Depreciation

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Chapter 11Depreciation

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Depreciation

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CHAPTER AT A GLANCE (Chapter 11)11.01 Meaning of Depreciation11.02 Characteristics of Depreciation11.03 Depreciation and Other Related Concepts11.04 Causes of Depreciation11.05 Accounting Concept of Accounting11.06 Objectives or Need for Providing Depreciation11.07 Factors or Basis of Providing Depreciation11.08 Methods of Recording Depreciation11.09 Methods of Charging Depreciation11.10 Change of Method of Depreciation11.11 Practical Issues Relating to Depreciation

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11.01 MEANING OF DEPRECIATIONDepreciation means a fall in the value of an asset because of usage or with efflux of time or due to obsolescence or accident. Every fixed asset looses its value, once it is put to use.

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11.01 MEANING OF DEPRECIATIONDepreciation is a part of the cost of fixed asset which has expired on account of its usage and/or lapse of time.

In other words, it is reduction in the value of a fixed asset.

It is important to note that depreciation is charged on all fixed assets except land.

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11.03 DEPRECIATION AND OTHER RELATED CONCEPTS1. Depreciation and Depletion2. Depreciation and Obsolescence3. Depreciation and Amortisation

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11.04 CAUSES OF DEPRECIATION1. Use of Asset2. Efflux of Time3. Obsolescence4. Accidents:

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11.05 ACCOUNTING CONCEPT OF DEPRECIATION The Accounting Concept of Depreciation means distribution of cost of fixed assets over its estimated life in a reasonable manner. According to this concept, in an accounting period,

diminution in the value of assets can be charged to that accounting period.

Annual depreciation in the value of assets is like an expense which is due to use of assets in the functions of business and thus, is a charge on profits.

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11.06 OBJECTIVES OR NEED FOR PROVIDING DEPRECIATION1. To Ascertain the Correct Profit or Loss2. To Show a True and Fair View of the Financial Position3. To Show the Asset at its Proper Value4. To Retain, Out of Profits, Funds for Replacement5. Compliance of Legal Provisions

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11.07 FACTORS OR BASIS OF PROVIDING DEPRECIATION1. Original (Historical) Cost of the Asset2. The Estimated Residual or Scrap Value at the End of

its Life3. Estimated Effective or Commercial Life or the Legal

Life Whichever is Shorter

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11.07 FACTORS OR BASIS OF PROVIDING DEPRECIATIONImportant Note(i) If the rate of depreciation is given with the words per

annum (e.g., 15% p.a.) Depreciation be charged only for the period for which the asset is held. (a) The date of acquisition is given. (b) The date of acquisition is not given.

(ii) If the rate of depreciation is given without words per annum, e.g., 15%

Depreciation be charged for the full year and a note explaining it be given. Depreciation be charged for the full year.

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11.08 METHODS OF RECORDING DEPRECIATION1. Depreciation is charged directly to the Assets Account2. A Provision for Depreciation/Accumulated

Depreciation Account is created.

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11.08 METHODS OF RECORDING DEPRECIATIONDifference between Provision for Depreciation Account being not maintained (Net Method) and Provision for Depreciation Account being maintained

(Gross Method)On the following basis Assets shown in balance Sheet Preparation of Assets Account Information

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11.09 METHODS OF CHARGING DEPRECIATION1. Fixed Percentage on Original Cost or Fixed Instalment

or Straight Line Method2. Fixed Percentage on Diminishing Balance or Reducing

Installment Method or Written Down Value Method.

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11.09 METHODS OF CHARGING DEPRECIATIONSale of an Asset. An asset may be sold before it is fully written off as depreciation. The sale proceeds may not be equal to the written down value of the asset. If the sale proceeds are more than the written down value of the asset on the date of sale, it is a case of profit on sale of asset. And if it is less than the written down value it is a case of loss on sale of the asset. Profit or loss on sale of asset is transferred to Profit and

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11.10 CHANGE OF METHOD OF DEPRECIATIONOne may decide to change the method of charging depreciation one had adopted by Fixed Instalment Method to Diminishing Balance

Method or vice versa. The change in the method of charging depreciation

may be either with prospective effect or with retrospective effect.

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11.10 CHANGE OF METHOD OF DEPRECIATIONAccounting Standard-6 (Revised) on Depreciation Accounting requires that whenever a change in the method of providing depreciation is affected, it should be from the date of purchase of the asset.

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11.11 PRACTICAL ISSUES RELATING TO DEPRECIATION Companies are required to charge depreciation on the

fixed assets as provided in the Companies Act, 1956 Enterprises other than companies may charge depreciation as considered appropriate by them. They however, charge depreciation at the rates and in

the manner provided under the Income Tax Act, 1961.

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11.11 PRACTICAL ISSUES RELATING TO DEPRECIATIONDepreciation Under the Companies Act, 1956 Depreciation on its fixed assets is charged either on

Straight Line Method (SLM) or Writtendown Value Method (WDV). The companies must provide depreciation on its fixed

assets at the prescribed rates. The Act has prescribed the rates in Schedule XIII of the

Companies Act, 1956 for both the methods.

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11.11 PRACTICAL ISSUES RELATING TO DEPRECIATION Depreciation is charged from the date the asset is put to use by the company. It means if an asset is put to use say on 1st January, 2010, depreciation for that year on that asset will be for 90 days. Depreciation on assets sold during the year is charged at the prescribed rate in accordance with the chosen method of depreciation up to the date the asset is sold. Depreciation rates under companies Act 1956 are minimum, companies can charge more Depreciation as per the nature and life of assets.

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11.11 PRACTICAL ISSUES RELATING TO DEPRECIATIONDepreciation Under the Income Tax Act, 1961 Assets are formed into groups (known as Block of Assets) for the purposes of charging depreciation. Depreciation under the Income Tax Act, 1961 is charged according to the Written-down Value (WDV) Method. Depreciation is to be provided at the rates prescribed

under the Act

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11.11 PRACTICAL ISSUES RELATING TO DEPRECIATION Depreciation is allowed from the date the asset is put

to use by the enterprise. If the period an asset has been put to use in its first year is more than180 days, depreciation is allowed for the full year. And if the

period an asset has been put to use in its first year is less than 180 days, depreciation is allowed for six months.

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11.11 PRACTICAL ISSUES RELATING TO DEPRECIATION As and when an asset is sold, the sale price is deducted

from the block of asset and thereafter depreciation is charged.

Depreciation rated under Income Tax Act, 1961 are maximum, companies cannot charge higher

depreciation for computing Income as per Income Tax Act.

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