2

Depreciation Accounting
LEARNING OBJECTIVES
At the end of this chapter, you would learn
(1)
The logic and meaning of depreciation as
OThe objectives of providing for depreciation.applicable to fixed assets.
The factors to be considered in arriving at the amount of
ifferent
(4) The diff methods of calculating depreciatioon.
thod, written down value method, etc. depreciation such as straight line
5 The determinaion oi gain or lss on the disposal of an asset and its
accounting reatment in asset accounts.
(6) Special depreciation systems like annuity method, sinking fund method,
insurance policy
method etc.
171 Important provisions of AS-6 particularly with reference to change of
preciation hod, disclosures in financial statements etc.

A-THEORY
Nature of Depreciation

The concept of 'depreciation' is closely related to the question of

determination of profit or loss for the period. Unless depreciation is charged
against the revenues, one cannot be said to have ascertained the
income
properly. The old view of depreciation was that it was meant to be a provision
discretion of the
to replace depreciable assets. Therefore, it was left to the
management to provide or not to provide for depreciation. and Naturally they used
to provide depreciation when the
firm made good profits dispense with it
This confusion was mostly because of
during the years the firm made losses. sunk and lost...but the floating
Lord Lindley's dictum that "fixed capital may be
must be kept up".It is interesting to note that even under
thecirculating
or
Companies capital
Act, 1956, provision of depreciation becomes necessary only
of
if the company wants to declare dividends. Even the accounting practice
and profit after depreciation tend to confirm
showing profits before aepreciation of profits. But the modern view
the view that some regard it as an appropriation
fixed assets can be imagined as a 'bundle
o1 depreciation is different. All the
the enterprise over the period of economic
life
01 uture services' to be used by
investment in such assets must be
01Such assets. Therefore, the cost of
of their economic life in a systematic
quitably allocated to different periods to each period is called depreciation
L rational manner. The amount charged such assets. Thus, it is a process of
represents the costs of expiration of understood that the process
Cation and not valuation. So it must clearly
be
recovering the cost of
of
arging depreciation is the accountant's technique
Jred assets over a period.
hat are depreciable assets ?
the Council of the
to AS-6, the accounting standard issued by
InetCCording assets are assets which
Institute
ute of Char
of Chartered Accountants of India, depreciable
during more than one accounting period;
are expected to be used
by the C.A. Institute
T AS-6 on Deprecíation Accounting issued
COretical discussion is based on
 II.2.2 p r o d u c t i o n
or supply of,fods
and
useful
life;
use
in
the p u r p o s e s
not
and n o t for the
limited for administrative

( h a v ea e n t e r p r i s e

for
held by an or b u s i n e s s .

the c o s t .of f
(üi) are
r e n t a l to
others,
of
clear
t h a t only cateted
for
c o u r s e

is
a s s e t s it
and service
ces, ordinary following
the
sale in the into
e
purpose of
depreciable
is used to
classified

d e f i n i t i o n of be expres
assets c a n fixed assets"
rom the Fixed "tangible mach
assets is tobbe
allocated.
The term l a n d , building. nery,
s u b s t a n c e , e.g.,
fixed
assets.
into two parts:
(a) Tangible have bodily divided

of assets
which f u r t h e r be unlimited
m of existence. The
term
types can
OSe h e s e
assets has an
to the years of benefit
furniture, vehicles. asset
which
the chapter)
is the only in limited ilife and their
(9 Land This asset explainedlater have
(depreciation, assets
cost of it is not allocated T h e s e
vehicles.

