Depreciation and Causes for Depreciation

Perhaps one of the most common accounting concepts, Depreciation is

a topic that requires in-depth and conceptual study. In order to gain a

fundamental understanding of the subject, it is very important to

understand the basics of this chapter. Before learning any definitions

and formulas in this chapter, one needs to understand the causes of

depreciation.

The Causes of Depreciation

Depreciation can be easily defined as a reduction in the carrying

amount of a fixed asset. Depreciation is equated with a value of

consumption of the asset for a specific period. Over the span of an

asset, over which it is considered usable, depreciation brings down the

value of the asset to a salvage value.

This salvage value is the sum of money that is expected to accrue to

the owner if he makes a sale of the asset. Or it can be said to be the

scrap value that he gets on disposal of the asset. Following are the

causes of depreciation:

Browse more Topics under Depreciation Provision And Reserves

● Methods of Calculating Depreciation Amount

● Straight Line Method and Written Down: A Comparative

Analysis

● Methods of Recording Depreciation

● Disposal of Asset and any Addition or Extension to the

Existing Asset

● Need for Depreciation and Factors Affecting Amount of

Depreciation

● Provisions

● Reserves

● Declining Charge Method

● Other Methods

Wear and Tear of the Asset

Every machinery or tool is bound to undergo wear over a period of

time. There will be parts that may need replacing or repairing.

Usually, such assets have a fixed span of life, after which, they need to

be scrapped. This wear and tear of the asset must be accounted for in

financial terms, hence depreciation.

Perishability of Inventory

Items such as raw material and inventory, undergone deterioration

over a quick span of time. This is faster in relation to a fixed asset,

which normally lasts for a few years at least. This perishability of

assets is a point of consideration for depreciation accounting.

Usage Right Expiration

Some assets such as software and licenses have a typical span over

which it can be used. As soon as this time span finishes, the owner has

to give up using the asset. So the depreciation of this asset must be

done over time, it cannot just be written off on the day of expiration.

Obsolescence

Another cause of depreciation is the obsolute nature of certain assets.

Over a period of time, every asset loses its novel value. A new

alternative can always be developed for replacing the asset and its

functions.

Need to Comply with Accounting Standards

As per the guidelines set down in the standard of accounting, a firm

needs to follow the matching concept. This means that the funds for

replacing the asset are set aside at regular intervals. Also, the expense

related to each period is charged to that period simultaneously.

It is mandatory to provide depreciation as per Accounting standard 6

and the Companies Act, 2013. Not providing depreciation during a

year is also a violation of the accounting standard and the provisions

stated therein. Further, providing for depreciation ensures that the

accounts of a firm present a true and fair view of the financial status of

the firm.

Solved Example for You

Question: X Corporation purchases the special deluxe machine for

INR 60,000. It has an estimated salvage value of INR 10,000 and also

a useful life of five years. How will X calculate straight-line

depreciation for the machine for the year ending?

Answer – Calculation of Depreciation is done as follows:

Purchase cost of INR– estimated salvage value of INR = Depreciable

asset cost of INR

60,000 – 10,000 = 50,000

Depreciation = Depriciable Cost / Useful Life = 50,000/5 years

Depreciation = Rs. 10,000/- per year.

Methods of Calculating Depreciation Amount

Depreciation is a simple and interesting concept to study in

accountancy. It holds the vital answer to the amount of expense which

is charged to the profit and loss account during a period. The amount

of depreciation, like other expenses, impacts the amount of profit

earned or loss incurred during a year. Therefore, it is important to

study the different methods, such as SLM, annuity method etc. Let us

study these methods.

