated useful life is the major reason that depreciation
expense is only an estimate. In most cases, management does not know in
advance exactly how long the asset will remain in use.

Useful life is either (i) the period over which a depreciable asset is
expected to be used by the enterprise; or (ii) the number of production or
similar units expected to be obtained from the use of the asset by the
enterprise.
Depreciable amount of a depreciable asset is its historical cost, or other
amount substituted for historical cost2 in the financial statements, less the
estimated residual value.

Explanation

1. Depreciation has a significant effect in determining and presenting the

financial position and results of operations of an enterprise. Depreciation
is charged in each accounting period by reference to the extent of the
depreciable amount, irrespective of an increase in the market value of the
assets.
2. Assessment of depreciation and the amount to be charged in respect
there of in an accounting period are usually based on the following three
factors: (i) historical cost or other amount substituted for the historical
cost of the depreciable asset when the asset has been revalued; (ii)
expected useful life of the depreciable asset; and (iii) estimated residual
value of the depreciable asset.
3. Historical cost of a depreciable asset represents its money outlay or its
equivalent in connection with its acquisition, installation and

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commissioning as well as for additions to or improvement thereof. The
historical cost of a depreciable asset may undergo subsequent changes
arising as a result of increase or decrease in long term liability on account
of exchange fluctuations, price adjustments, changes in duties or similar
factors.
4. The useful life of a depreciable asset is shorter than its physical life and
is:
(i) Pre-determined by legal or contractual limits, such as the expiry dates
of related leases;
(ii) Directly governed by extraction or consumption;
(iii) Dependent on the extent of use and physical deterioration on account
of wear and tear which again depends on operational factors, such as, the
number of shifts for which the asset is to be used, repair and maintenance
policy of the enterprise etc.; and
(iv)Reduced by obsolescence arising from such factors as:

(a) Technological changes;

(b) Improvement in production methods;
(c) Change in market demand for the product or service output of the
asset; or
(d) Legal or other restrictions.

5. Determination of the useful life of a depreciable asset is a matter of

estimation and is normally based on various factors including experience
with similar types of assets. Such estimation is more difficult for an asset
using new technology or used in the production of a new product or in the
provision of a new service but is nevertheless required on some
reasonable basis.
6. Any addition or extension to an existing asset which is of a capital
nature and which becomes an integral part of the existing asset is
depreciated over the remaining useful life of that asset. As a practical
measure, however, depreciation is sometimes provided on such addition
or extension at the rate which is applied to an existing asset. Any addition
or extension which retains a separate identity and is capable of being used
after the existing asset is disposed of, is depreciated independently on the
basis of an estimate of its own useful life.
7. Determination of residual value of an asset is normally a difficult
matter. If such value is considered as insignificant, it is normally regarded
as nil. On the contrary, if the residual value is likely to be significant, it is
estimated at the time of acquisition/installation, or at the time of
subsequent revaluation of the asset. One of the bases for determining the
residual value would be the realizable value of similar assets which have

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reached the end of their useful lives and have operated under conditions
similar to those in which the asset will be used.
8. The quantum of depreciation to be provided in an accounting period
involves the exercise of judgment by management in the light of
technical, commercial, accounting and legal requirements and
accordingly may need periodical review. If it is considered that the
original estimate of useful life of
an asset requires any revision, the unamortized depreciable amount of the
asset is charged to revenue over the revised remaining useful life.
9. There are several methods of allocating depreciation over the useful
life of the assets. Those most commonly employed in industrial and
commercial enterprises are the straight-line method and the reducing
balance method. The management of a business selects the most
appropriate method(s) based on various important factors e.g., (i) type of
asset, (ii) the nature of the use of such asset and (iii) circumstances
prevailing in the business. A combination of more than one method is
sometimes used. In respect of depreciable assets which do not have
material value, depreciation is often allocated fully in the accounting
period in which they are acquired.
10. The statute governing an enterprise may provide the basis for
computation of the depreciation. For example, the Companies Act, 1956
lays down the rates of depreciation in respect of various assets. Where the
management’s estimate of the useful life of an asset of the enterprise is
shorter than that envisaged under the provisions of the relevant statute,
the depreciation provision is appropriately computed by applying a higher
rate. If the management’s estimate of the useful life of the asset is longer
than that envisaged under the statute, depreciation rate lower than that
envisaged by the statute can be applied only in accordance with
requirements of the statute.
11. Where depreciable assets are disposed of, discarded, demolished or
destroyed, the net surplus or deficiency, if material, is disclosed
separately.
12. The method of depreciation is applied consistently to provide
comparability of the results of the operations of the enterprise from
period to period. A change from one method of providing depreciation to
another is made only if the adoption of the new method is required by
statute or for compliance with an accounting standard or if it is
considered that the change would result in amore appropriate preparation
or presentation of the financial statements of the enterprise. When such a
change in the method of depreciation is made, depreciation is recalculated
in accordance with the new method from the date of the asset coming into
use. The deficiency or surplus arising from retro sportive recompilation
of depreciation in accordance with the new method is adjusted in the

