Accounting for

Depreciation

Accounting for Depreciation

Fixed assets other than land lose their ability
over time to provide services
Costs of equipment, buildings, and land
improvements should be transferred to
expense accounts in a systematic manner
during their expected useful lives.
DEPRECIATION

Adjusting entry to record depreciation is

usually made at the end of each month or at
the end of the year Fixed assets other than
land lose their ability over time to provide
services

Adjusting Entry
Account
Depreciation expense
Accumulated depreciation - truck

Debit

Credit

Rs.7,000
Rs.7,000

FIXED ASSETS
tangible resources used in the
operation of a business
not intended for sale to customers

FIXED ASSETS
FIXED assets are subdivided into various
classes:
1. Land
2. Land improvements
3. Buildings
4. Equipment
5. Furniture
6. Goodwill, patents, copy rights
7. Leaseholds, mines
5

Causes of Depreciation
Usefulness may decline because of ( Internal
factors)
Wear and tear : P&M
Depletion eg. in wasting assets mines

External :
Obsolescence : Better substitutes
Inadequacy : Due to increase in scale of
production

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.

Land is not
depreciated.

No wear and tear

No obsolescence

Depreciation
Accumulated depreciation
Shows the amount that the asset has lost in value since
its purchase

Depreciation expense
Shows the amount that the asset has lost in value this
period.

Factors that cause a decline the ability of a fixed

asset to provide services may be identified as
Physical depreciation
Occurs from the wear and tear while in use and from the
action of the weather

Functional depreciation
Occurs when a fixed asset is no longer able to provide
services at the level for which it was intended.

Factors in Computing Depreciation

Expense
The fixed assets initial cost
Its expected useful life
Its estimated value at the end
of its useful life.

Depreciation Methods
Straight line
Declining balance
Units of production

Depreciation Methods
I. Fixed / Equal Instalment OR Straight Line Method
(i) A fixed portion of the cost of a fixed asset is
allocated and charged as periodic depreciation.
(ii) Such depreciation becomes an equal amount
in each 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.

Straight-Line Method
Example

(Cost Salvage value)

years of useful life
(30,000 500)
5

= Depreciation per year

= Rs.5,900

13

STRAIGHT-LINE
DEPRECIATION
METHOD

Depreciation amount is the same for

each year of the assets useful life.
Using this method, depreciation is
measured only by time.

14

Depreciation Methods
Reducing / Diminishing Balance Method OR
Written Down Value Method
(i) Depreciation is calculated at a fixed percentage on
the original cost in the first year. But in subsequent
years it is calculated at the same percentage on the
written down values gradually reducing during the
expected working life of the asset.
(ii) The rate of allocation is constant (usually a fixed
percentage) but the amount allocated for every year
gradually decreases.

Straight line Method

Provides for the same amount of
depreciation expense for each year
of the assets useful life
Annual depreciation expense =
Cost Salvage value
Life

Example 1
A machine had a cost of Rs.24,000, salvage value
of Rs.2,000 and useful life of 5 years
Annual depreciation expense =
Cost Salvage value
Life
= Rs.24,000 - Rs.2,000
5 years
= Rs.4,400 annual depreciation

Adjusting entry
Account
Depreciation expense
Accumulated depreciation - truck

Debit

Credit

Rs.4,400
Rs.4,400

Example 2
A machine had a cost of Rs.30,000,
salvage of Rs.5,000 and useful life of
6 years. Compute depreciation under
the straight line method?
What is depreciation expense in year
3?

Units of Production
This method provides for the same
amount of depreciation expense for
each unit produced or each unit of
capacity used by the asset

Units of Production
Depreciation rate per unit =
Cost Salvage value
Estimated
units
Depreciation Expense =
Depreciation rate x annual
units

Example 3
A machine had a cost of Rs.24,000,
salvage value of Rs.2,000, estimated
total hours of production of 10,000
and annual hours used of 2,100
hours. Compute depreciation for the
period under the units of production
method.

Example 3
Depreciation rate per unit =
Cost Salvage value
Estimated hour
= Rs.24,000 - Rs.2,000 = Rs.2.20
10,000
hours
Annual depreciation expense =
Hourly depreciation rate x annual hours
= Rs.2.20 x 10,000 hours = Rs.2,200

Example 4
A machine had a cost of Rs.30,000,
salvage value of Rs.5,000, estimated
total hours in production of 5,000
and annual hours used of 900 hours.
Compute the depreciation expense
for the period using the units of
production method

Declining Balance Method

Provides for a declining periodic
expense over the estimated useful
life of the asset.
Book value
= Cost Accumulated
depreciation

Declining Balance Method

Steps
Compute the DB rate = 100/Life of asset
For double declining balance
Multiply rate time 2

Depreciation expense =
Beg. book value X Rate
Rule: the book value may never by less
than the salvage value of the asset

Example 5:
A machine had a cost of Rs.24,000, salvage value of Rs.2,000,
estimated life of five year. Compute depreciation
Year

Cost

Accumulat
ed
Depreciati
on

Rs.24,000

24,000

Book
value at
beginning
of year

Rate

Depreciati
on

Book
value at
end of
year

Rs.24,000

40%

Rs.9,600

Rs.14,400

9,600

14,400

40%

5,760

8,640

24,000

15,360

8,640

40%

3,456

5,184

24,000

18,816

5,184

40%

2,073.60

3,110.40

24,000

20,889.60

3110.40

1,110.40

2,000

Example 6
Example 6: A machine had a cost of Rs.30,000, salvage value
of Rs.5,000, estimated life of 6 years.
Compute
depreciation using the double declining balance method.