(ii) Machinery, J
Jurniture,
of benefit.
ar
of s u c h a s s e t s are
o v e r the years
Examples
c o s t s a r e spread
o r wasting
assets.
through extracti
exhaustion
ction.
Natural
resources
subject to k n o W n a s depletion
u
oilfields, minesaand quarries
which a r e assets is
such wasting fixed a s s e t s " is used to
in relation to
T h e periodic charges term "intangible
fixed a s s e t s .
The Examples are patents.
Intangible substance.
(b) which lack physical costS. From the cost
describe those assets organisation
leaseholds, goodwill,
copyrights, trade marks, into two categories:
a r e again divided
allocation point
of view they e.g., patents, copyrights.
limited term ofexistence,
Intangibles having a
over (amortization,
explained later in the
assets a r e spread
The costs of these of their useful ife. trade marks,
chapter) the years existence., e.g.,
not having a limited term of benelit. They
(ti) Intarngibles o v e r the years
of
of these assets are not spread
goodwill. The costs
conservatism, written off (amortized)
of course, keeping in view of concept the
are,
decided.
Over s o m e years arbitrarily
Meaning of Depreciation of
Since the.cost of fixed asset i_ nothing but "the price paid for a series
its cost over a number of years during
future services", it is necessary to spread
of spreading the cost of fixed
which benefit of the asset is received. This process
view of depreciation is stated in IAS
asset is termed as "depreciation". The same
4 dealing with the subject. "Depreciation is the allocation of the depreciable
amount of an asset over its estimated useful life. AS-6 also, after explaining
the nature of depreciation, defines depreciation in the same way as IAS-4.
According to AS-6 depreciation "is a measure of 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. Depreciation is allocatea
so as to charge a fair proportion of the depreciable amount in each amounting perioa
during the expected useful life of the assets. Depreciation includes amortisation
of assets whose useful life is predetermined.
The words shown in italics by the authors make it clear that 1AS-4 and AS
6 view depreciation in the same sense. From the above definition it is clear that each
accounting perlod must be charged with a fair proportion of the depreciable amount
of the asset, during the expected useful life of the asset. Depreciable amount of al
asset is its historical cost less the estimated residual value. Sometimes the
historica
cost may be revised in the financial statements, in which case the revised figure is ui
relevant figure for calculating the depreciable amount of the asset.
other Definitions
(1) AICPA, in its
Accounting Research Bulletin No. 22, states
undelute
"Depreciation accounting is a system of accounting which aims to distriDu
as
 Ltung

he cost or other basic value II.2.3

#he estimated useful life of the
of
tangible capital
eustematic and rational unit (which assets, less salvage (if
manner. It is a may be a group of any), over
nepreciation for the
year the portion of
is process of assets) in a
that is allocated to the the total allocation, not of valuation.
account occurences during year. Although charge under such a
the allocation
the year, it is not intendedmay
system
of the effect of all such properly take into
(2) The occurrences." to be the
measurment
concept depreciation
of
income. Since part of the service is
closely linked to the concept of
in the
revenue-getting process
potential
of
of the
depreciable business
asset is exhausted
be deducted from revenue each period, the cost of these services
in
be recovered before the measuring
business periodic income; the
must
well off asexpired
of the period. is considered 'as cost must
Depreciation is a measure of
this cost."
at the
beginning
-Intermediate
(3) The allocation of the Accounting by Walter B. Meigs and
the particular original cost of plant, others.
periods or products that benefit property and equipment
from the utilization of assets." to
-Accounting for Managerial Control by Horngren
Depreciation, depletion, amortization and dilapidation
Although in
the allocation of everyday talk, the word depreciation is often
cost of any kind of fixed associated with
asset, different terms have been
developed accounting usage for describing this
in
assets. These various terms have been process for different types of
explained
Depreciation. The term "depreciation"
below:
is used when
expired utility of a
physical asset (building, machinery or equipment) is to be recorded.
Depletion. The term "depletion" is applied to the process of
measuring and
recording the exhaustion of natural resources _uch as ore deposits;
timber stands, quarries, etc. oil-wells,
Depletion differs from depreciation in that the
former implies removal of a natural resource, ie., a physical
shrinkage
lessening of an estimated available quantity, while the latter implies
or
a reduction
in the service capacity of an assét.
Amortization. The term "Amortization" is used for describing the process
of writing down the long-term investments in
intangibles such as leaseholds
patents, copyrights, trade marks, goodwill and heavy organisation costs.
Obsolescence. The term "obsolescence" refers to reduction in the useful
life of the asset arising from such factors as (a) technological changes, (b)
improvement in production method. (c)change in market demand for the product
or service output of the asset; or (d)legal or other restrictions. it is distinguished
from exhaustion, wear and tear and deterioration in that these terms refer to
functional loss arising out of a change in physical condition.
It may be commented here that though the terms depreciation, depletion.
amortization and obsolescence must be used in the sense described above, there
is a general tendency to use the term depreciation even for describing the
processes of depletion and amortization.
Dilapidations. When a property is returned to the landlord after the expiry
of lease period then he (landlord) is entitled to demand that it be in as good a
condition as when it was leased out. For this purpose leaseholders often set aside
some amount each year to provide for any dilapidation that may need to be put
right when the property is returned. For accounting purposes the expected
amount of dilapidations is added to the cost of leased property. The depreciation
1s provided on the total cost thus arrived at.
 II.2.4 m a c h i n e
in a state of
keepinga will not
maintained,
Depreciation vs. Maintenance for
are
necessary
if properly degree of care,. the
.