4
accounts in the year in which the method of depreciation is changed. In
case the change in the method results in deficiency in depreciation in
respect of past years, the deficiency is charged in the statement of profit
and loss. In case the change in the method results in surplus, the surplus
is credited to the statement of profit and loss. Such a change is treated as
a change in accounting policy and its effect is quantified and disclosed.
13. Where the historical cost of an asset has undergone a change due to
circumstances specified the depreciation on the revised unamortized
depreciable amount is provided prospectively over the residual useful life
of the asset.

DAPRECIATION METHOD

THE STRAIGHT-LINE METHOD

Under the straight-line method, an equal) Portion of the asset’s cost is
recognized as depreciation expense in each period of the asset’s useful
life. Annual depreciation expense is computed by deducting the estimated
residual value (or salvage value) from the cost of the asset and dividing
the remaining depreciable cost by the years of estimated useful life.
Using the data in our example, the annual straight-line depreciation is
computed as follows:

Cost-Residual Value = $17000-$2000 = $3000 per year

Year of useful Life 5Year

THE DECLINING-BALANCE

The most widely used accelerated depreciation -method is called fixed-

percentage-of decliningba1ançe depreciation. However the method is
used primarily in income tax re turns rather than financial statements.
Under the declining-balance method, an accelerated depreciation rate Is
computed as a specified percentage of the straight-line depreciation rate.
Annual depreciation expense then is computed by applying this
accelerated depreciation rate to the un depreciated cost (current book
value) of the asset. This computation may be summarized as follows:

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Depreciation Expense = Remaining Book Value X Accelerated
Depreciation Rate

The accelerated depreciation rate remains constant through out the life of
the asset. Hence, the rate represents the “fixed-percentage’ described in
the name of this depreciation method. The book value (cost minus
accumulated depreciation) decreases every year and represents the
“dec1ipin-ba1ance.’

Thus far we have described the accelerated depreciation rate as a

specified percentage’ of the strtight-1ihe rate. Most often, this specified
percentage is 200 percent, meaning that the accelerated rate is exact1y
twice the straight-line rate. Asaresu1t, the declining-balance method of
depreciation often is called double-declining-balance (or 200 percent
declining-balance). Tax rules, however, often specify a lower percentage,
such as 150 percent of the straight-line rate. This version of the declining-
balance method may be described as “150 percent declining-balance.

THE UNITS-OF-OUTPUT METHOD

Under the Units-of-output method, depreciation is based on some

measure of output rather . than on the passage of time. When.
depreciation based on units of output, more depreciation
is recognized in the periods in which the assets are most heavi1y used.
To illustrate this method, consider S&G’ de1iver’ truck, which cost
$17,000 and has an estimated salvage value of $2,000 Assume that S&G
plans to retire this truck after it has been
driven 100000 miles. The depreciation rate per mi1e of operation is 15
cents, computed as follows: -

Cost — Residual Value = Cost per Unit of Output(Mile)

Estimated Units of Output (MiIes)

$17,000-$2,000
100000 miles =$0.15 Depreciation per Mile

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At the end of each year, the amount of depreciation to be recorded is
determined by mñtip1y- mg the 15-cent rate by the number of miles the
truck has been driven during the year After the truck has gone
100,000miles, it is fully depreciated, and the depreciation process is
stopped
This method provides an excellent matching of expense with revenue.
However, the method should be used only when the total units of output
can be estimated with reasonable accuracy Also, this method is used only
for assets such as vehicles and certain types of machinery Assets such as
buildings, computers, .and furniture do not have wellc1efined “units of
output’
In many cases, units-of-output is an accelerated method. Often assets are
used more extensively in the earlier years of their useful lives than in the
later years.

