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Meaning of Depreciation Except land, all fixed assets have a limited life.

During such period, due to continuous use and/or lapse of time, the value of some assets starts decreasing. Such a gradual decrement of value of assets is called Depreciation. Hence, depreciation can be defined as a permanent decline in the value of an asset due to constant use. Note: Depreciation is charged in case of fixed assets only. E.g. building, plant and machinery, furniture and fixtures etc. There is no question of depreciation in case of current assets - such as stock, debtors, bills receivable etc. Causes of Depreciation Depreciation is a measure of reduction in the value of an asset. It can be physical deterioration or decrease in the market value. The primary causes of depreciation are as follows: 1. Wear and Tear: Due to constant use, assets get worn or torn out. 2. Exhaustion: Exhaustion is the depletion of some assets due to continuous use and lapse of time. In case of mines and oil wells, the continuous extraction of minerals or oil, a stage comes when the mine or well gets completely exhausted an nothing is left. 3. Obsolescence: Some assets are discarded before they are completely worn out because of changed conditions. This is the case when an asset becomes usefulness because of technological advancement, new invention, change in style etc. in that asset. 4. Efflux of time: Certain assets get decreased in their value with the passage of time. This is true in case of assets like leasehold properties, patents and copyrights etc. 5. Accidents: Accidents can cause depreciation in the value of the asset. Objectives of making provision for depreciation Depreciation accounting is a must for every business for attaining the following objectives: 1. To ascertain net profit Depreciation is the expense for the business. Hence to ascertain the net profit, it must be included in the total cost of sales. 2. To depict the true financial position of the business The balance sheet depicts true financial position of a business at a point of time. To depict the true financial position of the business the assets should be shown in balance sheet not in its original cost but at the depreciated cost. That is all fixed assets should be shown at cost less the amount of depreciation suffered by them till the date of the balance sheet. 3. To ascertain cost of production Depreciation is an expense. Hence it is necessary to charge depreciation in the total cost of production to fix true sales price of the goods and service. 4. Replacement of assets One of the primary objectives of depreciation is the provision for the replacement cost on the

retirement of original assets. 5. To follow the company act According to company act, it is compulsory to charge depreciation on fixed assets. 6. To ascertain income tax If depreciation is not charged, the operation will show more profit. As a result, the taxable income will be higher. Hence, depreciation is charged for the correct ascertainment of total taxable income. Methods of Depreciation There are a number of different methods of providing depreciation for the assets. The method of depreciation depends on a number of factors such as type of asset, life, policy organization etc. The following are the list of methods of depreciation: 1. Fixed installment method 2. Diminishing Balance method 3. Sum of the year digits method 4. Annuity method 5. Depreciation Fund method 6. Insurance policy method 7. Revaluation method 8. Depletion method 9. Machine hour rate method 10. Double declining methods 11. MACRS (Modified Accelerated Cost Recovery System) method 12. Replacement method Out of above following two methods are common and widely used: 1. Fixed installment method is also known as straight line method (SLM) or original cost method. Under this method the expected life of the asset or the period during which a particular asset will render service is the calculated. The cost of the asset less scrap value, if any, at the end f its expected life is divided by the number of years of its expected life and each year a fixed amount is charged in accounts as depreciation. The amount chargeable in respect of depreciation under this method remains constant from year to year. This method is also known as straight line method because if a graph of the amounts of annual depreciation is drawn, it would be a straight line. 2. Diminishing balance method is also known as written down value method or

reducing installment method. Under this method the asset is depreciated at fixed percentage calculated on the debit balance of the asset which is diminished year after year on account of depreciation.