Maintenance expense:
m a c h i n e ,

that
of the the highest m a c h i n e must
cost of
mean

efficiency. But this does not w o r d s , in

spite Thus
Thus
not be allowed
reach a state of scrap..In
o t h e r d i s c a r d e d .

c ost
st
should
s hobu
w h e n it is maintenance

machine must reach a point and

its u s e
be spread over the perio of
cost.
to substitute the depreciation the profit
the fit aand
profit nd
for charging
d e p r e c i a t i o n

of
charging
Replacement cost a s the
basis
main
objective of c o s t of
thea an asset
that the spread
is to T h u s the basis for
stated
already beens
It has
of
depreciation

loss account with the amour of a s s e t . But

determination.

pose ofincome the cost price

over its useful life for the should be challenged
the of depreciation has been
aing
amount
reckoning
depreciation in the
of to c h a n g e s
validity of this basi_ that due
ne They say c o s t - b a s e d d e p r e c i a l i o n has
and authors.
professionals
of charging
power of m o n e y the policy
Prcnasing In o t h e r words,
failed to: at their proper
values.

in the balance sheet below their c u r r e n t

Show assets
at values far
balance sheet of their
in the trye picture
s s e t s appear shareholders do not obtain a
Thus their money.
TCplacement values. in which they
have i n v e s t e d
of assets of companies and loss
p r e s e n t value
income in that
sales shown the protit
(D reveal correct amount of of money whilst depreciation
the current purchasing power in the
account represent in the purchasing power of
money prevailing
there is
expressed
shown mismatch, namely matching
This results in a
year of the purchase of asset. not realistic.
of current revenues with past costs and therefore is

c)accumulate sufficient amount replaceto the asset when it is completely

worn out. If an asset costs Rs. 80,000, then only Rs. 80,000 c a n be made
cost of that asset is Rs. 1,30,000, then
If
available through depreciation. the new historical
this amount falls short in feplacing the asset. Depreciation based on
cost is sometimes called the 'Expired capital' theory. There is a rival theory
known as Accrued Renewals' theory according to which funds must be set aside
periodically, so as to replace the worn-out assets without throwing the finances
of the enterprise out of gear. So under this theory depreciation is meant to provide
for accrued renewals. In this, ca_e amounts set aside must be based on
replacement cost.
From the above discussion it is clear that depreciation should be provided
on replacement cost of the assets rather than their historical cost.
cost also takes into account the changes in technology. Some Replacementsuggest the
substitution of revaluation price (price at current rates) as the basis for charging
depreciation. While this method adjusts lor inflation it ignores the changes in
technology. But given beloW are some arguments against this basis of charging
depreciation:
(1) The essence of the definition of depreciation (AICPA) is that it is a
of allocation, not of valuation. Thus depreciation is not process
value of the asset. dependent on replacement
(2) Depreciation, the physical deterioration of
an asset, is an
incurred now, during the current accounting
replaced at a later date or not. period, whether this expense
asset is
(3) The purpose of the
depreciation charge is not to provide for a fund for
replacing the asset lalthough that be its
to account for an expense- the costmay incidental and useful result)
of using the but
asset.
Depreciation is first and
 Depreciation Accounting H.2.5

foremost the recovery, spread over the life of the asset, of the prepaid cost
incurred by its acquisition.
(4) It is difficult to measure the replacement values of assets for there does
not appear to be available a suitable index of prices.
(5) It is not acceptable to income-tax authorities.
(6) It is difficult to say that an asset will be replaced by the same type of
asset. Assets are quite often replaced by new and improved types of assets which
are made available at the time of the replacement of the worn-out assets. So
it will be difficult to obtain replacement values of similar assets due to

technological changes.
(7) The replacement values of assets unlike historical cost are not objective
and verifiable.
Thus from the above discussion it can be seen that the question ot
determining the basis of depreciation is a difficult one. The Association of
Certified and Corporate Accountants has suggested the following line of working:
The depreciation charge can be divided into two parts:
(a) The basic charge, calculated on recorded cost and designed to
recover

it over the useful life of the asset; and

(b) A supplementary charge, for the difference by which the basic charge
calculated
falls shorts of the amount which would appear a s a n expense if it were
on a basis homogeneous with maintenance, repairs and other current expenses.
The basic would continue to be deducted from the book value
depreciation
of the asset in the balance sheet and the supplementary depreciation brought
to special replacement provision account.
a

