Depreciation
Depreciation denotes permanent and continuous decrease in the book value of fixed assets over efflux of time. Depreciation does not refer to any physical deterioration or decrease in its market value.
- Depreciation is the process of allocating the cost of a fixed asset, less any residual or salvage value, over its estimated useful life, in a rational and systematic manner.
- Depreciation is a process of allocation, not of valuation. Depreciation includes amortization of assets whose useful life is pre-determined.
- Depreciation is charged to comply matching concept over the period of useful life of the asset (not on physical life of the asset).
Nature of Depreciation
Depreciation is acknowledgement of reduction of value of Assets depleting over time & use.
The accounting for depreciation is an internal transaction of allocating the cost of a fixed asset, less any residual or salvage value over its estimated useful life of the asset. Depreciation is simply a book entry and it has no outside connection (a fund cannot be created just through passing a book entry). It is actually a non cash expense.
Depreciation affects taxable income and hence affects income tax payable
As no cash is outgoing in spite of charging it as expenses, Depreciation may sometimes look as Source of Funds. Under no circumstances depreciation is a source of fund (though it is a popular wrong phenomenon).
Depreciable Assets : Depreciable Assets are Assets on which Depreciation is charged to reduce its value over efflux of time. These are Assets which are expected to be used during more than one accounting period, have a limited useful life, and are held by an enterprise for use but not for sale in the ordinary course of business.
Land : Freehold Land is treated as non-depreciable asset. But leasehold land is treated as depreciable asset.
Depreciable Amount : Depreciable amount is the historical cost, of a depreciable asset in the financial statement, less estimated residual value. The depreciable amount (Historical Cost or other amount substituted for historical cost) of a depreciable asset should be allocated on a systematic basis to each accounting period, during the useful life of the asset.
Objective of Providing Depreciation
- Correct Profit / Loss measurement : The diminution in value of asset due to depreciation is to be considered for computation of proper Profit / Loss
- True Financial Position : The true value of fixed asset would be represented in the Financial position by considering the depreciation
- Funds for replacement : Though Depreciation is not real source of fund or financing, the provision of depreciation is necessary to make adequate funds available for replacement of the old depleted fixed asset after its useful life.
- Proper Cost of Production : To compute proper cost of production, the depreciation should be considered for the fixed assets for the respective process / produced item
Depletion, Amortization and Obsolescence
The terms Depletion, Amortization and Obsolescence refers to diminution of value of asset over efflux of time
- Depletion: Depletion refers to the physical deterioration of natural resources or wasting assets like mineral reserves, oil reserves, mines, quarries etc.
The life of such asset is normally expressed in terms of quantity rather than in years.
Depreciation rate (r) = Cost of the asset / estimated quantity likely to be available
Example: A mine was purchased for Rs.10,00,000. Minerals in the mine were expected to be 20,00,000 tons. In the first year, 1, 00,000 tons of minerals were used. The depreciation rate is Rs.10,00,000 /20,00,000 tons x Re.0.50/Ton = Re 0.50 / Ton. The depreciation for the first year is 0.50 x 1, 00,000 tons = Rs.50, 000
- Amortization: Amortization means provision for depreciation on intangible assets.
Such Intangible Asset value (like Goodwill, Patent, Trademark, Computer Software etc.) is written over the beneficial life of the asset.
- Obsolescence: Obsolescence refers to the economic deterioration by way of technological development, taste etc. (e.g old photocopying machines using photosensitive paper, Cameras using film, which are no more in use due to advent of technologically better devices).
Accounting for Depreciation
There are two ways to record depreciation in books. The final implication of accounting treatment of Depreciation, in either of the ways are same.
Provision for Depreciation Account is not maintained: In this method, depreciation is charged to Profit & Loss Account and the cost of asset is reduced. The books show only the written down value of the asset after providing depreciation. The original cost (Historical Cost) is no more maintained in accounts.
