Briefly explain different method of providing

depreciation?
Answer:
DEPRECIATION-A noncash expense that reduces the value of an asset as a result of wear and
tear, age, or obsolescence. Most assets lose their value over time (in other words, they
depreciate), and must be replaced once the end of their useful life is reached. There are several
accounting methods that are used in order to write off an asset'sdepreciation cost over the period
of its useful life. Because it is a non-cash expense, depreciation lowers the company's reported
earnings while increasing free cash flow.
(i) Fixed Installment or Straight Line Method
(ii) Fixed Percentage on Diminishing Balance Method
(iii) Sum of the years Digits Method.
(iv) Annuity Method.
(v) Depreciation Fund Method./ Sinking fund method (SFM)
(vi) Insurance Policy Method.
(vii) Revaluation Method.
(viii) Machine Hour Rate Method.
(ix) Depletion Method.
(x) Repairs Provision Method.
xi) Double-Declining-Balance Method
(i) Fixed Installment or Straight Line or Fixed Percentage on Original Cost. Under this method,
the Depreciation is calculated on the basis of either a fixed percentage of the original value of the
asset or divides the original value of asset by the number of years of its estimated life. Every
year, the same amount is written off as Depreciation so as to reduce the asset account to nil.
Depreciation =
(Cost of the Asset + Installation Charges - Scrap Value + Removal Cost) / Estimated useful Life
of the Asset
Example: For $2 million, Company ABC purchased a machine that will have an estimated useful life of
five years. The company also estimates that in five years, the company will be able to sell it for $200,000
for scrap parts.

Depreciation Expense
= Total Acquisition Cost – Salvage Value / Useful Life
Straight-line depreciation produces a constant depreciation expense. At the end of the asset's useful life,
the asset is accounted for in the balance sheet at its salvage value.
(ii) Diminishing Balance Method. Under the diminishing Balance method, depreciation is
calculated at a fixed percentage on the opening balance of each year. Each year the opening
balance may be decreasing in value. This decreasing book value is commonly known as written
down value of the asset. While applying the depreciation rate both salvage or scrap value and
removal costs are ignored. There are no possibilities to reduce the book value to zero.
(iii) Sum of the Years Digits Method. It gives decreasing depreciation charge year by year. For
the purpose of obtaining yearly depreciation diminishing percentages to the cost of the asset, less
salvage value is applied. Under this method, the rate of depreciation is a fraction having the sum
of the digits representing the useful life of the asset as its denominator and individual year as its
numerator.
Sum-of-Year Method:

Depreciation In Year i
= ((n-i+1) / n!) * (total acquisition cost - salvage value)

Example: For $2 million, Company ABC purchased a machine that will have an estimated useful life of
five years. The company also estimates that in five years, the company will be able to sell it for $200,000
for scrap parts.
n! = 1+2+3+4+5 = 15
n=5