Summary
Nature of depreciation c a n be summarised a s under:
suffer
(a) All assets (with certain possible exceptions, e.g., land, antiques)
depreciation.
illustration of a n expense-the using up or
is an
(b) Depreciation
normal c o u r s e of business.
consumption of an asset in the
of it is a process of
(c) Depreciation is not the process of valuation asset;
cost of the asset over the period of its life.
allocation of
(d) The basis of depreciation is the cost price (not replacement price)-and
incidental to, but not a fundamental question
the question of replacement is only
ofdepreciation. fund method, insurance
(e) Accumulating cash resources (by depreciation
for ensuring its replacement. That
policy method) is only a financial procedure
is not the fundamental objective of depreciation.
Maintenance of assets in a state of effieciency is nota substitute for the
(9
depreciation provision.
bjectives of providing depreciation
Depreciation is provided in order to achieve the following objectives:
(a) To calculate proper profits. It is a common understanding that profit
of any year can be calculated only when all costs of earning revenues have been
properly chharged against them. Asset is an important tool in earning revenues.
The fall in the book value of assets refled s the cost of earning revenues from
the use of assets in the current year and hence like other costs, e.g., salary,
wages, it must also be provided for proper matching of revenues with expenses.
Depreciation is charged in each accounting period by reference to the effect of
the depreciable anmount. That being the case depreciation has to be provided
 assets. objective o f
even if value of second
there
(b) To
is ease in the
market
reasonable
value. The
forward only
that part
show thea sis e t a t
providir depreciation
its
result in
carrying service. If
is that it should expected future
of the as On unexpired
cost of the
b a l a n c e sheet

the e p r e s e n t s the
asset will
appear in position
depreciation not provided
is p r o v i d e d then the state t h e
financial

at the over-stated value. So in oraerr to

correctly

depreciation is to be provided. When depreciation

i s provided it

of cash
lon
resources.
saves the casn resources
c e s the neconceOnt-after-depreciation
figure and
this
distributed by way
of
OT the extent of depreciation) from being at the
Vdend. Theo the is able to produce
set aside every year,
a of the life
of unt So saved, if it.
1s
life of the amount required to
asset the repe
depreciation a
source of
working capital nle
that depreciation is
owever,
do. that
it is wrong to consider, a s s o m e people do, depreclau
depreciation is added back
to net s nds. This confusion has arisen becauseThe latter depends o n the
t o a r r i v e at funds from operations. not influenced by
the CS received and expenses involving cash outlay and is is
of
depreciation. By doubling or trebling depreciation it not
sS1bble tto increase the working capital, However, as depreciation is admissible
possibble
den ng income for tax purposes, by adopting accelerated methods of
fn ation,
increase lesser taxes are paid and thus it indirectly helps the business to
its cash resources.
h avingin taxes. Although depreciation is riota cash cost, it is permitted
to
De deducted from profits for tax purposes. This is no mean advantage naving
regard to the fact that for certain types of companies the tax rate is as high as 48%.
Causes of depreciation
Depreciation may be said to arise from two causes-internal and external.
Internal depreciation is that
arising from the
to, o r inherent in, the asset itself. External operation of any cause natural
operation of forces external to the asset. These depreciation is arising from the
have been discussed below:
Internal causes-(a) Wear and tear. "Wear and
of depreciation in the case of tear" is an important cause
tangible fixed assets like building,
machinery,
furniture, fixtures, tools, fitting, etc. "Wear and tear"
result from friction
vibration, strain, çhemical reaction,
handling. standard of weathering. intensity of the use, care in
of plant, etc. The term maintenance,
minor accidents inevitable in the handling
depreciatuon
indicate the expired utility of an asset(not amortization") is generally used to
due to reasons