Journal Entry for Depreciation
| On purchase of Asset Asset A/c To Bank A/c | Providing depreciation Depreciation A/c To Asset A/c | Charging to PL A/c Profit & Loss A/c To Depreciation A/c | On Disposal of asset Bank A/c To Asset A/c |
Provision for Depreciation Account is maintained: In this method, the original cost (Historical Cost) is not reduced. The depreciation for each year is accumulated to a separate account viz. Provision for Depreciation Account. The current year Depreciation is charged to Profit & Loss Account
Journal Entry for Depreciation
| On purchase of Asset Asset A/c To Bank A/c | Providing depreciation Depreciation A/c To Provision for Depreciation A/c | Charging to PL A/c Profit & Loss A/c To Depreciation A/c | |
| On Disposal of asset | |
| Bank A/c To Asset A/c | Provision for Depreciation A/c To Asset A/c |
The Profit / Loss on Disposal of Asset is adjusted by passing Journal Entry to square off the balance of the Asset a/c
Methods of Depreciation
There are several methods of computation of Depreciation
Based on Useful Life
- Straight Line Method : A fixed amount is charged as depreciation every year. At the end of the life of the asset, the amount of the asset becomes zero.
- Diminishing Balance Method : A fixed Rate on the reduced balance of the asset is charged as depreciation every year.
- Sum of Years of Digit Method : The total of all digits of working life is summed up and the Depreciation rate is applied based on the digit of the respective year and the total of digits of all the years.
Based on Funds required to replace the Asset
- Sinking Fund Method : The amount retained by writing off depreciation is invested in a fund, known as Sinking Fund or Depreciation Fund, to build up fund to replace the asset at the end of its useful life
- Insurance Policy Method : Depreciation is charged to take out an insurance policy to replace the asset at the end of its useful life
- Annuity Method : Depreciation is computed as per annuity table and interest rate
Based on Output received from the Asset
- Machine Hour Method : Working Machine Hours is computed on expected life of Asset. The depreciation is charged applying the Machine Hour Rate.
- Production Unit Method : Production Unit method is used on depleting assets like Mines, Quarries, etc. like depletion method
Straight Line Method
In Straight line method of Depreciation, a fixed amount (the amount of depreciation remains same to each period) is charged as depreciation every year. It is also known as Fixed Instalment Method, Original Cost method.
Annual Depreciation= (Original Cost of the asset – Scrap value) / Estimated useful life.
Ex. A machine costing purchased at Rs.1, 00, 000. Salvage value Rs.10, 000 and a life of 10 years.
Annual Depreciation = (1, 00, 000 – 10, 000) / 10 = Rs.9, 000.
Straight Line Depreciation Rate : Instead of computing the Amount of annual depreciation, the rate of Straight line depreciation may also be computed as
(Straight Line Depreciation / Cost of Asset) x 100%.
So, the Straight Line Depreciation Rate for the above example may be computed as (9000/1, 00, 000) x 100% = 9%. So, applying the rate to Cost of Asset, we get the amount of Straight Line Depreciation = 1, 00, 000 x 9% = 9000
Straight Line Method – Problems
We now explain Straight line Method of Depreciation through an example. A machine, which was purchased for Rs.50, 000, on 1st Jan 2013, was sold out on 30th June, 2015 for Rs.35, 000. The company closes its books on 31st December and it maintains Provision for Depreciation Account. Prepare Plant & Machinery Account and Provision for Depreciation Account for all the years’ upto the year ending 31st December, 2015 taking into account depreciation @ 10% p.a. on straight line basis and also show Plant & Machinery Disposal Account.
Calculation of depreciation on sale of plant
On straight line method, Depreciation for each year is 10% of 50, 000 = 5, 000.