MACRS
Most businesses use a depreciation method called MACRS (Modified
Accelerated Cost Recovery System) in their federal income tax returns.
Some small businesses also use this method-in their financial statements,
so they do not have to compute 4epréciation in several different ways
MACRS is based on the declining-balance method, but should be
considered for use in financial statements only if the designated recovery
periods” and the assumption, of no salvage value are reasonable. For
publicly traded companies, the use of MACRS m financial statements is
usually not considered to be in conformity with generally accepted
accounting principles.

SUM-OF-THE-YEARS-DIGITS
Sum-of-the-years’ digits, or SYD, is a form of accelerated depreciation It
generally produces results that lie between the -double-declining-balance
and 150 percent-declining-balance methods.
SYD is a traditional topic that is- included m many accounting textbooks
But it is the most complex of the accelerated methods-especially when
partial years are involved SYD is rarely used in today’s business world.
Only 6 of the 600 corporations surveyed—less than 1 percent—make any
use of this method Because of its complexity, it is even less frequently
used in small businesses SYD is seldom used for income tax purposes,
because tax laws usually define allowable depreciation rates in terms the
declining-balance method for these reasons, we defer coverage of the
mechanics of this method to later accounting courses.

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 DEPRECIATION METHOD IN USE

Every year, the American Institute of Certified Public Accountants

(AICPA) conducts a survey of 600publicly owned companies to
determine the accounting methods most widely used
in financial statements. The various depreciation methods in use during a
recent -year are summarized in diagram. Notice that the number of
methods in use exceeds 600. This is because some companies use
different depreciation methods for different types of assets.

600 Companies surveyed

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9
Practical
study

HBL established operations in Pakistan in 1947 and moved its head office
to Karachi. Our first international branch was established in Colombo, Sri
Lanka in 1951 and Habib Bank Plaza was built in 1972 to commemorate
the bank’s 25th Anniversary.

With a domestic market share of over 40%, HBL was nationalized in

1974 and it continued to dominate the commercial banking sector with a
major market share in inward foreign remittances (55%) and loans to
small industries, traders and farmers. International operations were
expanded to include the USA, Singapore, Oman, Belgium, Seychelles
and Maldives and the Netherlands.

On December 29, 2003 Pakistan's Privatization Commission announced

that the Government of Pakistan had formally granted the Aga Khan
Fund for Economic Development (AKFED) rights to 51% of the
shareholding in HBL, against an investment of PKR 22.409 billion (USD
389 million). On February 26, 2004, management control was handed
over to AKFED. The Board of Directors was reconstituted to have four
AKFED nominees, including the Chairman and the President/CEO and
three Government of Pakistan nominees.

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Rating
HBL is currently rated AA (Long term) and A-1+ (Short term) and has a
balance sheet size of over USD 11 billion. It is the first Pakistani bank to
raise Tier II Capital from external sources.

Depreciation of HBL Assets

Tangible
Surplus on revaluation of fixed assets to the extent of the incremental
depreciation charged on the related assets is transferred by the Bank to
un-appropriated profits (net of deferred tax).
All operating assets are being depreciated over their expected economic
lives using the straight-line method from the date the assets are available
for use.
Depreciation is calculated so as to write-off the assets over their expected
economic lives at the rates specified to these financial statements. The
depreciation charge for the year is calculated after taking into account
residual value, if any. The residual values, useful lives and depreciation
method are reviewed and adjusted, if appropriate, at each balance sheet
date.
Fixed assets and capital work-in-progress, are stated at cost or revalued
amount less accumulated depreciation, where applicable, and
accumulated impairment losses (if any).
Cost of fixed assets of foreign branches includes exchange differences
arising on translation at year-end rates. Land and buildings
are revalued by independent professionally qualified values with
sufficient regularity to ensure that the net carrying amount does
not differ materially from the fair value. Surplus arising on revaluation is
credited to the ‘surplus on revaluation of fixed assets’
account (net of deferred tax). Under the provision of the Companies
Ordinance, 1984, deficit arising on revaluation of fixed assets is adjusted
against the balance in the above surplus account.