(b) Depletion. Depletion is also one of
the internal
mentioned above.
the value of wasting causes of decrease in
The term "Depletion such assets
as
mines, guarries, oil-wells and forest-stands.
(neither
to refer to the expired "amoruzation nor
"depreciation") is correctly used
utility of a
wasting asset.
External causes-(a) Obsolescence. It is an
that many times a
particular machine is discarded experience in everyday life
wornout. This means that there are before it is completely
responsible for throwing out or use an Some external factors too which are
For example with the adventor asset wnicn 1Ss
otherwise in good condition.
have been discarded by Indianelecunc ana alesel locomotives, steam
This is a case of obsolescence. Kaiiways although they were in goodlocomotives
leof black and white T.Vs. mariy With
the introduction of condition.
have become obsolete and users have
#aem although they are in gooa conaiuon. colourT.Vs...
factors as discarded
Obsolés¢ence can arise from
rom:such
 Depreciation Accourttng
II.2.7
h
technological changes as results of continuous
a
hical improvements to the assets or research resulting
H improvement in product methods;emergence of mnore producttve a_sets;
change in market demand for the product or
iv) legal or other restrictions. service output of the asset;
or
Ch Inadequacy. When there is a
d to the discarding of certain assets.change in the scale of operations it may
For example, a firm
roduction of sophisticated data processing beçause of the
system
ipment under the manual system. The introduction of have to discard the
may
cessitated by the change in scale of operations. EDP system is u_ually
nnot be utilised with optimum efficiency Stmilarly, plant assets which
because
of operations will have to be discarded even if they areof the change in the scale
in soundtondition.
In the case of both obsolescence and
sCrapping the assets. These assets may be inadequacy there is no question of
of use to other enterprises and
therefore can be sold to such other erterprises. Obsolescence and inadequacy
are also classified as economic or
functional factors causing depreciation.
c) Efluxion of time. There are so ne intangible fixed assets which
in value as time elapses. For example, if Rs. 50,000 are paid for a certaindecrease
lease
(excluding lease of mine) for 10 years, then with the lapse of every year the
value
of the asset goes down by Rs. 5,000 whether, utilised or not. Its value is reduced
to zero at the end of the 10th year. Copyrights, patent rights are other
examples
of intangible fixed assest which decrease in value due to effluxion of time. The
term "amortization" (not "depreciation") is generally used to indicate the fall in
the value of such-assets.
Another way to classify causes of depreciation is to list them as physical
deterioration (wear and teardiscussed above), economic or functional factors
(obsolescence and inadequacy), the time factor and depletion.
Professor W. Authur Lewis* has enumerated five causes of depreciation
as follows:
First. portions of the asset may be consumedin process ofuse; for example,
rubber tyres are worn away.
Secondly. the physical of
yield the asset
may for example, the
decline:
physical output of the most radio valves decline with use.
Thirdly, the asset may become costier to operate, either because
it u s e s
more labour or materials per unit of output or because it breaks down more often
and maintenance costs rise.
Fourthly, a new machine may be invented which is cheaper than the existing
because
machine ever was, either because ie is cheaper to build and install, or
it requires a smaller input of labour or materials per unit of output.
because new products come on the market
Fythly, the asset may lose value
wh'ch the buyers prefer.
Faetors influencing the total amount of depreciation
be charged in respect thereof
Assessment of depreciation and the ämount to
based on three factors:
n an accounting period are usually
substituted for the historical cost of the
(0 historical cost or other amount been
asset has revalued;
aepreciable asset when the the depreclable asset kngwn as the economic life
of
( expected useful life
ofthe asset; and
of the depreciable aaset.
tii) estimated residual value
costing-article reproduced in the book
Depreciation and obsolescence factors in(1967).
as