Practical Problems: 1. On 1st January, 2007 a company purchase a machine for Rs. 20,000. On 1 st January, 2008 another machine was purchase for Rs. 8,000 and paid Rs. 400 for its fitting in the factory. On 1 st January, 2005 purchased a third machine for Rs. 6,000 and a fourth machine for Rs. 10,000 was purchase on 31st March, 2010. Prepare Machine account for four years providing depreciation at the rate of 5% per annum accounting to Fixed Installment Method. Books are closed on 31 st December every year. 2. A) Jain Brothers acquired a machine on 1st July, 2008 at a cost of Rs. 14,000 and spent 1,000 on its installation. The firm writes off depreciation @ 10% p.a. on original cost every year. The books are closed on 31st Dec. every year. On 31st march 2011 the machine is sold for Rs. 9,500. Show the machinery account and depreciation account. B) Work out on the basis of Diminishing value method also. [MBA 2008] 3. On 1st January, 2007, machinery was purchased by X Ltd. for Rs. 50,000. On 1st July, 2008, additions were made to the extent of Rs. 10,000. On 1st April, 2009, further additions were made to the extent of Rs. 6,400. On 30th June 2010, machinery, original cost of which was Rs. 8,000 on 1st January, 2007, was sold for Rs. 6,000. Depreciation is charge @ 10% p.a. on original cost. Show Machinery Account for the years from 2007 to 2010 in the books of X Ltd. Given that its closes its Books of accounts on 31st December every year. 4. On 1st Jan., 2006 a merchant purchased some furniture costing Rs. 55,000. It is estimated that its working life is 10 years at the end of which it will fetch Rs. 5,000. Additions are made on 1 st Jan., 2007 and 1st July, 2009 to the value of Rs. 9,500 and Rs. 8,400 (residual value Rs. 500 and Rs. 400 respectively). Show the Furniture Account for the first four years, if depreciation is written off according to the straight line method. 5. A company whose accounting year is the calendar year purchase on 1 April, 2006 machinery costing Rs. 30,000. It purchased further machinery on 1 Oct., 2006 costing Rs. 20,000 and on 1 July, 2007 costing Rs. 10,000. On 1 Jan., 2008 one-third of the machinery installed on 1st April, 2006 became obsolete and was sold for Rs. 3,000. Show how machinery account would appear in the books of the company, it being given that machinery was depreciated by Fixed Installment at 10% p. a. What would be the balance of machinery account on 1 st Jan., 2009? [MBA 2009] 6. On 1st July 2005, a plant was purchased for Rs. 60,000 on 1st April 2006; another plant was purchased for Rs. 90,000. Depreciation is charged @ 20% p.a. on straight line method. On 30 th April, 2007 the first plant was sold for Rs. 50,000. Prepare Plant account from 2005 to 2008 assuming that accounts are closed on 31st December every year.

7. A company whose accounting year is the calendar year purchased on 1 st April, 2002, machinery costing Rs. 90,000. It purchased further machinery on 1st October, 2002 costing Rs. 40,000 and on 1st July, 2003 costing Rs. 20,000. On 1st Jan., 2004, one-third of the machinery which was installed on 1st April, 2002, became obsolete and it was sold for Rs. 10,000. Show how the Machinery Accounting would appear in the books of the company, it being given that the machinery was depreciated by the Fixed Installment Method at 10% per annum. What will be balance in Machinery Account on 1st January, 2005? 8. XYZ & Co. purchased a machine on 1st January 2005 for Rs. 9,250 and immediately spent Rs. 750 on its erection. On 1st July, 2006, it purchase another machine for Rs. 2,500 and on 1 st July, 2007, it sold off the first machine purchased in 2005 for Rs. 7,000 and on the same date it purchased another machine for Rs.6,250. On 1st July, 2008, the second machine, purchased for Rs. 2,500 was also sold off for Rs. 500. Depreciation was provided on the machinery on written down value basis at 10% p.a. Give the Machinery account for four years commencing from January 1, 2005. Calculations are to be made to the nearest rupee. Accounts are closed on 31 st Dec. every year. 9. On 1st January 2005, a company bought old machinery for Rs. 90,000 and spent Rs. 7,000 for its repair and Rs. 3,000 for its installation. On 1st September 2006, another machine was purchased for Rs. 60,000. On 1st July 2007, the first machine became obsolete and sold for Rs. 50,000. On the same day a new machine was purchased for Rs. 80,000. Company charges depreciation @ 10% p.a. on written down value method. Prepare Machinery account for 4 years. Accounts are closed on 31st March every year. 10. A firm purchased on 1st January, 2000, certain machinery for Rs. 58,200 and spent Rs. 1,800 on its erection. On 1st July, 2000 additional machinery costing Rs. 20,000 was purchased. On 1 st July, 2002 the machine purchased on 1st January, 2000 having become obsolete was auctioned for Rs. 28,600. On the same date, fresh machinery purchased at a cost of Rs. 40,000. Depreciation was provided for annually on 31st December at the rate of 10% p.a. on written down value. In 2003, however, the firm changed that method of providing depreciation and adopted the method of providing 5% p. a. depreciation on the original cost of the machinery. Give the machinery account as it would stand at the end of each year from 2000 to 2003. [MBA 2010] 11. A company purchased a second hand machine on jan.2004 for Rs. 37000 and immediately spent Rs. 3000 on its erection. On July 2005 it purchased another machine for Rs 10000 and on July 2006 it sold off the first machine for Rs.28, 000 and bought another for Rs. 25000. On July 2007