The Methods of Charging Depreciation

(Source: accountlearning)

Straight Line Method (SLM)

The straight line depreciation is the most commonly used depreciation

method in accounts and is used mainly owing to its simplicity. For the

application of the straight line method, a firm charges an equal amount

of the asset’s cost to each accounting period. The straight line formula

that is used to calculate depreciation expense is as follows:

Asset’s historical cost – the asset’s estimated salvage value / the

asset’s useful life

Units of Production

The units of production depreciation method allocate an equal amount

of expense to each unit produced or service rendered by the asset. This

method is usually applied to assets used in the production line. The

formula to calculate depreciation expense involves the following

steps:

Determine the depreciation per unit:

(Asset’s historical cost – estimated salvage value) / estimated total

units of production during the asset’s useful life

Determine the expense for the accounting period:

Browse more Topics under Depreciation Provision And Reserves

● Depreciation and Causes of Depreciation

● Straight Line Method and Written Down: A Comparative

Analysis

● Methods of Recording Depreciation

● Disposal of Asset and any Addition or Extension to the

Existing Asset

● Need for Depreciation and Factors Affecting Amount of

Depreciation

● Provisions

● Reserves

● Declining Charge Method

● Other Methods

(Depreciation per unit X number of units produced in the period)

Sum of Year’s Digits

Sum of years’ digits is a depreciation method that results in a more

accelerated write off of the asset than the straight-line method, but less

accelerated than that of the double-declining balance method. Under

this method, annual depreciation is determined by multiplying the

depreciable cost by a series of fractions based on the sum of the

asset’s useful life digits. The sum of the digits can be determined by

using the formula:

(n2+n)/2, where n is equal to the useful life of the asset

Double Declining Balance

The double-declining balance method is a type of accelerated

depreciation method that calculates a higher depreciation charge in the

first year of an asset’s life and gradually decreases depreciation

expense in subsequent years. This method is used if the organization

wants to increase the expenses for the year, to reduce tax liability.

Annuity Method

Annuity depreciation methods are usually not based on time, but on a

level of Annuity. This could be miles driven for a vehicle, or a cycle

count for a machine. When the asset is acquired, its life is estimated in

terms of the level of activity or annuity. Assume a vehicle above is

estimated to go 50,000 miles in its lifetime. The per-mile depreciation

rate is calculated as follows:

(INR 17,000 cost – INR 2,000 salvage) / 50,000 miles = INR 0.30 per

mile

Each year, the depreciation expense is then calculated by multiplying

the number of miles driven by the per mile depreciation rate.

Solved Question for You

Question: Discuss group depreciation method.

Answer – We use the group depreciation method for depreciating

multiple assets using a similar type of depreciation method. The assets

must be similar in nature and also have approximately the same useful

lives for using this method.

Straight Line Method and Written Down: A Comparative Analysis

The basis of charging depreciation in accounts impacts the amount of

profit earned or loss incurred during a year. Thus, it is important to

choose the method of charging depreciation wisely, in order to arrive

at the correct value of gain or loss. Let us understand how the straight

line method of depreciation is different from the written down value

method.

Learn depreciation and causes of

depreciation here.

The Straight Line Method

In this method of depreciation, we write off a fixed value every year

during the useful life of the asset. The reason for this being reduction

of the value of the asset to zero or the scrap value at the end of the

useful life. In this method, we spread the cost of the asset equally over

the lifetime of the asset. This method is also known as fixed

instalment method.

A particular asset is expected to generate equal utility during its useful

life. Let’s understand the formula for calculating the rate of

depreciation by the straight line method:

Depreciation rate = Depreciation / cost of asset * 100

Browse more Topics under Depreciation Provision And Reserves

● Depreciation and Causes of Depreciation

● Methods of Calculating Depreciation Amount

● Methods of Recording Depreciation

● Disposal of Asset and any Addition or Extension to the

Existing Asset

● Need for Depreciation and Factors Affecting Amount of

Depreciation

● Provisions

● Reserves

● Declining Charge Method

● Other Methods

The Written Down Value Method

In this method, a fixed percentage of the reducing balance is written

off every year as depreciation. This reduces the fixed asset to its

residual value at the end of its working life. This method is also

known as reducing balance or diminishing balance method where the

annual charge of depreciation keeps on decreasing every year.

The depreciation charged in the initial years is higher as compared to

the subsequent years. According to this method, the value of the asset

is not fully extinguished. Let’s understand the formula for calculating

the rate of depreciation:

(Source: Quora)

What are the Factors affecting the amount of Depreciation? Learn

here.