Total Depreciation provision upto 310.6.2015 = 5000 (2013) + 5000 (2014) + 2500 (2015 for 6 months) = 12500. So, WDV as on 30 June 2015= 50, 000 – 12, 500 = 37, 500. So, loss on sale= (37, 500-35, 000)= 2500
Plant & Machinery Account
| Date | Particulars | Dr | Date | Particulars | Cr. |
| 01.01.13 | To Purchase | 50, 000 | 31.12.13 | By Balance c/d | 50, 000 |
| 01.01.14 | To Balance b/d | 50, 000 | 31.12.14 | By Balance c/d | 50, 000 |
| 01.01.15 | To Balance b/d | 50, 000 | 30.06.15 | By Mach. Disposal | 50, 000 |
| 1, 50, 000 | 1, 50, 000 |
Provision for Depreciation Account
| Date | Particulars | Dr | Date | Particulars | Cr |
| 30.06.15 | To Mach Disposal A/c | 12, 500 | 31.12.13 | By Deprn A/c | 5, 000 |
| 31.12.14 | By Balance b/d | 5, 000 | |||
| 30.06.15 | By Deprn A/c | 2, 500 | |||
| 12, 500 | 12, 500 |
Machinery Disposal Account
| Date | Particulars | Rs. | Date | Particulars | Rs. |
| 30.06.16 | To Mach A/c | 50, 000 | 30.06.16 | By Prov for Depn A/c | 12, 500 |
| By Bank A/c (sale) | 35, 000 | ||||
| By P& L A/c (loss on sale) | 2, 500 | ||||
| 50, 000 | 50, 000 |
Diminishing Balance Method
In Diminishing Balance Method, Depreciation at a fixed rate on the reduced balance of the asset is charged every year. As a constant percentage is applied to the written value of the asset, the amount of depreciation will reduce every year. It is also known as Reducing Balance Method, or Written Down Value Method (WDV).
Formula for Depreciation rate computation
Depreciation rate (r) = 1- (s / c) 1/n, whereSalvage value= s, Cost of asset = c, Useful life (in years) =n
Formula for Depreciation computation
D=W x r (where W= WDV at the beginning of the period. R = Rate of Depreciation for the period). The WDV at the end of the year would be WDV= W-D.
Formula for WDV computation
W= Cx (1-r)n, where W=WDV after n years. C = Original Cost, n=number of Period (years). R=rate of depreciation per period (year).
Higher depreciation is charged in initial year which gets reduced every successive year. Expenses on repairs and maintenance, is lower at initial years and higher at later years. Thus total charges are approximately equalized.
Ex. Machine was bought for 50, 000 two years ago. The current book value of the machinery is 36, 125. Rate of Depreciation r = 1 – (36, 125 / 50, 000) ½ = 1 – (0.7225)1/2 = 1 – (0.85) = 0.15 or = 15%
Ex. Original Cost 10, 000, WDV after 1 year @12% pa= 10000 x (1-r)n= 10000x (1-.12) =10, 000 X 0.88 = 8800. WDV after 2 year @12% pa = 10000x (1-.12)2 = 10, 000 x 0.7744 = 7744. You may check this as, WDV after 1 year = 8800. Depn for 2nd year = 12% of 8800 = 1056, WDV after 2 years = 8800 – 1056= 7744
Ex. Original Cost 50, 000, WDV @ 15% pa after 2 years = 50000 x (1-.15)2 = 50, 000×07225 = 36, 125
Straight Line vs Diminishing Balance Method
The key differnce between Straight Line & Diminishing Balance Method are explained here.
| Basis | Straight Line | Diminishing Balance |
| Computation | In Straight Line Method, Depreciation is calculated on the original cost each year. | In Diminishing Balance Method, Depreciation is calculated on written down value. |
| Amount | In Straight Line Method, Depreciation Amount is constant each year. | In Diminishing Balance Method, depreciation Amount declines each year. |
| Yearly Depreciation | In Straight Line Method, depreciation amount is lower than diminishing balance method in earlier years. | In Diminishing Balance Method, Amount of depreciation is higher than straight line method in earlier years. |
| Writing Off | In Straight Line Method, if estimated salvage value is nil, asset is fully written off. | In Diminishing Balance Method, Asset is not fully written off. |
| Maintenance Expenses | In Straight Line Method does not take into consideration expenses on increasing repairs and maintenance over time. | This method takes into consideration expenses on repairs and maintenance, which is lower at initial years and higher at later years. Thus total charges are approximately equalized. |
Sum of Digits Method
Sum of Digits method is just a variation of Reducing Balance Method, in which the Depreciation Amount successively reduces over the years. However, this method is not popular in India.
