DEPRECIATION

DEPRECIATION
Definition:- Depreciation is a measure of the wearing out,
consumption or other loss of value of a depreciable asset
arising from use, effluxion of time or obsolescence
through technology and market changes.
In other words depreciation is nothing but distribution of
total cost of an asset over its useful life.
DEPRECIATION
Depreciation has two connotations i.e.:

(i) Depreciation is a provision to replace depreciable

assets (Old School of thought) and

(ii) Depreciation is a process of allocation and not valuation

(Modern School of thought).
DEPRECIATION

Depreciable Asset means an Asset which

1. Is held by an enterprise for use in the
production or supply of goods and services.
2. Is not meant for resale in the ordinary course
of business.
3. Is expected to be used during more than one
accounting period
4. Has limited useful life.
DEPRECIATION

Significance
1. It represents the charge of a fair proportion of
the depreciable amount to P&L account over the
useful life of an asset.
2. Depreciable amount is the historical cost or
revalued amount of the asset less residual value.
3. It plays a significant role in determining the
financial performance of an enterprise.
4. It is charged in each accounting year.
Methods of Depreciation
Two popular methods:
Straight line method (SLM)
Written down value method (WDVM)

While
Companies Act, 1956 (Schedule XIV)
recognises both the methods, Income Tax Act,
1961 generally recognises only one method
(WDVM)
Other methods:
sum-of-the-years digits method
Production-units method
How It Appears in the Balance
Sheet
Gross Block xxx
Less: Accumulated
Depreciation xxx
-------
Net Block xxx
====
 DEPRECIATION
Methods of Depreciation
1. Straight Line Method:- Under this method
depreciation is charged equally over the useful life of the
asset.
Formula:
Depreciation =
Cost of asset- Estimated residual value
------------------------------------------------------
Estimated useful life
DEPRECIATION

2. Written Down Value method:- Under this method,

depreciation is charged at a fixed rate on the reduced
balance of the asset every year.
Rate of Estimated residual value
Depreciation = 1- Cost of asset
n
 Other Methods of Depreciation

Units of Production Method

Acquisition cost Salvage = Rs. Per Unit of output
Number of units likely to
be produced during the life time

Sum of the years digit method

Depreciation is calculated by adding up the number of years of the
useful life of the assets. Sum of the years digits are ascertained by
arranging the years in descending order
DEPRECIATION
Requirements of Companies Act
Sec. 205 and 350 deal with depreciation
1. Sec.205 states that no dividend shall be declared or
paid out of profits without providing for depreciation.
2. Depreciation has to be provided
a) as provided in sec.350, or
b) as arrived at by dividing 95% of the original cost of
the asset by the specified period
3. Sec.350 provides that depreciation has to be charged as
per schedule XIV to the Companies Act.
DEPRECIATION
Provisions of Income Tax Act
1. Only WDV method is recognised
2. Block of assets method is followed
3. 100% dep. Is allowed if the asset is used for 180 days
or more. 50% dep. if used for less than 180days
DEPRECIATION

Consistency Principle
It requires that a method of dep. , once adopted ,
should be applied consistently unless
1. The statute requires the adoption of a new
method.
2. It is required to comply the provisions of an
accounting standard
3. The change is necessary for a more
appropriate preparation and presentation of
the financial statements.
Change in Method
If during a particular year there has been a change in the
method of depreciation, depreciation should be
recalculated in accordance with the new method
retrospectively.
The deficiency or surplus arising from such retrospective
recomputation of depreciation should be adjusted in the
accounts in the year of change.
Impairment of Assets
An asset may loose its expected value for a number of
reasons
If the recoverable value from future use of an asset is less
than its carrying amount, the asset is said to have
suffered an impairment loss
It is to be recognised as an expense in the income
statement