Policy by J.I. Melji

Depreciation and Replacment
 the mone
represents

assets
commissioni
II.2.8
cost ofthe and
a
nge
chan g as a

exchange
H i s t o r i c a l installatjon undergo

may
o fe
( Cost of t a s s e t s .a c q u i s i t i o n ,
The
cost
a c c o u n t

íts on factors.
cConneot thereof.
liability s i m i l a r
orWth

a t dition
p r o v e m e n t

in
long-term
duties
or insurance
e.
decreas in transit
result increac
ase or changes and machinery
a ndd any
ments, t r a n s p o r t a t i o n

iuct
uctuation[, price adjust costs of erection
of
i n s t a l l a t i o n .

include for of
Acquisition
CO costs
sts wages
paid
at the
time
expenditure

sts of installa include

Any
on or
r e c o n d i t i o n i n g c o m m i s s i o n e d .

S p e n t on repairs before it is
capitalised.

be
it takes a lo long
also to
tested
nust be
The installation must is
machinery
is
started

incurred for commissioning' the factory arises

costs.
When a The q u e s t i o n
Capitalisation of borowir
borrouwing the plant. This is a
commission capitalísed.

time and finally to be

t o acquire nstall
borrowed is capitalisation,
since
whether
Whetherth the interest paiddd on funds favour
funds while
generally
do not own
their
controversial uestion. countants
may
use
of assets.
interest is a financing charg Some companies difference in the value
c o n t r i b u t e to interest
others borrow. That should not asset is purchased,
similar
Those whof inclusion argue that if a
view that interest
IS also a
will be incl in the price such of
an asset. They
Institute of Chartered
future assets. The
St paid for acquiring the services of the capitalisation of borrowing cOSts.
Ccountants of India does not favoùr asset. The useful life of
an asset
useful or economic life of the
y The utility to the enterprise.
8enerally to be taken in terms of the asset's expected
involve the of assetss
asset management polícy of the enterprise may disposal
ueraSpecitied time-or after consumption of a
certain portion of the economic
benefits embodied in the asset. Therefore, the useful life of an asset may be
shorter than its physical life. The estimation of the u_eful life of the asset is a
matter ofjudgement basedon the experience of the enterprise with similar assets.
For an asset
or
using new technology or used in the production of a neW product
service, estimation of the useful life difficult.
is more
The starting point for
of the asset and then it is estimating
the useful life of an asset is the physical life
modified taking into account the
asset, factors of obsolescence and expected use of the
mentioned here that land and experience with similar assets. It may be
buildings
the point of view of useful life, even
are to be treated as
separable assets from
has an unlimited life and thereforewhennotthey are acquired together. Land normally
life, such as certain is depreciated. Land which has a limited
agricultural
land or land
depreciated over its useful life. Buildings have acquired for extractive purposes, is
depreciable assets. An increase in
the value
a limited
life and therefore
does not affect the of the land on
which
are
determination
The economic life
of the useful life
of the
a
building stands
of asset shorter than its building.
pre-determined byanlegal
is
(a)
of related leases; or physical life and is
contractual limits such
(b)directly governed by as the expiry dates
(c dependent on the extraction or consumption;
(d) reduced by extent of
Estimation obsolescence use and the state of
of the economic (already maintenance; and
economic Hfe of an asset. lYe. It is discussed).
difficult
tt The
should be reduced after starting point is the to
estimate precisely the
of obsolescence and also taking into account physical life of the
estimation is more previous
difficuit experience expected use of the asset and
duction of a new ior an asset in Dased
with similar types of asset, factors
nevertheless required product
on
some
or on new
the provision oftechnology assets.
or used in
Such
reasonable basis.
a
new
service,
the
but is
 Depreclation Accounting

II.2.9

The estimated resiaual value. Residual value is the realisable (net)

e end of its
the
the asset at economic life. This
value
lisposal and removal costs from value should be calculated
the sale value of the asset.
ius net residual value 1s called the depreciation base or
r depreciable cost and it is this amournt that has to depreciable
be charged over
amo omic life pf the asset. If the residual value is considered as
as nil, insignificant,
t is normally regarded
One of the bases 1ordetermining the residual value would be the realisable
value ofsimila asset which have reached the end of their useful life and have
perated underer conditions similar to those in
which the asset will be used.
of allocating depreciation
Methods
There are several methods of allocating depreciation over the useful life of
the assets, such as straight line method, reducing balance or written-down value
aethod, depletion method, sum of the years digits method, etc. The accounting
tandards do not recommend any particular method. Those most commonly
employed in industrial and commercial enterprises are the straight line method
(SLM) and the writtern down valuemethod (WDV). An organisation selects the
mast appropriate methodls) based on various important factors, e.g., (i type of
asset, (i0 the nature of the use of such asset and (iüi) circumstances prevailing
the business. A combination of more than one method is sometimes used. In
the case of depreciable assets having insignificant value, the entire depreciable
amount may be charged off to the year of purchase.
Requirement of Companies Act, 1956
Sec. 205 (2) of the Companies Act deals with the provision of depreciation.
The Companies Act, 1988 has delinked depreciation under the Companies Act
from that under the Income Tax Act. The Act now provides the rates of
depreciation in schedule XIV to the Act. Every company has thefollowing
alternatives with respect to provision for depreciation. They are:
(0 provide depreciation on the written down value at the rates specified
in Schedule XIV to the Act, at the end of the each financial year.
(0 provide depreciationby dividing 95% of the original cost of each
depreciable asset by the specified period in respect of such asset.
(ü) Any other method with the prior consent from the Central Govt: which
would ensure writing off at 95% of the original cost during specified period.
(w) For assets for which schedule XIV does not provide rates on basis approved
by Central Govt. by any general or special order published in oficlal Gazette.
of
Schedule XIV provides separate ratesfor depreciation for WDV basis and
straight line basis. Rates are also specified single shift, double shift and three
shifts. Companies Act also stipulates that in the event an asset is sold, discarded.
difference
demolished or destroyed before the few provision of depreciation, the
off in the
between the book value and sale proceeds of the asset must be written
financial year in which the asset is sold, discarded, demolished or destroyed.