the second machine was also sold off for Rs. 2,000. Depreciation was provided on machine @10% on the original cost annually on Dec. 31. In 2005 the company changed the method of depreciation and adopted the written down value method the rate of depreciation being 15% p.a. Given the machinery account for 4 years commencing from the date of acquisition of machine. [MBA -2006] 12. ABC Ltd. purchased on 1st January, 1998 second hand plant for Rs. 30,000 and immediately spent Rs. 20,000 for its overhauling. On 1st July, 1998 additional machine at a cost of Rs. 25,000 was purchased. On 1st July 2001, the plant purchased on 1st January, 1998 became obsolete and was sold for Rs. 10,000. On same day new machinery was purchased at a cost of Rs. 60,000. Depreciation was provided for annually on 31st December @ 10% on original cost of asset. At the end of the year 2001, the company changed third method of providing depreciation and adopted the method of writing off 15% on the diminishing value. Show the plant and machine account as it would appear in the books of the company for the years 1998 to 2003. 13. A company purchased second hand machinery on 1st January, 2007 for Rs. 95,000 and spent Rs. 3,000 on its repairs and Rs. 2,000 on its installation. On 1st July 2008 it purchased another machine for Rs 50,000 and on July 2009 it sold off the first machine for Rs.75, 000 and bought another for Rs. 25,000. On July 2010 the second machine was also sold off for Rs. 20,000. Depreciation was provided on machine @10% on the original cost annually on Dec. 31. In 2009 the company changed the method of depreciation and adopted the written down value method the rate of depreciation being 15% p.a. Given the machinery account for 4 years commencing from the date of acquisition of machine. 14. A firm closes its accounts on 31st December every year and depreciates the machinery by the reducing installment method @ 20% per annum. On 1st January 2000 the written down value of the machine was Rs. 2,47,020. 15. Abhinav Traders Limited, which depreciates its machinery at 10% according to diminishing balance method, had on 1st January, 2008 Rs. 9,72,000 balance on Machinery Account. During the year 2008, part of the machinery is purchased on 1st January, 2006 for Rs. 80,000 was sold for Rs. 45,000 on 1st July, 2008 and new machinery at a cost of Rs. 1,50,000 was purchased and installed on the same date, installation charges being Rs. 8,000. The company wanted to change its method of depreciation from diminishing balance method to straight line method with effect from 1st January, 2006 (retrospective effect) and adjust the difference on 31st December, 2008. The rate of depreciation remains the same as before. Show the machinery account and ascertain the amount chargeable to profit and loss account as depreciation and loss on the sale of machinery in the year 2008.