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Depreciation on addition and deletion of tangible assets during the year is
charged in proportion to the period of use.
Normal repairs and maintenance are charged to the profit and loss
account as and when incurred. However, renewals are capitalized.
Gain or losses arising on the disposal of fixed assets are included in
income currently. Surplus on revaluation of fixed assets (net of deferred
tax) realized during the year is transferred directly to un-appropriated
profit.

Intangible
Intangible assets having a finite useful life are stated at cost less
accumulated amortization and accumulated impairment losses, if any.
Such intangible assets are amortized using the straight-line method over
their estimated useful lives. Amortization is charged at the rate stated.
Amortization on additions and deletions of intangible asset during the
year is charged in proportion to the period of use. The useful life and
amortization method are reviewed and adjusted, if appropriate at each
balance sheet date.
Intangible assets having an indefinite useful life are stated at acquisition
cost.

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Data Collection Method
Primary Data

BOOKS

Financial & Managerial Accounting

14th Edition

Chapters# 4, 9

Pages # 148, 149, 405, 408,410

Web site

www.wikipedia.org

www.investorwords.com/1416/depreciation.html
www.investopedia.com/terms/d/depreciation.asp
www.businessdictionary.com/definition/depreciation.html

Secondary Data
Organization

Habib Bank Limited

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Web site

http://www.habibbankltd.com

SWOT Analysis
Strength Weakness
Habib bank is one of an old bank of Surplus on revaluation of fixed
Pakistan there fore they have great assets (net of deferred tax) realized
reputation in country. during the year is transferred
directly to un-appropriated profit.
Habib bank has many fix assets in
foam of Lands and buildings.

Habib bank using the straight-line

method which is very useful and
common.
Opportunities Threats

The bank has an opportunity to get The competition in banking sector

the rent building for branches and
the depreciation charges are used to
renovate these buildings.
of Pakistan is also effect the
organization.
The economical condition and
inflation in business is also one of a
big threat

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15
Conclusio
n
Conclusion
In this assignment we discuss the depreciation of different assets. In my
opinion the commercial banks are the best example of assists
depreciation.

Commercial banks normally using the straight-line method which is very

commonly used in banking sector. They follow a proper principles and
they depreciate there fixed assets according to there product.

Today's commercial banks are more diverse than ever. We can find a
tremendous range of opportunities in commercial banking, starting at the
branch level where you might start out as a teller to a wide variety of
other services such as leasing, credit card banking, international finance
and trade credit.

The banking sector in Pakistan has been going through a comprehensive

but complex and painful process of restructuring since 1997. It is aimed
at making these institutions financially sound and forging their links
firmly with the real sector for promotion of savings, investment and
growth. Although a complete turnaround in banking sector performance
is not expected till the completion of reforms, signs of improvement are
visible. The almost simultaneous nature of various factors makes it
difficult to disentangle signs of improvement and deterioration. The
Habib bank is one of an old bank they have a good reputation and there
fixed assets are in large of number and for there depreciation they used
the straight-line method which is very effective.

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Recommendations
As we already discuss that the Habib bank is one of an old bank they
have a good reputation and there fixed assets are in large of numbers they
using a proper the straight-line method which is very successful
depreciation method and I recommend them to keep it continues because
it is very supportive method.

References

BOOKS

Financial & Managerial Accounting

14th Edition

Chapters# 4, 9

Pages # 148, 149, 405, 408,410

Web site

www.wikipedia.org

www.investorwords.com/1416/depreciation.html
www.investopedia.com/terms/d/depreciation.asp
www.businessdictionary.com/definition/depreciation.html
http://www.habibbankltd.com

17