The sum of all the years of the Asset Life is summed up. The rate of Depreciation is computed as the value of the current year divided by the sum of digits of year
Depreciation for the current period = Cx(n/S). where C=Depreciable amount, , s=Sum of digits of period over whole life. n = Balance life period.
Ex: Cost of Asset Rs 1, 00, 000. Salvage Value Rs 5, 000, Working Life 10years
Total digit of Years (for 10 Years) S= 10+9+8+7+6+5+4+3+2+1=55, Depreciable Amount = 1, 00, 000-5, 000=95, 000
Depreciation for 1st yr = 95, 000 x 10/55 = Rs.17, 273, 2nd year = 95, 000 x 9/55 = Rs.15, 545 and so, on for later years.
Sinking Fund Method
Sinking fund method is a technique for depreciating an asset while generating money to purchase a replacement for the asset at end of its useful life. The business makes adequate investment annually to replace the asset from the proceeds of Principal & Interest earned thereon.
The investment needed for asset replacement fund each year is calculated from the amount needed to replace the asset, useful life, rate of interest (based on compounding). So, the sinking fund method is not commonly used, particularly when interest rates / asset replacement value cannot be reasonably predicted.
The amount written off as depreciation is kept aside and invested in a fund, known as Sinking Fund or Depreciation Fund. The investments are made in readily saleable securities (like govt. securities). The interest is also reinvested. After the expiry of life of the assets, the securities are sold and new assets are purchased from the sale proceeds.
Journal entries are to be passed for Sinking Fund Method.
First Year
| Depreciation A/c Dr To Sinking Fund A/c (For provision of Depreciation by the Instalment amount computed from Sinking Fund Table) | Sinking Fund Investment A/c To Bank (Depreciation Amount invested in securities) | Or, combined entry Depreciation A/c Dr To Sinking Fund A/c (Depreciation amount invested in securities) |
Subsequent Years
| Bank A/c Dr To Interest on Sinking Fund Investment A/c (Interest Received on Investment) | Interest on Sinking Fund Investment A/c Dr To Bank A/c (Interest received transferred to the credit of Sinking Fund A/c). |
For Investment of Depreciation & Interest Amount
| Depreciation A/c Dr To Sinking Fund A/c (For provision of Depreciation) Sinking Fund Investment A/c To Bank Dr (Annual Installment plus Interest invested) |
Final year on redemption of security
| Bank A/c Dr To Interest on Sinking Fund A/c (interest received on investments) | Bank A/c Dr Sinking Fund Investment A/c (Invested Securities redeemed) |
Any balance (Debit or Credit) remaining in Sinking Find A/c, if any, is transferred to P & L A/c
Sinking Fund Method – Problems
We now explain Sinking Fund Method of Depreciation through an example
A lease was purchased for Rs.40, 000. It is to be replaced at the end of 3 years. It is expected that the investment will yield a net interest of 4% p.a. A Sinking fund is made to collect the necessary amount. The Sinking fund investment realized Rs.19, 000. The new lease cost Rs.43, 000.