How do SLM and WDV Method of Depreciation Compare?

BASIS FOR COMPARISON SLM WDV

Meaning In this method of depreciation, the cost of the asset is spread equally over the life years by writing off a fixed amount every year.

In this method of depreciation, a fixed rate of depreciation is charged on the book value of the asset, over its useful life.

Calculation of depreciation On original cost On written down value of the asset.

Annual depreciation charge

Remains fixed during the useful life. Reduces every year.

Value of asset Completely written off Not completely written off

Amount of depreciation Initially lower Initially higher

Impact of repairs and depreciation on P&L A/c Increasing trend Remains constant

What are the provisions? Learn here.

Question for You

Ques: Compare the arithmetical difference between SLM and WDV

method of charging depreciation.

Answer – Suppose the amount of fixed asset is INR 1,00,000. The rate

of depreciation is 10%. Over a span of 4 years, if repair charges are

2,000, 4,000, 6,000 and 8,000 every year, the depreciation will be

charged as follows:

SLM:

Year Depreciation Amount debited

1 10000 12000

2 10000 14000

3 10000 16000

4 10000 18000

WDV:

Year Depreciation Amount debited

1 10000 12000

2 8000 12000

3 6000 12000

4 4000 12000

Methods of Recording Depreciation

Depreciation is an integral component of accounting. It stands to

impact the preparation of accounts. The amount recorded under the

head of depreciation ultimately impacts the amount shown as profit or

loss in the statement of income. Hence, it is pertinent to study and

make calculations for the same in a calculated manner, which ensures

fair and accurate presentation of accounts. Let us study the methods of

recording depreciation as per depreciation accounting.

Methods of Depreciation Accounting

Usually, there are two methods of recording depreciation in

depreciation accounting. They are as follows:

Direct Method (No Provision for Depreciation Account is Maintained)

You can charge depreciation by debiting the Depreciation Account

and crediting the respective Asset Account. Further, close the

Depreciation account by transferring the amount to the Profit and Loss

Account at the end of the year. The asset account then appears in the

Balance Sheet at its written down value that is, cost less depreciation

at the end of the year.

Let’s take a look at the journal entries that must be recorded under this

method of depreciation accounting

Recording Amount of Depreciation

Depreciation A/c – Dr.

To Asset A/c

Closing Depreciation Account

Profit & Loss A/c – Dr.

To Depreciation A/c

Purchase of an Asset

Asset A/c – Dr.

To Bank A/c

Sale of an Asset (Disposal)

Bank A/c – Dr.

To asset A/c

Transfer of Profit on Sale

Asset A/c – Dr.

To Profit & Loss A/c

Transfer of Loss on Sale

Profit & Loss A/c – Dr.

To Asset A/c

Indirect Method (Provision for Depreciation Account is Maintained)

You have to debit the amount of depreciation to the Depreciation

Account and credit it to the Provision for Depreciation Account (or

Accumulated Depreciation Account, if so maintained). The amount of

depreciation is then transferred to Profit and Loss Account at the end

of the year. However, the Asset Account will appear at cost.

Further, the accumulated depreciation appears either shown as a

deduction from the asset or the same may appear in the liability side of

the Balance Sheet. Let’s take a look at the journal entries that are

different from the direct method. The other entries will remain same.

Recording the Depreciation Amount

Depreciation A/c – Dr.

To Provision for depreciation A/c

To Close Depreciation Account

Profit & loss A/c – Dr.

To Depreciation A/c

To Close the Provision Account and Asset Account

Provision for depreciation A/c – Dr.

To Asset A/c

Take note that the profit and loss on sale of the asset will remain the

same.

Browse more Topics under Depreciation Provision And Reserves

● Depreciation and Causes of Depreciation

● Methods of Calculating Depreciation Amount

● Straight Line Method and Written Down: A Comparative

Analysis

● Disposal of Asset and any Addition or Extension to the

Existing Asset

● Need for Depreciation and Factors Affecting Amount of

Depreciation

● Provisions

● Reserves

● Declining Charge Method

● Other Methods

Solved Question for You

Question: The cost of a machine is IR 1,000 and its depreciation is

10% p.a. show the entries to record the depreciation.

