The word depreciation lays its roots within the Latin word depretiare. ‘de’ means down and ‘pretium’ means price. So, literal translation of the word brings out the meaning as downfall in price. But, in modern scenario, the utilization of the word depreciation is restricted to fixed assets only (except land).
Now, first we’ve to know what depreciation actually means. We know, to hold on day to day operations, every organisation has got to deploy numerous fixed assets to use. Quite obviously, no asset can perform with same capacity all throughout its life. it’ll face gradual wear and tear thanks to continuous usage or even due to remaining idle for therefore long. This leads to reduction of efficiency of the concerned asset. The phenomenon discussed above is usually termed as depreciation. we’ve to stay in mind that as depreciation as an idea is vital , it’s accounting is additionally important. There are various scientific methods of accounting for depreciation. the foremost important of them are line method and written down Value method (as per your syllabus).
As per Schedule II under the businesses Act, 2013, Depreciation is that the systematic allocation of the depreciable amount of an asset over its useful life. The depreciable amount of an asset is that the cost of an asset or other amount substituted for cost, less its residual value. The useful lifetime of an asset is that the period over which an asset is predicted to be available to be used by an entity, or the amount of production or similar units expected to be obtained from the asset by the entity.
Thus there are 3 important factors for computing depreciation:
Estimated useful lifetime of the asset
Cost of the asset
Residual value of the asset at the top of the of its estimated useful life
Depreciation is allocated so on charge a good proportion of the depreciable amount in each accounting period during the expected useful lifetime of the asset.
Straight line method
this method is that the easiest method of calculating depreciation on fixed assets. Under this method, the value of purchase of the concerned fixed asset, the salvage value(scrap value) of the asset and duration of use are considered. This method is additionally referred to as original cost method, because, the speed of depreciation is applied on the first cost of the machine. to determine the quantity of depreciation to be allocated to an asset, the subsequent formula is used:
Depreciation= (cost of asset+ installation charges-scrap value)/ duration of use
Under this method, total depreciation of an asset is apportioned equally along the duration of use. Suppose, total cost of an asset is Rs. 1200 and it’s employed by the organisation for 10 years. Let, the scrap value of the asset be Rs. 200. So, the quantity of depreciation to be th allocated per annum would be: (1200-200)/10 = Rs. 100. So, at the top of the ten year, the worth of the asset would be completely diminished.Hence, from the above chart, we will see that the trend of depreciation follows a line . that’s why, the tactic discussed above is usually referred as line method.From the above chart, we will see that the worth of asset decreases at a continuing rate. that’s why, the diagram may be a downward sloping line .
Though this method is straightforward to follow and account for, but it’s not completely logical. Because, in real world , no machine is equally used right along its life. So, in real scenario, the quantity of depreciation would differ.
Written down value method:
under this method, an asset is depreciated at a specific rate which is charged on the worth of asset on st the 1 day of every fiscal year . So, unlike line method, amount of depreciation would vary annually and it’ll gradually decrease. This method is more logical because the depreciation is charged on the effective value of the asset rather than its original cost. Suppose, cost of an asset is Rs. 1000 and rate of depreciation is 10%. So, for the primary year, amount of depreciation would be (1000*10%)= Rs. 100. So, the written down value of the asset on the primary day of next fiscal year are going to be Rs. 900. during this year, depreciation are going to be charged @10%on Rs. 900, viz: 900*10% = Rs. 90. Hence, this process will continue until the worth of the asset reaches zero.
PROVISION FOR DEPRECIATION:
Now we’ll specialise in the vital method of accounting for depreciation which is named “provision for depreciation method”. Please remember that this is often not a way of CALCULATING depreciation but a way of ACCOUNTING. during this method we prepare the asset account at cost, provision for depreciation account and a machinery disposal account. allow us to discuss intimately . Under this method depreciation is separately recorded in provision for depreciation account. The fixed asset account appears at its original cost.
In the profit and loss account current period’s depreciation is merely recorded. within the record fixed asset account is disclosed by deducting the accumulated depreciation i.e. the depreciation till the record go back the first cost.
Sum of Years of Digits Method
It is variation of the “Reducing Balance Method”. during this case, the ansnual depreciation is calculated by multiplying the first cost of the asset less its estimated scrap value by the fraction represented by:
The depreciation to be written of within the frst year are going to be 10/55 of the value of the asset less estimated scrap value; and therefore the depreciation for the second year are going to be 9/55 of the value of asset less estimated scrap value then on.
The method isn’t yet in vogue; and its advantages are an equivalent as those of the Reducing Balance Method.
Annuity Method
This is a way of depreciation which also takes under consideration the element of interest on capital outlay and seeks to write down of the worth of the asset also because the interest lost over the lifetime of the asset. It assumes that the quantity laid call at acquiring asset, if invested elsewhere, would have earned interest which must be reckoned as a part of the value of asset. thereon basis, the quantity of depreciation to be annually provided within the accounts is ascertained from the Annuity Tables, to write down of every year interest on the capital outlay also as a part of the capital sum at a rate that the entire of the capital sum and interest accruing thereon would be written of over the lifetime of the asset.
Though the quantity written of annually is constant, the interest within the earlier years being greater, only bit of the capital outlay is written of. This proportion is reversed with the passage of your time . This method is eminently suitable for writing of the amounts purchased long leases which involve a substantial capital outlay. it’s not practicable to adopt this method for writing of depreciation of plant and machinery on account of frequent changes within the value of such assets which might necessitate the recalculation of the quantity of depreciation to be written of annually.
Sinking Fund Method
If an outsized sum of cash is required for replacement of property, plant and equipment at the top of its efective life, it’s going to not be advisable to go away within the amount of depreciation set apart annually, for it’s going to or might not be available within the sort of the readily realisable assets to the enterprise at the time it’s required. To safeguard this position, the quantity annually provided for depreciation could also be placed to the credit of the fund Account, and at the same time an equivalent amount could also be invested in Government securities.
The interest on these securities, when received, would be re-invested and therefore the amount thereof would be credited to the fund Account. the quantity of annual provision for depreciation in such a case is calculated after taking under consideration interest, that the amounts annually invested shall be earning over the amount these will remain invested. When the asset is due for replacement, the securities are sold and therefore the new asset is purchased with the proceeds of their sale. The value of the old asset, at the time, is transferred to the fund Account. Any amount realised on sale of the old asset, also because the proft or loss on sale of securities, is transferred to the fund Account and it’s closed of by transfer of the balance of the Proft and Loss Account or General Reserve.
The amount to be set apart annually by way of depreciation is ascertained from fund tables. They readily show the quantity which must be invested annually to accumulate to Rs 1 at a given rate of interest within the stated period.
