DEPRECIATION

Depreciation is the diminution in the financial value of an asset owing to

wear and tear, efflux of time, obsolescence or similar causes.
Depreciation is a permanent continuing and gradual shrinkage in the value
of a fixed asset. It is also defined as the permanent and continuous
diminution in the quality, quantity or the value of assets.
The gradual decrease in the value of an asset because of any cause.
The amount of depreciation is charged on the basis of cost of machine,
life of the assets and the cost of replacement.

TYPES OF DEPRECIATION:-
(1) STRAIGHT LINE METHOD: Straight-line depreciation is the simplest and most-
often-used technique, in which the company estimates the salvage value of the asset at the end of
the period during which it will be used to generate revenues (useful life) and will expense a portion
of original cost in equal increments over that period. The salvage value is an estimate of the value
of the asset at the time it will be sold or disposed of; it may be zero or even negative. Salvage
value is also known as scrap value or residual value

(2) DOUBLE DECLINING DEPRECIATION METHOD: Depreciation

methods that provide for a higher depreciation charge in the first year of an asset's life and
gradually decreasing charges in subsequent years are called accelerated depreciation methods.
This may be a more realistic reflection of an asset's actual expected benefit from the use of the
asset: many assets are most useful when they are new. One popular accelerated method is the
declining-balance method. Under this method the Book Value is multiplied by a fixed rate.
(3) WDV OR DIMINISHING METHOD: Written down value, applicable to
machines that have high rates of depreciation in the initial year or two, and later taper it e.g.
a car, is a usable method.

• Under this method, depreciation is charged at a fixed rate every year,

ON THE REDUCING BALANCE A certain percentage is applied to the
previous year’s book value, to arrive at the current year’s depreciation/ book
value, WHICH SHOWS A DECLINING BALANCE, WEIGHTED FOR
EARLIER YEARS, AND LOWER AND LOWER FOR LATER YEARS, as the
machine grows older.
• Accelerates depreciation taken in early years. Reduces the amount taken in
later years. Ignores salvage value; starts with depreciable base = asset cost.
(4) SUM OF YEAR DIGIT METHOD: Sum-of-Years' Digits is a
depreciation method that results in a more accelerated write-off than
straight line, but less than declining-balance method. Under this method
annual depreciation is determined by multiplying the Depreciable Cost by
a schedule of fractions.

(5) Activity depreciation: Activity depreciation methods are not

based on time, but on a level of activity. 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 this level of activity. Assume the vehicle above is
estimated to go 50,000 miles in its lifetime. The per-mile depreciation rate
is calculated as: ($17,000 cost - $2,000 salvage) / 50,000 miles = $0.30
per mile. Each year, the depreciation expense is then calculated by
multiplying the rate by the actual activity level
(6) Units-of-Production Depreciation Method: Under the
Units-of-Production method, useful life of the asset is expressed in terms
of the total number of units expected to be produced. Annual depreciation
is computed in three steps.
(7) Units of time depreciation: Units of Time Depreciation is
similar to units of production, and is used for depreciation equipment used
in mine or natural resource exploration, or cases where the amount the
asset is used is not linear year to year.A simple example can be given for
construction companies, where some equipment is used only for some
specific purpose. Depending on the number of projects, the equipment
will be used and depreciation charged accordingly.
(8) Group Depreciation Method: Group Depreciation method is
used for depreciating multiple-asset accounts using straight-line-
depreciation method. Assets must be similar in nature and have
approximately the same useful lives.
(9) Composite Depreciation Method: The composite method is
applied to a collection of assets that are not similar, and have different
service lives. For example, computers and printers are not similar, but
both are part of the office equipment. Depreciation on all assets is
determined by using the straight-line-depreciation method.
METHODS OF DEPRECIATION (how to calculate):--
(1) STRAIGHT LINE METHOD
(2) WDV OR DIMINISHING METHOD
(3) SUM OF YEAR DIGIT METHOD
(4) DOUBLE DECLINING DEPRECIATION METHOD

Explanations

(1) Straight line method WDV or diminishing method :

(a)For Example: Say a machine costs Rs. 10,000
and Rs. 1,000 (as additional set-
up/installation/maintenance expenses) = Rs 11,000
but we anticipate/guess its Kabari (Scrap Value) at
Rs. 3,000 at the end of its useful life, of say, 10 yrs,

we get:

Cost of Machine + Installation + Directly

Associated Costs = Total Cost

Total Cost - Salvage Value (At end of 10 yr.