As per the Sinking fund table shows = Re.1 at the end of 3 years @ 4 % p.a. annual investment of Rs. 0.235490
Journal Entries for 1st Year
| Depreciation Account Dr 9, 419.60 To Sinking Fund Account 9, 419.60 (Annual depn provision for Sinking Fund, 40, 000 x 0.235490 = 9, 419.60) | Sinking Fund Investment Dr 9, 419.60 To Bank 9, 419.60 9, 419.60 (Annual installment invested) |
2nd Year Journal Entries
| Bank A/c Dr 376.78 To Interest on Sinking Fund Investment A/c 376.78 376.78 (Interest earned on 9, 419.60 @ 4% p.a = 376.78 ) | Interest on Sink Fund Invest A/c Dr 376.78 To Sinking Fund A/c 376.78 376.78 (Interest transferred to Sinking Fund) |
| Depreciation A/c Dr 9, 419.60 To Sinking Fund A/c 9, 419.60 9, 419.60 (Deprn for the year transferred to Sinking Fund A/c) | Sinking Fund Investment A/c Dr 9, 796.38 9, 796.38 To Bank 9, 796.38 Amount with Interest (9, 419.6 + 376.78 = 9796.38) invested |
3rd Year Journal Entries
| Bank A/c Dr 768.64 To Int on Sink Fund Invst A/c 768.64 (Interest received on investment (4% on 9, 419.6 +9, 796.38 ) 768.64 | Int on Sink Fund Invst A/c 768.64 To Sinking Fund A/c 768.64 768.64 (Interest transferred to Sinking Fund) |
| Depreciation A/c Dr 9, 419.60 To Sinking Fund A/c 9, 419.60 (Deprn amount transferred to Sinking Fund A/c) |
Final Year entry on disposal
| Bank A/c Dr 19, 000 To Sinking Fund Investment A/c 19, 000 (sale of sinking Fund) | Sinking Fund A/c Dr 215.98 To Sinking Fund Investment A/c 215.98 (transfer of loss [19, 000 – (9, 419.6 + 9, 796.38)] on sale of investment) |
Close of old Lease A/c and New Lease Purchase
| Profit & Loss A/c Dr 215.98 To Sinking Fund A/c 215.98 (Sinking Fund closed by transferring to P& L A/c.) | New Lease A/c 43, 000 To Bank A/c 43, 000 (New lease purchased) |
Annuity Method
Annuity method takes into account the element of Interest to acquire the fixed Asset, for writing off the value of asset together with the Interest, over the useful life of the Asset. The logic is that the amount invested in acquiring the Asset would have earned Interest, had it been invested elsewhere.
This method is suitable for long leases, but may not be very suitable when there is frequent changes in the value of Asset as that would require recalculation of depreciation to be written off.
Under Annuity Method of depreciation the cost of asset is regarded as investment and interest at fixed rate is calculated thereon. Had the proprietor invested outside the business, an amount equal to the cost of asset, he would have earned some interest. So as a result of buying the asset, the proprietor loses not only cost of asset by using it, but also the interest thereon. Hence depreciation is calculated to cover both the elements of losses.
Depreciation amount is computed from Rates taken from Annuity Table. The amount of depreciation includes a portion of the asset and a portion of its expected income (interest).
Depreciation Calculation: 1st year interest is calculated on the book value of asset. Subsequent years- on that balance of the year asset which is on the 1st day of the next year and so on
Example: Lease for 5 year Rs.10, 000. Rate of interest 5%., annuity rate =0.230975. The depreciation per year:
Depreciation of Re.1 in one year is 0.230975
So the depreciation of Rs.10, 000 in one year is 0.230975 x Rs.10, 000 = Rs.2, 309.75.
12A Accounting entries for Annuity Method
| Charging Interest on Asset Asset A/c Dr To Interest A/c Cr | Charging Depreciation on Asset Depreciation A/c Dr To Asset A/c Cr | Transferring Depn to PL P L A/c Dr To Depreciation A/c | Transferring Interest to PL Interest Dr To PL A/c |
Example : A firm purchased a 5 years’ lease for Rs.40, 000 on first January. It decides to write off depreciation on the annuity method. Presuming the rate of interest to be 5% per annum.
As per annuity table, the annual Depreciation Rate at 5% interest for 5 years for 1 Re is 0.230975
So, annual Depreciation is 40000 x 0.230975 = 9239
Lease A/c
| Dr | Cr | ||||
| Jan 1 (1st Year) | To Bank | 40, 000 | 31 Dec (1st Year) | Depreciation | 9239 |
| Dec 31 | To Interest (5% on 40000) | 2000 | 31 Dec | Bal C/d | 32761 |
| 42000 | 42000 | ||||
| Jan 1 (2nd Year) | Bal C/d | 32761 | 31 Dec (2nd Year) | Depreciation | 9239 |
| Dec 31 | Interest (5% on 32761) | 1638 | 31 Dec | Bal C/d | 25160 |
| 34399 | 34399 |
P L A/c
| Dr | Cr | ||||
| Dec 31 (1st year) | Depreciation | 9239 | Dec 31 (1st year) | Interest | 2000 |
| Dec 31 (2nd year) | Depreciation | 9239 | Dec 31 (2nd year) | Interest | 1638 |
So, you see the Depreciation is charged equally on the Asset value and Interest keeps on reducing as the value of asset reduces.
