DEPRECIATION

In any machine performing useful work wear and tear is present , it can be minimised by maintenance but cannot be fully prevented. Therefore its efficiancy and value reduces with time .this is known as depreciation. So some money is kept aside so that when the machine become uneconomical ,it can be replaced by a new one. New machine cost+installation charges+ repair charges-scrape is calculated and charged with overheads for the entire working life of the machine. Obsolescence is depreciation of existing machine due to new and better invention , design, equipment process etc.. types of depreciation:-

Due to wear and tear- when machines performs work wear and tear occurs.proper lubricating and cooling can minimise it but cannot prevent it. Physical decay-certain materials like insualtion, cables, furniture, chemicals etc get decay because of environmental effects Accidental-accidents occur by some wrong operation,loose components which may result in heavy damages. Neglect-not following proper instuctions given by the manufacturer Inadequacy-reduction in efficiancy of an asset. Obsolesence-reductio n in efficiancy and value due to the arrival of new and better invention , design, equipment process etc..

Methods of calculating depreciation: Straight line method Diminishing balance method Sinking fund method Annuity charging method Insurance policy method (Endowment policy) Revaluation or regular valuation method Machine hour basis method Sum of the years digits method

Straight line method:- assumes loss of value to the machine is directly proportional to age. Also known as fixed installment method.same amt is deducted every year . no consideration is given to maintanence or repair charges. (Depreciation amount per year) D=(C-S)/N where C initial cost, S-scrape value and N- no of years Diminishing balance method-also called reducing balance method. The value deducted will be greater in early years , when repairs and maintenance are not costly Certain percentage of the book value of the equipment (which goes on decreasing year by year)is taken as depresiation amount 1/N (Fixed percentage taken to calulate yearly depreciation ) x=1-(S/C) where C=initial cost, S= scrape value and N= no of years. Sinking fund method- depreciation will be equal to the actual loss in the value of the machine taking into account its interest . this is constant throught the entire life of the machine. N (Depreciation amount per year) D=(R(C-S))/(1+R) -1 where R=rate of interest,C=total cost of machine, S= scrape value, N=no of years Annuity charging method-here interest is charged on the cost of machine every year on the book value, but the rate of depreciation is constant every year N N (Depreciation Rate ) D={[C(1+R) -S][1-(1+R)]}/[1-(1+R) ] where C=cost of the machine,S=scrape value, N=no of years, R=rate of interest Insurance policy method-the machine is insured and premiums are paid. When the policy matures the machine is replaced.. Revaluation method-every year the value of machine is revaluated and the difference in the book value and the revaluated value is charged as depreciation Machine hour basis method-here the rate of depreciation is calculated considering the total number of hours a machine runs in a year Sum of years digit method-Reduction value will be greater initially and it will go on decreasing gradually The net amount is spread over the whole life in a decreasing proportion Reasons for Replacement Deterioration decline in performance, may occur due to wear & tear, misalignmnt, increases maintenance and labour costs, decreases qlty,production rate, efficiency. Obsolescence Inadequacy Working conditions old machines which create unpleasent and hazardous working conditions

Methods for replacement studies Pay back period method:- It determines as to how long it will take to pay back the invested capital , P = C/R where P=pay back period, C=original investment, R=annual return expected, Not reliable , Return is constant Total life average method:- In this all costs involved in buying, operating, and maintaining an equipment are added together into one figure and divided by total estimated life Annual cost method:- To compare the annual costs of obtaining service from different equipments , Annual cost = capital recovery+ operating cost Present worth method:- Accurate method , Used to evaluate the present value of the new n equipment , F= P(1+i) , P = F/(1+i)n where F=worth of money in future, P=present amt of money,i=interest rate, n=number of years. Rate of return method :- Average annual net income is expressed as percentage of capital investment , %return rate = (earnings per year/net investment ) X 100, (Discounted rate of return) C = R/(1+r)n where C=investment cost, R=expected earning in the nth year, r=rate of return, n=no of years MAPI method :- Machinery Allied Products Institute, Use widely , adjusted after-tax rate of return criterion, Cost is based on process and system performance , It estimates the initial rate of return and not average rate of return , it allows obsolescence, Uses charts and forms to reduce calculations 1 A one year comparison period and sum of digits tax depreciation method 2 A - one year comparison period and double declining balance tax depreciation 3 A - one year comparison period and straight line tax depreciation

Advantages :-Calculations are simple, Replacement timeis known , Can be applied to a single or combination of machines , aids inBudgeting , full provision for future deterioration and obsolescence on new machines