Revision of Depreciation
Revising the estimates of the residual
value and the useful life is normal
Used to determine depreciation
expense in future periods

Example 7
Assumed a fixed asset purchased for
Rs.130,000 was originally estimated to have
a useful life of 30 years and a residual value
of Rs.10,000. The asset has been
depreciated for 10 years by the straight line
method.
At the end of ten years, the assets book
value of Rs.90,000. During 11th year, it is
estimated that the remaining useful life is 25
years and that the residual value is Rs.5,000.
Compute depreciation expense for the 11 th
year using the new information provided.

Example 7
Depreciation expense=
= Rs.130,000-Rs.10,000
30
= Rs. 4,000.00 per year before changes
Accumulated Depreciation balance
=Rs.4,000 X 10 years
= Rs.40,000
Book value
= Rs.130,000.00 Rs.40,000 = Rs.90,000

Example 7
New depreciation expense =
Book value new salvage
Remaining life
= (Rs.90,000-Rs.5,000)
25
= Rs. 3,400.00 per year for
remaining years

Disposal of Fixed Assets

Discarding of Fixed Assets
When asset has no residual value and is
fully depreciated.

Example 8
Asset with a cost of Rs.25,000 and fully
depreciated is discarded

Account

Debit

Credit

Accumulated Depreciation Rs.25,000

Fixed Asset

Rs.25,00
0

Selling of Fixed Assets

Three things can happen
Sale at book value
No gain or loss

Sale below book value

Loss is recognized

Sale after book value

Gain is recognized

Selling at book value

Example 9:
Asset with cost of Rs.25,000 and
Accumulated Depreciation of Rs.10,000 is
sold for Rs.15,000 cash.

Account

Debit
Credit
Cash
Rs.15,000
Accumulated depreciation Rs.10,000
Fixed Asset
Rs.25,000

Selling price above book

value
Gain is recognized
Example 10:
Asset with cost Rs.25,000, Accumulated
Depreciation of Rs.10,000 is sold for Rs.20,000
cash.

Account
Cash
Accumulated depreciation

Debit
Rs.20,00
0
Rs.10,00
0

Credit

Selling price below book

value
Loss is recognized

Example 11: Asset with cost of Rs.25,000, Accumulated

Depreciation of Rs.10,000 is sold for Rs.12,000 cash.

Account
Cash
Accumulated Depreciation
Loss on disposal of asset
Fixed Asset

Debit
Rs.12,000
Rs.10,000
Rs.3,000

Credit

Rs.25,00
0

Exchanging Similar Assets

Old equipment is often traded in for new
equipment having a similar use.
The seller allows the buyer an amount
for the old equipment traded in called
TRADE IN ALLOWANCE.
The remaining balance the amount
owed is either paid in cash or recorded
as a liability called BOOT

Gain on exchanges
Not recognized for financial reporting
purposes.
When trade-in allowance exceeds the book
value of an asset traded in and no gain is
recognized, the cost recorded for the new
asset can be determined in either of two
ways:
Cost of new asset = List price + Unrecognized gain
Cost of new asset = Cash given + book value of oldNot
recognized for financial reporting purposes.

Example 12
New equipment is purchased with a list
price of Rs.5,000, trade in allowance of old
is Rs.1,100, cost of old equipment is
Rs.4,000, accumulated depreciation
Rs.3,200. Record the entry. New
equipment is purchased with a list price of
Rs.5,000, trade in allowance of old is
Rs.1,100, cost of old equipment is
Rs.4,000, accumulated depreciation
Rs.3,200. Record the entry.

Example 12
Account
Fixed Asset new
Accumulated Depreciation
Fixed Asset old

Debit

Credit

Rs.800
Rs.3,200
Rs.4,000

Losses on Exchange
For financial reporting purposes, losses
are recognized on exchanges of similar
fixed assets.
If trade in is less than the book
value of the old equipment, there is
a loss

Example 14
New equipment is purchased with a list price
of Rs.5,000, trade in allowance of old is
Rs.700, cost of old equipment is Rs.4,000,
accumulated depreciation Rs.3,200. Record
the entry.
Account
Fixed Asset new

Debit
Rs.700

Accumulated Depreciation

Rs.3,200

Loss on exchange of asset

Rs.100

Fixed Asset old

Credit

Rs.4,000