Insurance Policy Method
Insurance policy method of depreciation is quite similar to like sinking fund method. The difference being that the annual depreciation is paid as premium to an insurance company, instead of investing in government papers or gilt-edged securities. The insurance company issues an insurance policy equivalent to cost of asset. At the end of the life of asset, insurance company pays money covered by the policy and a new asset is purchased with it.
The depreciation charged is the amount of premium payable to take out an insurance policy with an insurance company (instead of investing money in securities, as is done in Sinking Fund Method.). The policy should mature immediately after the expiry of the useful life of the asset. The received policy amount is invested to replace the asset.
13A Accounting entries of Insurance Policy Method
| On payment of Premium | Depreciation charged (equal to premium) | On Policy Maturity | Transfer of Excess over premium | Retirement of Asset | Sale of Scrapped Asset |
| Insurance Policy A/c Dr To Cash A/c Cr | P L A/c Dr To Depreciation Fund A/c Cr | Bank Dr To Insurance Policy A/c Cr | Insurance Policy A/c Dr To Depreciation Fund A/c Cr | Depreciation Fund A/c Dr To Asset Cr | Cash A/c Dr Asset Cr |
Example : A business purchased a three years lease of premises for Rs10, 000 and provision for replacement of the lease be made by purchased insurance policy for annual premium of Rs.3, 200.
Journal entries (1st Year)
| 1st Jan | Leasehold A/c Dr To Bank A/c Cr (3 year lease purchase) | 10, 000 | 10, 000 |
| 1st Jan | Depreciation Fund Policy Dr To bank (payment of premium) | 3, 200 | 3, 200 |
| 31 Dec | P L A/c Dr To Depreciation Fund Cr (charge of premium) | 3, 200 | 3, 200 |
=>
Journal entries (2nd Year)
| 1st Jan | Depreciation Fund Policy Dr To bank (payment of premium) | 3, 200 | 3, 200 |
| 31 Dec | P L A/c Dr To Depreciation Fund Cr (charge of premium) | 3, 200 | 3, 200 |
=>
Journal entries (3rd Year)
| 1st Jan | Depreciation Fund Policy Dr To bank (payment of premium) | 3, 200 | 3, 200 |
| 31 Dec | P L A/c Dr To Depreciation Fund Cr (charge of premium) | 3, 200 | 3, 200 |
| 31 Dec | Depreciation Fund A/c Dr To Leasehold A/c Cr (Retirement of Lease Property) | 10, 000 | 10, 000 |
| 31 Dec | Bank A/c Dr To Depreciation Fund Policy Cr (policy maturity proceeds) | 10, 000 | 10, 000 |
| 31 Dec | Depreciation Fund Policy Dr To Depreciation Fund A/c Cr (transfer of excess over premium) | 400 | 400 |
Machine Hour Rate Method
Where it is practicable to compute the running hours of the machine over its useful life, it is logical to provide depreciation on machine hour rate for more accurate charging of machine cost to items produced. This method is suitable where automated machinery is used with little manual labour, and is very scientific, practical and accurate method of recovery of manufacturing overheads.
Machine Hour Depreciation rate is computed on expected machine hours to be run over life of an asset, for plant or machinery, calculated in hours (not in years for which it will be used).
Total effective working hours are estimated (estimated hrs. – Idle time) during the whole life of the machine. The rate is computed as Machine Hour Rate = (Cost of the machine – Scrap value) / Effective Working hrs.
This method does not consider depreciation when a machine not in use.
Ex.: Original cost of a machine Rs.60, 000. Estimated scrap value Rs.10, 000. Expected effective working hours are 25, 000 hrs. The depreciation charge per machine hour would be as follows-
Depreciation per machine hour rate = (60, 000 – 10, 000) / 25, 000 = Rs.2./hr.
