DEPRECIATION

TOPICS
CONCEPT
OBJECTIVES

CAUSES
DEPRECIATION

METHODS

CONCEPT
Depreciation

is the cost of lost usefulness

or cost of diminution of service yield from
a use of fixed assets.

permanent fall in the value of fixed

assets arising through wear and tear from
the use of those assets in business.

Definition
Depreciation

is a measure of the wearing out,

consumption or other loss of value of
depreciation 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.

Objectives
To
To

calculate proper profits.

show the asset at its reasonable value
To maintain the original monetary
investment of the asset intact.
To provide for replacement of an asset.
Depreciation is permitted to be deducted
from profits for tax purposes.

Causes of
Depreciation
Internal

causes: wear and tear, disuse,

maintenance, change in production,
restriction of production, reduced demand,
technical progress & depletion.

External

causes: obsolescence

What can be depreciated

Depreciation

can be done on assets if it meets the

following criteria
It is used in business or held for the production of
income.
It must be expected to last for more than one year.
It is property that wears out, decays, get used up,
becomes obsolete, or looses value from natural
causes.
Depreciable property can be either tangible or
intangible

Factors in measurement of
depreciation
Total

cost of asset
Estimated useful service life or economic
life
The estimated turn-in (residual) value.

Methods of Depreciation
1.

Straight Line Method

Straight line method of depreciation is based on the cost

of an asset that is then depreciated by the same amount,
over the estimated useful life of the asset.
Example: ABC Ltd bought a machine at a cost of Rs 40,000.
The machine has an expected useful life of 5 years and at the
end it has no salvage value. Calculate depreciation.
Cost

Annual Depreciation

Net Book Value

End of 1st year

8,000

32,000

End of 2nd year

8,000

24,000

End of 3rd year

8,000

16,000

End of 4th year

8,000

8,000

End of 5th year

8,000

Beg. Of Year

40,000

Question: Calculate the depreciation on a machine which costs

Rs 80,000, having expected life of 5 years. Salvage value Rs

Straight line method or fixed installment

Under this method, the same amount of
depreciation is charged every year
throughout the life of the asset.
The formula = Total cost of acquisition - residual value
or

scrap value
Estimated life

r =R/C * 100;
r = depreciation rate
R = Amount of depreciation, C = Acquisition cost

Straight line method

Advantages of Straight line method:
Simple, easy to understand and to apply
It provides uniform charge every year
Its calculated on original cost over the life time
Disadvantages:
Depreciation is not related to the usage factor
It ignores the fact that in the later years of the life of
the asset, efficiency of the asset declines.

Methods of Depreciation
2. Reducing Balance Method

Depreciation is calculated on a fixed percentage on the

Diminishing Balance of the Asset (Net Book Value). This
results in a higher depreciation charge in the earlier years
of assets estimated useful life.
Example: A machine costs Rs 50,000 is depreciated at
15% Calculate depreciation
using
ReducingNet
balance
Cost
Annual
Depreciation
Book Value
method.
Beg. Of Year

50,000

50,000

End of 1st year

50,000 * 15% =
7,500

42,500

End of 2nd year

42,500 * 15% =
6375

36,125

End of 3rd year

36,125 * 15% =
5,419

30,706

End of 4th year

30,706 * 15% =
4,606

26,100

End of 5th year

26,100 * 15% =
3,915

22,185

Reducing Balance Method

Advantages
1. Appropriate for assets which lose value quickly in
early year.
2. Appropriate for assets which become obsolete

Disadvantages
1. Asset is never completely written of