Revision of estimate of,useful life

involves
The quantum of depreciation to be provided in an accounting period
the exercise of judgement by management in the light of teehnica, commercial,
need periodical review.
accounting and legal requirements and accordingly may
f it is considered that the original estimate of useful life
of an asset requires
of the asset is charged to
any revision, the unamortised depreciable anount
revenue over the revised remaining uselul ile. Alternatively, the aggregate
on the basis of the revised useful
depreciation charged to date is recomputed
 ife and in the accountin
period ofexcess
is adjusted
so determined
revision.
ot short depreciation disclosed as an
extraordinary item in
the
accounts of the
the saidnis
should be

period.
Depreciation
Wheretheondepre
revaluation revision of historic
or
cost

assets are revalued, the provision ior depreciation

Sould be be ebaseddepreciable of the remaininaG
useful life of on the
t revalued amount and on the estimate
of
the revisio
assets.
depreciation, , the
In case the revaluation has a material ettect on the amount
the same should be disclosed separately in the year in whËch
the :
revision is carried out.
lability on Where the historical cost is revised consequent on changes in longterm
or similar u n t ofexchange fluctuation, price adjustments, changes in duties
amount should, the depreciation on the revised unamortised depreciable
ThieSnould
his be
again is an provided prospectively over the residual useful life of the aSset.
Additions or impovement over IAS4.
extensions to an existing asset
a
uhich
rhiuddon or extension to an existing asset
Wnich becomes an integral part of the existing asset is of a capital nature
which is ofacapítal nature
aining useful life of that depreciated over the
asset. As a practical measure, however,
neimes provided on such addition or extension at the rate depreciation
Isung asset. If this suggestion of AS-6 is followed thewhich is applied
Such addition may not be fully amount Spent
original asset. allocated over the remaining useful life of ti
Any addition or
used after theextension asset
which remains a
OI
being existing separate identity and is capable
on the
basis of an estimate of its ownis
disposed of. is depreciated independently
Assets useful life.
inyolving liability in foreign
in the case of assets currency
or
decreases as the purchased from abroad on credit, the
or decrease
in such
foreign currency appreciates or llablity increases
cost of the fixed liability should be added to or depreciates. The increase
11 asset concerned.
This is in deducted from the historical
'Accounting for the effects
of the accordance with Para 22 of
a casethe
depreciation on the changes
revised
in
foreign exchange .rates.' AS
prospectively over the
to be followed when residual useful depreciable
life of the amount
nount shoul
In
I n such
should be provided
e i e n historical
historical c l the asset. The
cost
in duties or
in dutles or similar
factors. changes due to price same procedure is
Illustration 1.-Nanditha Ltd.
1996, when
adjustments, changes
the
to pay the balanceexchange rate was 1a=Rs.purchased machinary from U.K. for
and 31-3-1998 werein 1£=
5
annual 60. The company paid 1,00,000£ on 1st April
on straight
Rs. 61 instalments
and 1& at the end ot the year. immediately
The £20,000 and agrees
line method.
vears, compute Assuming that Rs.62
=

respectively. The closing rates on

31-3-1997
depreciation
for
relevant accounting standards. the year
the company writes
machine has no scrap value and off
ending 3l-3-1997 and its depreciation
useful
Solution. 31-3-1998 in accordance life is 10
Historic cost of the asset with the
on 1-4-1996
Sterting laibility as on 31-3-97 &1,00,000xRs. 60
Increase in
laibility on account Rs. 60,00,000
of fluctuation in Rs. &80.000
Depn for the yearexchange
ending
rate
31-3-1997
&
80,000x (Rs. 61-Rs.
Historic cost as on 1-4-1997 Rs. 80,000 60)
adding increase in laibility after 10% of Rs.
Unamortised amount as on 1-4-97 60,00,000+60,00.000
80,0000
Remaining useful life
60,80,0000
Rs. 60.80,000-Rs. 6,00,000
Rs. 54,80.000
9 years
 Deprectation Accounttng

for the year ended u.2.11

Deprectatlor

31-3-98
1/9th of Rs.
54,80,000
Scrapping
of a n asset 6,08,888.
my depreciable asset is
the
rplus or deficiency, disposed of, discarded,
if materlal, should demolished or destroyed.
be disclosed
nleclosure of depreciation in financial statements separately.
have already seen the effect of
halance sheet. Because of this, depreciation
AS-6
policy on income statement
information in the financial statements: requires disclosure of following
the historical cost or other amount
substituted for historical cost of
class of depreciable assets; each
0 total depreciation for the period for each class of assets; and
it) the related accumulated depreciation.
Along with the other accounting policies the
depreciation should also be mentioned: following in relation to