Answer –

Depreciation a/c Dr. 100

To Machinery a/c 100

(Being depreciation charged on machinery @10% p.a.)

Profit and loss a/c Dr. 100

To Depreciation a/c 100

(Being transfer of depreciation)

Q: What are the advantages of maintaining a Provision for

depreciation account?

Ans: The advantages are as follows,

● The Asset continues to be recorded at historical cost. This

important for continuity purpose.

● Provision for Depreciation ensures that the accumulated

depreciation of every asset is easily available at all times.

● When fixed asset needs to be revalued it is easy, since they

were maintained at historical cost.

Disposal of Asset and any Addition or Extension to the Existing Asset

Depreciation is one of the most important concepts of the accounting

world. It governs the posting of the value of a fixed asset in the

balance sheet of a firm. Disposal and addition of an asset will also

have an impact. Let us see how.

The method of charging depreciation during a particular year not only

impacts the carrying value of an asset on the balance sheet but also

affects the profit earned or loss incurred during a specific period.

Thus, the role of an accountant in a firm finds an intense importance

when it comes to the calculation relating to the depreciation of fixed

asset list.

Browse more Topics Under Depreciation Provision And Reserves

● Depreciation and Causes of Depreciation

● Methods of Calculating Depreciation Amount

● Straight Line Method and Written Down: A Comparative

Analysis

● Methods of Recording Depreciation

● Disposal of Asset and any Addition or Extension to the

Existing Asset

● Need for Depreciation and Factors Affecting Amount of

Depreciation

● Provisions

● Reserves

● Declining Charge Method

● Other Methods

How does Addition and Disposal of an Asset Affect the Amount of Depreciation?

The amount of depreciation which is charged during a year depends

on various factors. These include the cost of the asset, the salvage

value of the asset, the expected life of the asset and more. Apart from

these, any form of addition or deletion from the asset, during a

specific period, also affects the effective value of depreciation which

will be charged to the profit and loss account.

In order to correctly calculate the total value of a firm’s assets and the

total of the amount of depreciation, it is always necessary to correctly

record the details of every purchase, which means an addition of a

fixed asset and every sale which implies a disposal of a fixed asset.

Period of 180 days or more

If an asset is being used for a period of 180 or more in the previous

year then it will be eligible for full rate depreciation whatever

applicable to the asset. If the asset is used for less than 180 days then

it will depreciate by half rate only.

In the case of additions, the following points should be borne in mind:

● The date of the purchase of the asset

● The provider of the asset

● The cash price of the asset at the time of its purchase.

● Details of the asset

In the case of Disposal, the following points should be borne in mind:

● The date of the sale of the asset

● The acquirer of the asset.

● The cash price for which the asset was sold for

● The total of the amount of accumulated depreciation at the time

of the sale.

Here are the options for accounting when a disposal of assets takes

place:

● No proceeds and fully depreciated:

Accumulated Depreciation A/c – Dr.

To fixed asset A/c

● Loss on sale:

Cash A/c – Dr. (for the amount received)

Accumulated depreciation A/c – Dr.

Loss on sale of asset A/c – Dr.

To fixed asset A/c

● Gain on sale:

Cash A/c – Dr. (For the amount received)

Accumulated depreciation A/c – Dr.

To fixed asset A/c,

To gain on sale of asset A/c

Question for You

Q: ABC International buys a machine for INR 50,000 and recognizes

INR 5,000 of depreciation per year over the following ten years. At

that time, the machine is fully depreciated, ABC gives it away. ABC

International sells at INR 100,000 machine for INR 35,000 in cash,

after having compiled INR 70,000 of accumulated depreciation. Pass

Entries.

Answer –

Accumulated Depreciation A/c – Dr. 50,000

To Machine A/c 50,000

Cash A/c – Dr. 35,000

Accumulated depreciation A/c – Dr. 70,000

To Gain on asset disposal A/c 5,000

To Machine asset A/c 1, 00,000

Need for Depreciation and Factors Affecting Amount of Depreciation

When an accountant prepares the accounts of a firm and jots down the

amount of depreciation, he brings down the potential gains of the firm.

