Accounting for Depreciation

 The costs relating to the use of long term assets should be properly calculated &
matched against the revenue earned so that periodic net income can be determined
 Depreciation is the name given to the “use-costs” of various assets

Types of Long Term Name of the expense for

Assets write-off
A) Tangible Assets:
(1) Land None
(2) Building, Equipment, Depreciation
Tools, Furniture,
Vehicles Depletion
(3) Natural Resources such
as oil, coal, ore,
mineral deposits
B) Intangible Assets such as Amortization
Patent, Copyrights,
trademarks & Goodwill
 Depreciation
 Depreciation is a term which is used in case of
tangible assets like building, machinery, furniture
etc.

 Depreciation refers to the systematic & rational

allocation of the acquisition cost of tangible assets
to future periods in which the benefits help to
generate revenue
Accounting Problem in Long-Term Assets

Measurement of cost to be written-

Acquisition
off over the asset’s life

Determination & allocation of Accounting for subsequent

Useful Life of the Asset consumed cost of assets to expenditures such as repairs
periods benefitted maintenance etc.

Recording of gain or loss on

Disposal
disposal
Causes For Depreciation

 Decline in the service potential of an asset

 Physical deterioration

 Obsolescence
 Need For Depreciation
The need for charging a reasonable amount of depreciation over the estimated
useful life of the asset arises for the following purposes:

To ascertain the true income for the period



To show the asset at its proper value



To maintain fund out of the profit for future replacement of the asset


To allocate the cost of fixed asset to product



To compute tax liability


 Factors in Computing Depreciation Expense

 Three factors determine the depreciation expense

for a fixed asset. These three factors are as follows:

1.The asset’s initial cost

2.The asset’s expected useful life

3.The asset’s estimated residual/salvage/scrap value

Methods of Charging Depreciation

 Straight Line Method: This method assumes that depreciation is a function of time
rather than use

Annual Depreciation = (Acquisition cost - Estimated Scrap Value) / Life in Years

Question # 1
A firm bought a plant for Rs. 4,00,000 on 1st Jan 2001 & its useful life was estimated to be 10
years. Its scrap value at the end of the 10 years was Rs. 40,000. Find out the amount of
depreciation for the first 3 years by straight line method.

Question # 2
ABC Ltd. Acquires a machine on 1st July 2001 at a cost of Rs. 2,80,000 & spent Rs. 20,000 on
its installation. The firm writes-off depreciation at 10% of the original cost every year. The
books are closed on 31st December every year. Find the amount of depreciation for the year
2001.
 Methods of Charging Depreciation

 Diminishing Balance Method: Under this method a fixed percentage of depreciation

is applied to written-down book value of the assets. In other words, depreciation is
calculated on the reduced balance (asset cost-depreciation) & not on the original cost

Question # 3
Y Ltd. Company purchased a machine costing Rs. 3,00,000 on 1 st Jan 1997. The
depreciation is to be charged at 25% per annum on diminishing balance method.
Calculate the depreciation for the first 3 years.

Question # 4
On 1st Jan 1999, a company purchased a machine costing Rs. 5,00,000. Its estimated
working life is 10 years at the end of which it will fetch Rs. 20,000. Calculate
depreciation for the first 4 years if 20 percent depreciation has to be applied on
diminishing balance basis.
 Methods of charging depreciation

 Units of Production Method: This method is based on use rather than time. The
more units produced, the more is the depreciation. In this method an estimation
of the total production capacity of the asset in terms of units is stated &
depreciation is charged as per the usage

Depreciation = (Depreciable Base /

Estimated Total Units Production Over Full Life) * Units Produced
in a Particular Year

Question # 5
A machine is purchased on 1st Jan 2001. Its cost is Rs. 3,00,000 & salvage value is
Rs. 10,000. The vendor estimates that the machine is able to produce 5,00,000 units
of the product over its lifetime. In 2001, 25,000 units have been produced, calculate
the amount of depreciation expense that should be charged.