During the year, the machine worked for 5000 Hours. So, depreciation provided for the year would be 5000×2 = 10, 000
Production Unit Method
Units of production method of depreciation estimates the depreciation based on the actual usage of the item (like Depletion Method).
In Units of production method of depreciation, depreciation is charged according to the actual usage of the asset. Higher depreciation is charged when there is higher production activity and less is charged when there is low level of operation. Zero depreciation is charged when the asset is idle for the whole period.
This method is mostly used for wasting assets like mines, quarries, oil etc, like as depletion method.
The life of such asset is normally expressed in terms of quantity rather than in years.
Depreciation rate (r) = Cost of the asset / estimated quantity likely to be available / produced
Example: A mine was purchased for Rs.10, 00, 000. Minerals in the mine were expected to be 20, 00, 000 tons. In the first year, 1, 00, 000 tons of minerals were extracted. The depreciation rate is Rs.10, 00, 000 /20, 00, 000 tons x Re.0.50/Ton = Re 0.50 / Ton. The depreciation for the first year is 0.50 x 1, 00, 000 tons = Rs.50, 000
If in the 2nd year, 80000 Tons are produced, the depreciation for the 2nd year = 80, 000x .50 = Rs. 40, 000
15 A Depletion Method
Depletion method is used for resources having limited quantity of materials (like mines and quarries). The computation is similar to Production Unit method.
Computation of Depreciation : Depreciation is usually provided for on the depletion unit basis, which means that such a sum is provided each year as represents the expired capital outlay on the basis of output compared with the estimated total contents of the mine etc.
Ex. A stone quarry estimated to contain 1, 00, 000 tons of stone, is acquired for Rs. 5, 00, 000, The amount of depreciation to be provided will be Rs 5 per ton of stone raised.
In the first year, 10, 000 tons of Stones were cut. The depreciation for 1st year is 10000×5 = Rs.50000
If in the 2nd year, 12, 000 Tons are cut, the depreciation for the 2nd year = 12, 000x 5 = Rs. 60, 000
15 B Profit / Loss on Sale of Fixed Asset
On sale of asset, the difference of Net Book Value of the Asset and Sales Realisation, is written off to Profit & Loss Account as Profit (when sale proceeds is more than Net Asset Value), or loss (when sale proceeds is less than the Net Asset Value)
When WDV is maintained in Books for Assets
An Asset with WDV 15, 000 is sold at Rs 18000.
Journal Entry :
Bank A/c Dr 18, 000
To Asset A/c Cr 15, 000
To Profit on Sales of Asset Cr 3, 000
When Original value and Provision for Depreciation is maintained in Books for Assets
An asset, originally Costing Rs 1, 00, 000 and Depreciation Provision till date Rs 85, 000 is sold at Rs 18000.
Journal Entry :
Bank A/c Dr 18, 000
Provision for Depreciation A/c Dr 85, 000
To Asset A/c Cr 1, 00, 000
To Profit on Sales of Asset Cr 3, 000
Changes in Method of Depreciation
As per Accounting Standards, changes in Accounting Methods need to be disclosed. So, change in Depreciation Methods need to be reported in P L Statement & Balance Sheet.
- Depreciation method should be applied consistently from period to period. A change from one method to another should be made only if the adoption of the new method is required by statute, for compliance with an accounting standard, or if the change would result in a more appropriate presentation of the financial statements.
- When such a change in the method of depreciation is made, depreciation should be recalculated in accordance with the new method from the date of the asset coming into use.
- The deficiency or surplus arising from retrospective recomputation of depreciation in accordance with the new method should be adjusted in the accounts in the year in which the method of depreciation is changed.
- Such a change should be treated as a change in accounting policy and its effect should be quantified and disclosed.
- Deficiency or surplus, as the case may be, should be reflected in the profit and loss statement,
Accounting entries for change in Depreciation Method
- The rate of change in depreciation is to be adjusted for under depreciation or over depreciation.