The amount of depreciation is an expense for an entity. Thus, it is

imperative to make the correct and accurate calculations. Let us

understand what is depreciation and why we need to provide for it.

Need to Provide Depreciation

Depreciation needs to be provided because an asset is bound to

undergo wear and tear over a period of time. This reduces the working

capacity and effectiveness of the asset. Hence, this should reflect the

value of the asset, at which it is carried in the books of accounts.

Also, every asset becomes obsolete over a period of time, as new

technology and innovation take over. The value of the asset will hence

decrease over time and this must be accounted for.

Browse more Topics under Depreciation Provision And Reserves

● Depreciation and Causes of Depreciation

● Methods of Calculating Depreciation Amount

● Straight Line Method and Written Down: A Comparative

Analysis

● Methods of Recording Depreciation

● Disposal of Asset and any Addition or Extension to the

Existing Asset

● Provisions

● Reserves

● Declining Charge Method

● Other Methods

Moreover, in order to comply with the matching principle of accounts,

it is ideal to provide depreciation. The Matching principle says that the

expense of a period must be recognized in the same period in which

we recognize it’s revenue. So an asset which generates income must

be depreciated as per given provisions.

Factors Affecting Amount of Depreciation

The amount of depreciation is impacted by a number of factors. Let us

take a look at some of them. There are four main factors to consider

when calculating the depreciation expense are as follows:

● The cost of the asset.

● The estimated salvage value of the asset. Salvage value (also

called residual value) is the amount of money that the company

expects to recover, less the disposal costs, on the date the asset

is scrapped, sold, or traded in.

● Estimated useful life of the asset. Useful life refers to the

window of time that a company plans to use an asset. Useful

life can be expressed in years, months, working hours, or units

produced.

● Obsolescence should be considered when determining an

asset’s useful life and will affect the calculation of

depreciation. For example, a machine capable of producing

units for 20 years may be obsolete in six years; therefore, the

asset’s useful life is six years in this case.

A company is free to make use of the most appropriate depreciation

method for its business operations. Accounting theory suggests that

companies should make use of a depreciation method that closely

reflects the company’s’ economic circumstances. Thus, companies can

choose a method that allocates the asset cost to accounting periods

according to benefits received from the use of the asset.

Most companies use the straight-line method for financial reporting

purposes, but they may also use different methods for different assets.

The most important criteria to follow is to Use a depreciation method

that allocates asset cost to accounting periods in a systematic and

rational manner.

Solved Question for You

Question: How do factors affecting depreciation impact the amount of

depreciation?

Answer – This can be understood through the following example:

Assume a purchased truck is valued at INR 10,000, has a residual

value of INR 5,000, and a useful life of 5 years. Its depreciation

expense for year 1 is INR 10000−INR 5000 = INR 1000 INR 10000 –

INR 5000/5 = INR 1000.

Provisions

If you have ever studied a balance sheet, you must have come across

an item of provisions. It is listed on the liabilities side of the balance

sheet. As easy as it sounds, it is not simple to understand the concept.

You ought to understand this term and the purpose why we make use

of it in accounts. Let us understand what provisions are.

What is a Provision?

A provision is usually an amount that is set aside from a company’s

profits, usually to cover an expected liability or a decrease in the value

of an asset, even though the specific amount of the same might be

unknown. A provision should not be understood as a form of savings,

instead, it is a recognition of an upcoming liability, in advance.

Reserves, another common accounting term, and provisions are

strictly not interchangeable terms. Whereas a provision is intended to

cover upcoming liabilities, a reserve is a part a business’s profit, set

aside to improve the company’s financial position through growth or

expansion.

