Depreciation can be defined as the falling

value of an asset due to age, use, and wear

and tear. As the machine grows old, its value
comes down. A certain amount of money has
to be collected after each year and kept
separate so that the money thus accumulated
can be used for buying a new machine, when
the present machine becomes old and fails to
give the required output. When it becomes
obsolete, it is usually sold at a price known as
salvage value.

Straight line method

Reducing/declining balance method

Sinking fund method

The annual depreciation charged under this

method is calculated as follows:
Annual depreciation charge=(C-S)/N
where C=acquisition/original cost of equipment
S= salvage value
N=operating life

It is constant all throughout the life of the

equipment. We do not charge any interest
normally in this system. This system is based on
a false assumption that an asset depreciates
equally every year which is obviously not true in
most of the cases of capital assets like machines.

The rate of depreciation in reducing balance method is

shown below:
R= 1-n(S/C)
where R= rate of depreciation in percentage collected
annually on an asset
After 1st year, depreciation collected=C X R
After 2nd year, depreciation collected
=CR+(C-CR)R = CR+CR-CR =2CR-CR
=C(2R-R) = C(1-1+2R+R)
=C{1-(1-R)}
After nth year, total depreciation accumulated =
C[1-{(1-R)^n}] = C-S
R= 1-n(s/c)

This method is based on the assumption of setting up a

sinking fund in which money is accumulated to replace
the existing asset at the proper time. An identical sum
is charged every year as depreciation. This is invested
outside the business so that from the end of the 2nd
year and each subsequent year, interest is added.
Sinking fund at the end of the 1st yr=Sf
Sinking fund after 2nd yr= Sf +Sf(i) + Sf
= 2Sf+ Sf(i) = Sf(2+i) = Sf(2+i)(i/i)
= (Sf/i)(2i+i) = (Sf/i){(1+i)-1}
Sinking fund after nth yr= (Sf/i)[{(1+i)^n}-1] = C-S
Sf= (C-S)[i/[{(1+i)^n}-1]]
i/[{(1+i)^n}-1] is called Sinking Fund Deposit Factor
(SFDF)

Reducing balance method

Straight Line method
Sinking fund method

Cost
(c)

s
1

3
4
Operating life in years

Original cost (C)= Rs.7000

Salvage value (S)=Rs.1000
Operating life= 6 yrs
Rate of Return on Investment= 8%
Calculate:
1. capital recovered
2. capital unrecovered beginning of the year
3. return on capital unrecovered
4. capital recovered + return

Annual depreciation charge= (7000-1000)/6=1000

Year

Capital
recovered

Capital
unrecovered
beginning of
the year

Return on
capital
unrecovered

Capital
recovered +
Return

1000

7000

560

1560

1000

6000

480

1480

1000

5000

400

1400

1000

4000

320

1320

1000

3000

240

1240

1000

2000

160

1160

i=.08

Year

n=6

SFDF=.08/(1.08-1) = 0.13632

Capital
recovered

Capital
unrecovered
beginning of
the year

Return on
capital
unrecovered

Capital
recovered +
Return

817.92

7000.00

560.00

1377.92

883.35

6182.08

494.56

1377.92

954.02

5298.73

423.90

1377.92

1030.35

4344.61

347.57

1377.92

1112.78

3314.26

265.14

1377.92

1201.80

2201.48

176.12

1377.92

R= 1-n(S/C) = 1-n (1000/7000) = 0.277

Year

Capital
recovered

Capital
unrecovered
beginning of
the year

Return on
capital
unrecovered

Capital
recovered +
Return

1939.00

7000.00

560.00

2499.00

1401.90

5061.00

404.80

1806.70

1013.57

3659.10

292.73

1306.30

732.81

2645.53

211.64

944.45

529.82

1912.72

153.02

682.84

382.84

1382.10

110.57

493.41