- Total depreciation provided on asset under existing method will be calculated up to end of the previous year under the existing method
- Total depreciation on asset from the date of retrospective effect to the date of change by would be computed adopting the new method of depreciation
- Difference between the new method and existing method will be calculated. It will be transferred to Profit & Loss A/c
- Depreciation will be charged from the date of change by adopting the new method
Changes in Method of Depreciation : Problems
We now explain the Accounting implication of Change of Method of Depreciation through an example.
A Company had a balance of Rs.4, 05, 000 on 1st January, 2015 in its Machinery account. 10% p.a. depreciation was charged by diminishing balance method. On 1st July, 2015, the company sold a part of machinery for Rs.87, 500, which was purchased on 1st January, 2013 for Rs.1, 20, 000, as a part of it become unless, and on the same date i.e. , on 1st July, 2015, the company purchased a new machine for Rs.2, 50, 000. On 31st December, 2015, the Directors of the company decide to adopt the fixed installment method of depreciation from 1st January, 2013 instead of diminishing balance method. The rate of depreciation will remain the same.
Compute Difference of Depreciation to be charged to P/L A/c and Prepare Machinery account for 2015.
- Computation of W.D.V. as on 1.7.15 and profit / loss on sale of machinery
Cost of machinery on 1.1.13 = 1, 20, 000 – Depr @ 10% for 2013 = 12, 000. W.D.V. as on 31.12.13 = 1, 08, 000
Less : Depreciation @ 10% for 2014 = 10, 800, W.D.V. as on 31.12. 14 = 1, 08, 000 – 10, 800 = 97, 200
Less : Depreciation @ 10% (for 6 months, up to 30th June, 2015) /2 = 9720/2=4, 860
W.D.V. as on 1.7.15 = 97, 200- 4, 860= 92, 340. Sale Value = 87, 500, Loss on Sale = 4, 840
2. Book value of remaining machine as on 1.1.2015 =
Book Value of Total Machinery (4, 05, 000) – Book Value of Machine Sold (97, 200) =3, 07, 800
3. Computation of Book value of unsold machinery as on 01.01.13.
Machine sold having WDV as on 1.1.15, originally cost on 1.1.13 Rs.1, 20, 000
Then the cost of remaining machine as on 1.1.13 was = Rs. 3, 07, 800 x (1, 20, 000 / 97, 200)= 3, 80, 000
4 Amount of Additional depreciation due to change in the method of depreciation :
WDV as on 31.12.1 4 as per FI Method
3, 80, 000 – [Depn for 2013 (38000)+ Depn for 2014 (38000)]= 3, 80, 000 – 76000= 3, 04, 000
WDV as on 31.12.1 4 as per WDVM Method = 3, 80, 000 – [Depn for 2013 (10% on 3, 80, 000 = 38000)+ Depn for 2014 (10% on 3, 80, 000 – 38, 000)= 10% on 3, 42, 000 = 34200)]= 3, 80, 000 – [38000+34, 200]= 3, 80, 000 – 72, 200 = 3, 07, 800
Hence, the difference in depreciation charged to P & L A/c= Rs.(3, 07, 800 – 3, 04, 000) = Rs.3, 800.
Machinery Account as on 31.12.15
Debit Side
| Date | Particulars | Dr |
| 01.01.15 | To Balance b/d | 4, 05, 000 |
| To Bank (Purch. of new machinery) | 2, 50, 000 | |
| 6, 55, 000 |
Credit Side
| Date | Particulars | Cr |
| 01.07.15 | By Bank :Sale of machinery | 87, 500 |
| 01.07.15 | By Deprn for 6 months | 4, 860 |
| 01.07.15 | By P&L A/c : (Loss on disposal) (W.N.1) | 4, 840 |
| 31.12.15 | By P&L A/c (W.N.4) (Adj.for addl deprn) | 3, 800 |
| By Depn (10%on 3, 80, 000= 38, 000) + 10% p.a., on 2, 50, 000 for new machine purchased, for 6 months = 12, 500 | 50, 500 | |
| By Balance c/d | 5, 03, 500 | |
| 6, 55, 000 |
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