Browse more Topics under Depreciation Provision And Reserves

● Depreciation and Causes of Depreciation

● Methods of Calculating Depreciation Amount

● Straight Line Method and Written Down: A Comparative

Analysis

● Methods of Recording Depreciation

● Disposal of Asset and any Addition or Extension to the

Existing Asset

● Need for Depreciation and Factors Affecting Amount of

Depreciation

● Reserves

● Declining Charge Method

● Other Methods

Providing a Provision in Accounting

In accounting terms, the matching principle states that the expenses

should be ideally reported in the same financial year as the correlating

revenues. This is because the costs that belong to a certain year can

become misleading if accounted for in the previous or the future

financial years.

Provisions, therefore, adjust the current year balance to be more

accurate by ensuring that costs are recognized in the same accounting

period as the relevant expenses. Provisions are recognized in the

balance sheet and are also expensed on the income statement.

Types of Provisions in Accounting

The most common type of provision is a provision for bad debt. A

provision for bad debt is one that has been calculated to cover the

debts encountered during an accounting period that is not expected to

be paid.

This provision is usually included in the budget which is created by a

company and can be estimated based on past experience with bad debt

amounts as well as industry averages. A general provision is not

allowed as a tax deduction. A specific provision in which specific

debts are identified is usually allowed as a tax deduction if there is

documentary evidence to indicate that these debts are unlikely to be

paid.

The Other common kinds of provisions in accounting include:

● Restructuring Liabilities

● Provisions for bad debts

● Guarantees

● Pension

● Depreciation

How can Provision be Created?

There are a number of factors that cause a company to create

provisions. There are certain requirements that must be fulfilled before

a financial obligation can be viewed as a provision. These include:

● The company must perform a reliable amount of regulatory

measurement of the obligation.

● It must be probable that the obligation results in a financial

drag on economic resources.

Solved Questions for You

Question: Through a journal entry, depict how a written off bad debt

provision will be recorded in the books of accounts.

Answer – The entry is as follows,

Bad debt expense A/c Dr

200

To Bad debt provision A/c 200

Question: Pass a journal entry for the provision of Audit Expense for

the year.

Answer: The journal entry is

Audit Expense A/c – Dr. Dr

20,000

To Provision for Audit Expense A/c 20,00

0

Reserves

Another common term which finds a place in the balance sheet of a

firm is reserves. The amount of reserves is a very important

component in the financial statements. This is because, any amount

which is kept aside in reserves, brings down the amount of profits of

the firms. Thus, the study of reserves and how they are created, are

pertinent to the understanding of accounting terms. Let us get to know

what is a reserve.

What is a Reserve?

When a company earns a given amount of profit at the end of a

financial year, a certain portion of it is usually retained in the business

to meet future contingencies, growth prospects and more. This amount

of money which is kept aside is termed as Reserves.

Reserves help in safeguarding the financial position of a company and

can be used for various purposes such as expansion, stable dividend

repayments, legal requirements, meeting contingencies, improving the

financial situation, investments and more. It is also sometimes referred

to as retained earnings. It is shown on the liability side of a balance

sheet under the head “Reserves and Surplus” along with capital. If a

company incurs losses then it is not created.

Browse more Topics under Depreciation Provision And Reserves

● Depreciation and Causes of Depreciation

● Methods of Calculating Depreciation Amount

● Straight Line Method and Written Down: A Comparative

Analysis

● Methods of Recording Depreciation

● Disposal of Asset and any Addition or Extension to the

Existing Asset

● Need for Depreciation and Factors Affecting Amount of

Depreciation

● Provisions

● Declining Charge Method

● Other Methods

Revenue Reserves

Revenue reserves are created out of profits earned from operations of

a company. It is reflected in profit and loss appropriation account. It

can be used for the following purposes:

● Dividend to shareholders

● Expansion of business

● Stabilizing the dividend rate

Revenue reserves are divided into two types & each is kept aside for

appropriation for profits. General reserves are created out of profits &

kept aside for general purpose and financial strengthening of the

company, it doesn’t have any special purpose to fulfill and can be used

for any useful reason in future. Such reasons include meeting

contingencies and expansions that cannot be foreseen.

Specific reserves, on the other hand, are created keeping a specific

reason in mind and can only be used for its designated purpose.

Examples of such reserves include Dividend Equalization Reserve,

Debenture Redemption Reserves, Contingency Reserves, Capital

Redemption Reserves and more.