The sum-of-year depreciation method produces a variable depreciation expense. At the end of the useful
life of the asset, its accumulated depreciation is equal to the accumulated depreciation under the straight-
line depreciation.
(iv) Annuity Method- Under the Annuity method, the annual depreciation charges would be
ascertained with the help of Annuity table. This method gives importance to interest factor. Other
methods do not take into account the interest factor while investing the assets. Fixed interest rate
is charged on the opening balance of each year and then cost of asset together with interest
thereon is written off equally over the life of the asset.
(v) Depreciation Fund Method-Depreciation fund method provides an adequate financial
requirement for the replacement of the asset when the asset is replaced by a new one.
Depreciation fund account is opened and the amount of depreciation is credited to that account.
The asset account stands year after year at its original cost. At the end of each year, the amount
of depreciation is debited and depreciation fund account is credited and the corresponding
amount is invested in securities of some reputed companies, for the purpose of mobilizing funds
for replacement.OR Sinking fund method (SFM) SFM is used where the aim is not only to cha4rge
depreciation but also to arrange funds for replacement. In case a large sum is required for replacement at
the end of the useful life of the asset, it may not be advisable to leave the amount of depreciation set apart
annually in the concern itself, because it may not be available in the form of readily realiseable asstes
whjen it is required. To safeguard this position, the amount anually provided for depreciation may be
transferred to sinking fun account and at the same time an equivalent amount may be invested in
securities. The interest on these securities, when received, would be re-invested and the balance of
interest account is creadited to the sinking fund account.
The annual amount of depreciation is calculated with the help of annuity table considering the interest
earned on the investment. When the asset is due for replacement, the investments are sold and the new
asset is purchased with the proceeds. The profit or loss on sale of investments is transferred to sinking
fund account, balance of sinking fund is then transferred to old asset account. The scrap sale proceeds of
old asset is credited to asset account. Balance in the asset account is then transferred to P & L account or
the general reserve account.
(vi) Insurance Policy -Method. Under this method, an insurance policy is taken from the
insurance company for the purpose of replacement of an asset. At the end of the definite period,
the insurance company will pay the assured sum with the help of which asset can be repurchased.
(vii) Revaluation Method.-This method is suitable for small and diverse items of asset such as
bottles, corks, trade marks, loose tools, livestock etc. Under this method the amount of
depreciation is ascertained to find the difference between the book value of the asset and the real
value of the asset. At the end of the year the difference is taken as depreciation.
(viii) Machine Hour Rate Method- The Economic Life of the asset is estimated in terms of
working hours. Hourly rate is determined by dividing total cost of the asset by total number of
hours to be operated in its life time. The annual depreciation charge is calculated by applying this
rate to the actual number of hours operated in the particular accounting period.
Machine hour rate = (Cost - Scrap Value ) / Total hours (who1e lifetime)
Depreciation for the year = Machine Hour value x Estimated Hours in a year.
(ix) Depletion Method-The Economic Life of the asset is determined by geographical survey
methods in terms of total units of resource deposits. The depletion rate per unit is calculated by
dividing the total cost of the asset by the estimated available number of units.
Sale, Exchange or Disposal of Depreciable Assets
Companies that are in the business of exploring, extracting and/or transforming natural resources
such as timber, gold, silver, oil and gas are known as "natural resource companies." The main
assets these companies have are their inventory of natural resources. These assets must be
reported at their carrying cost (or cost of carry). The carrying costs for natural resources include
the cost of acquiring the lands or mines, the cost of timber-cutting rights and the cost of
exploration and development of the natural resources. These costs can be capitalized or
expensed. The costs that are capitalized are included in the cost of carry. The cost of carry does
not include the cost of machinery and equipment used in the extraction process.
When a resource company purchases a plot of land, it not only pays for the physical asset but
also pays a large premium because of what is contained in the plot of land. However, once a
company starts extracting the oil or natural resource from the land, the land loses value, because
the natural resources extracted from a plot of land will never regenerate. That loss in value is
called "depletion." That is why cost of carry is depleted over time. The depletion of these assets
must be included in the income statement's accounting period. This is the only time land can be
depleted.
The carrying costs of natural resources are allocated to an accounting period by means of the
units-of-production method.
Example:
A company acquired cutting rights for $1 million. With these cutting rights, the company will be
able to cut 5,000 trees. In its first year of operation, the company cut 200 trees.
Journal entries:

Certain types of assets are amortized rather than depreciated. Amortization describes the
deduction of capital expenses over a specific period of time (usually over the asset's life). More
specifically, this method measures the consumption of the value of intangible assets, such as a
patent or a copyright. What is the difference between amortization and depreciation? Because
very few assets last forever, one of the main principles of accrual accounting requires that an
asset's cost be proportionally expensed based on the time period over which the asset was used.
Depreciation and amortization (as well as depletion) methods are used to prorate the cost of a
specific type of asset to the asset's life. Remember, these methods are calculated by subtracting
the asset's salvage value from its original cost.

(x) Repairs Provision Method- Under this method, first the total repair and renewal costs are
determined for the whole life of the asset and then it is added to the capital cost to get a total
value. Then, this value is divided by its estimated life. The resultant value is treated as Repair,
Renewals and depreciation. It has to be charged to the profit and loss Account each year. The
corresponding Credit is given to provision for depreciation and Repairs account
(xi) Double-Declining-Balance Method:-
The DDB method simply doubles the straight-line depreciation amount that is taken in the first year, and
then that same percentage is applied to the un-depreciated amount in subsequent years.

DDB In year i = (2 / n) * (total acquisition cost - accumulated depreciation)

n = number of years

Example
For $2 million, Company ABC purchased a machine that will have an estimated useful life of five years.
The company also estimates that in five years the company will be able to sell it for $200,000 for scrap
parts.

The double-declining-balance method produces a very aggressive depreciation schedule. The asset cannot
be depreciated beyond its salvage value.
Cash Flow And Relationships Between Financial Statement - The Relationship
Between Financial Statements
The income statement, balance sheet and cash flow statement are all interrelated. The income
statement describes how the assets and liabilities were used in the stated accounting period. The cash
flow statement explains cash inflows and outflows, and it will ultimately reveal the amount of cash the
company has on hand, which is also reported in the balance sheet. By themselves, each financial
statement only provides a portion of the story of a company's financial condition; together, they provide
a more complete picture.
The Relationship Between the Financial Statements

Stockholders and potential creditors analyze a company's financial statements and calculate a number
of financial ratios with the data they contain to identify the company's financial strengths and
weaknesses and determine whether the company is a good investment/credit risk. Managers use them
to aid in decision making. (To learn more, check out Reading The Balance Sheet, Understanding The
Income Statement and The Essentials Of Cash Flow.)
One important way the financial statements are used together is in the calculation of free cash flow
(FCF). Smart investors love companies that produce plenty of free cash flow. It signals a company's
ability to pay debt and dividends, buy back stock and facilitate the growth of business - all important
undertakings from an investor's perspective. However, while free cash flow is a great gauge of corporate
health, it does have its limits and is not immune to accounting trickery.