Period) = Depreciable base

10,000 + 1,000 =11000 (Total cost)

11000 – 3,000 = 8,000 as the Depreciable Base

Depreciable Base = Rs. 8,000, Spread out over 10

yrs = Rs. 8000/10(Yrs) = Rs 800/- depreciation per
year.
(b) if an assets has been purchased for Rs. 10000 ans it will have a
scrap value of Rs 1000 at the end of its useful llife of 10 year, the
amount of depreciation is to be charged every year over the
effective life of the assets will be computed as follows:
Depreciation= 10000 – 1000/10 years.
RS 900 each year or 9%
(2) Sum of year digit method :
under this method, the numbers 1, 2, 3, …..n (where n is useful
economic life) are added and depreciation rate is calculated as
follows:
Year depreciation rate

1 n/sum of n
2 (n-1)/sum of n
3 (n-2)/sum of n
4 (n-3)/sum of n
5 (n-4)/sum of n
6 *
7 *
Where n = 1+2+3+4+5……..+n.
These rates are then applied to the net cost. For a machine of 10
years economic life and Rs. 100000, the depreciation for each is
computed as follow:
Year depreciation Rate. Annual dep. Net book value

1 10/55 18182 81818

2 9/55 16364 65454
3 8/55 14545 50909
4 7/55 12727 38182
5 6/55 10909 27273
6 5/55 9091 18182
7 4/55 7273 10909
8 3/55 5455 5454
9 2/55 3636 1818
10 1/55 1818 1818
(b) if the cost of an asset is RS 10000 and it has an effective life of
5 year. The amount of depreciation to be written off each year will
be computed as follows:
1st year 5/1+2+3+4+5 * 10000 = 3333
2nd year 4/15 * 10000 = 2666
rd
3 year 3/15 * 10000 = 2000
th
4 year 2/15 * 10000 = 1333
th
5 year 1/15 * 10000 = 667

(3) Double declining depreciation method:

EXAMPLE OF DOUBLE DECLINING BALANCES METHOD:

[The Double Declining Method takes an amount (usually double, i.e. 200% of the
amount that we take in the Straight Line Method) and applies it to the book value of
an asset each year]:

Suppose the asset costing Rs.16,000 has AN ESTIMATED USEFUL LIFE OF 5

YEARS, the depreciation would be calculated as follows:

YEAR DEPRECIABLE BASE PERCENTAGE (FIXED) DEPRECIATION

1 16000-0 x 0.40 6,400
2 16000-0-6400 x 0.40 3,840
3 16000-6400-3840=5750 x 0.40 2,304
4 16000-6400-3840-2304 x 0.40 1,382
th
Depreciation in the 5 year is only Rs. 74 to finally write off the entire machine
5
depreciable base (Rs. 16000/-) less scrap value (Rs. 2000).

(b) A plant having a scrap value of RS 10000 and life of 5 years

was purchased for Rs 10000 in Jan. 1990. You required calculating
amount of depreciation for each of the year according to the double
declining method.
Sol.
According to the fixed installment method (without considering
salvage value) depreciation would amount to Rs 2000 i.e. 10000/5
years each year. The rate of depreciation therefore comes to 20 %.
In case of double declining method rate of depreciation would be
twice of this rate i.e. 40%.
Amount of depreciation for each year would therefore be
Year book value in the beginning amt. of depreciation.
1 10000 4000
2 6000 2400
3 3600 1440
4 2160 860
5 1300 300

(4) WDV or diminishing method:

Under this method depreciation is calculated by applying
depreciation rate to the net book value of the assets at the
beginning of that year rather than to the original cost.
For a machine whose acquisition cost is Rs. 100000, useful
economic life is 10 year and the rate of depreciation is 20 %,
the depreciation under WDV method will be as follow:

Year annual depreciation net book value

1 100000*.20= 20000 80000

2 80000*.20= 16000 64000
3 64000*.20= 12800 51200
4 51200*.20= 10240 40960
5 40960*.20= 8192 32768
6 32768*.20= 6553.6 26214
7 26214*.20= 5242.88 20971.52
8 20971*.20= 4194.3 16777.22
9 16777*.20= 3355.44 13421.78
10 13421*.20= 2684.35 10737.43

(b)
If the cost of an asset is RS 10000 and residual value RS
1296, economic life 4years and the rate of depreciation
would be 40% calculated as follows:
Depreciation rate = 1- 4 (1296/10000) ^1/2

= 1 – 6/10
= 40%.