Capital Reserve

A capital reserve is created upon revaluation of an asset, such that it

reflects the current market value. The capital reserve is created out of

capital profits & are usually not distributed as dividends to

shareholders. As a rule, they cannot be created out of profits earned

from core operations of a company.

How are Reserves Created?

When an appropriation for an amount for reserves, record an entry to

create the reserve account by debiting retained earnings and crediting

the general or specific reserve account.

Profit & Loss A/c – Dr.

To reserve A/c

Solved Question for You

Question: A business wants to reserve funds for a future building

construction project. It credits a Building Reserve fund for INR 5

million and debits retained earnings for the same amount. The

building is then constructed at a cost of INR 4.9 million, which is

accounted for as a debit to the fixed assets account and a credit to

cash. What happens when the building is completed?

Answer: The original entry is reversed, where INR 5 million will be

debited to the building reserve account and credited to the retained

earnings account.

Other Methods

Depreciation refers to the decline or decrease in the value of a

depreciable fixed asset due to the normal wear and tear or efflux of

time or obsolescence. There are various methods of depreciation that

we can apply to accounts. We treat depreciation as an expense and

thus, charge it to the Profit and Loss A/c. Besides the uniform charge

method and declining charge method, there are also other methods of

charging depreciation.

Other Methods of Depreciation

The following methods fall under this category:

● Group Depreciation Method

● Depletion Method

● Machine Hour Rate Method

● Inventory System (Valuation)

Group Depreciation Method

Under this method, we combine all the fixed assets of a similar nature

into a pool with a common cost base in order to calculate depreciation.

The basis underlying the pooling is that they are similar in the way

they function or each asset is too small to consider it material

individually.

This method is also known as the Composite depreciation method. For

example, the trolleys that we use in the shopping malls are their assets

but are too small to consider each of them as material. Thus, we can

charge depreciation on them as per the group depreciation method.

Generally, this method is used for smaller items that have a low cost.

It simplifies the calculation of the depreciation. Also, it saves time and

costs incurred in accounting and auditing work. However, due to the

various accounting software that easily records depreciation of the

individual assets, the use of this method is less in use.

Depletion Method

Depletion refers to the exhaustion of natural resources. Thus, we use

this method where our assets are some natural resources. We pay a

price to use the natural resources. Examples of such assets can be the

oil well, coal mines, mineral deposits, etc.

Under this method, we calculate depreciation on one unit of output.

This is calculated by dividing the total cost of acquisition or the

purchase price of the asset by the expected number of units that can be

produced. This method is similar to the Units of Production Method.

Depreciation per unit of output =

Costoftheasset

Estimatedtotalunitsofoutput

Machine Hour Rate Method

Under this method, we calculate the hourly rate of depreciation. This

is done by dividing the total cost of the asset by the estimated working

hours. Thus, the useful life of the asset is the estimated number of

machine hours for which it can be used.

In this case, the actual depreciation depends on the working hours

during the period. This method is useful in case of textile and jute

mills and also in the handloom industry.

Depreciation per hour =

ostoftheAsset–ResidualValue

Estimatedtotalmachinehours

Browse more Topics under Depreciation Accounting

● Accounting Concept of Depreciation

● Uniform Charge Methods

● Declining Charge Methods

Solved Example For You:

Amrit Ltd. purchases a machine on 1st April 2015 for ₹110000 and

pays ₹20000 for its installation. At the end of its useful life, the

machine may realize ₹30000. It’s expected life in machine hours is

200000 hours. The machine hours utilized in 2015 are 10000, in 2016

are 15000 and in 2017 are 25000. Calculate the amount of

depreciation.

Ans.

Hourly Rate of depreciation =

ostoftheAsset–ResidualValue

Estimatedtotalmachinehours

=

110000+20000–30000

200000

= 0.50 paise per hour

Depreciation = Machine hours x rate per hour

2015: 10000 x 0.50 = ₹5000

2016: 15000 x 0.50 = ₹7500

2017: 25000 x 0.50 = ₹12500