(0 depreciation methods used; and

(i) depreciation rates or the useful life of assets, if they are different from
the principal rates Specified in the statute governing the enterprise.
Sometimes changes in accounting policies will have material effect on
financial statements and hence the following must also be disclosed:
(9 Where assets are revalued and such revaluation has a material effect
on the amount of depreciation, the same is disclosed separately in the year in
which the revaluation is carried out.
( 0Any change in method of depreciation is treated as a change in
accounting policy and its effect should be quantified and disclosed.
(ii Any adjustment of excess or short depreciation made in any accounting
assets is
period due to the revision in estimate of the useful life of depreciable
treated as extraordinary item and disclosed accordingly.
Methods of recording depreciation
in the books:
There a r e two methods of recording depreciation
for depreciation account is not
First Method-(When provision
maintained)
1. Debit Depreiation account
Credit Asset account
depreciation)
(Entry for providing
account
2. Debit Profit and loss
Credit Depreciation account

depreciation account)
(Entry for closing account is mantained

Second method-(When
provision for derpeciation
account
. Debtt Depreclation account
for depreciation
Credit Provision
provision
for depreciation)
providing
(Entry for
loss account
2. Debit Profit and
Credit Depreciation account
account
depreciation
(Entry for closing
 A d u a n e d

II.2.12
depreciation

jor
Differencebetween two methods
When
provision

is not
maintained

When provision for depreciation account at what iss

asset aPpears
c o s t less
account is maintained (1) The
value-namely,

at
T h e asset always appears called
book
depreciation written off.
originalcost year after yeal
sheet asset is
2 at balance sheet asset
1s showm
In the
(2) In
the
balance

t h e begîmning
original cost lessdepre- the value at
C1ation provision. The amount to s h o w n at written
less d e p r e c i a t i o n
the credit of provision account of the year The net figure
shows the total depreciation written the year.
off during under provision
off to date. shown will be as

(3) This method is more method.

of any
revealing
the
as one can
understand (3) In the
absence

form a n idea
relative age of the asset and the difficult to
details, it is
Cumulative depreciation indicated asset is n e w o r old.
whether the
Dy the provision for a s to

account. depreciation

DEPRECIATION
METHODS OF CALCULATING THE PERIODIC
CHARGE

to be
nere are various methods of calculating the amount'of depreciation
t e n off each period during the economic life of the asset. In each case the
preciation accounting entries are the same (as given above). It is only the
ount of depreciation which varies and which depends on the selection of the
ethod ofecalculation. In order to explain these methods the following symbols
and simplified amounts are used (examination problems relating to these
methods have been given in secton C of this
chapter):
Item Symbol Amount
Acquisition cost including the cost of installation C 1,000
Residual (turn-in or scrap or
salvage) value less
removal and disposal costs
Estimated economic Life: S 100
In years
n 3
in service Hours
(running time)
In productive
output (units of output) 3,000
Depreclation rate 4.500
Amount of depreciation per
(in rupees) accounting period R
1. Straight-line method
Under this method the
depreciation is charged evenly every year
the life of the asset. This is called
straight-line method, since the throughout
depreciation plotted on a graph paper
results is:
computing the periodic deprecíation charge amount of
in a straight line. The formula for
Formula2
Application
R-CS n R
1,000-Rs. 100
3 =
Rs. 300 per
period
perioa
Depreciatiorl H.

I1.2.13
reciation
Depre
may bee expressed as a
e
rate. The rate on cost will be calculated
a s u n d e r :

rx100=300x10 =
30% on cost

Anpraisal of thestraight-line method. (oThis method is simple to apply as

rithmetical calculations are simple.
the
rhis method does not take into consideration the seasonal
booms, and depressi If in.one year machine is used day and fluctuations,
night and inh
ar
the second year only for some months - e v e n then the
the same.
depreciation for both
the years is
ail Though the usefulness of the machine to the business is more in the
heginningyears than wnat it is in later years, the depreciation is the same for
all the years.

(tii The total charge in respect of an asset is not equal from year to year
though the depreciation is the same for all the years. For example, repairs cost
together with depreciation charge in the beginning years is much less than what
it in the later years. Thus, the burden on the profit and loss account in earlier
is
years is less.

2: Service hours method

for
This method takes into consideration the "running time" the
in the case
of asset
the purpose of calculating the amount of depreciation. For example, of
of an aircraft, the estimated useful life may be calculated
in terms "flying
for computing the depreciation rate is as follows:
hours". The formula
Formula Application
rC-s Rs.
r= 1,000- Rs, T00
3,000
_ Rs. 0-30 per service hour
n

The depreciation charge, assuming 1,000 service hours operated during

can be calculated a s under:
the year,
service hours operated during R= 0.30 x 1,000 = Rs. 300
R=TX
current period

where
method. The method is useful
Appraisal of the
(a) obsolescence is not a 'primary factor,
measured in terms of time,
(b) use of asset c a n be
the utility of the asset is directly
related to its working time.
(c) D
method / h 0
3. Productive output
is essential to
it
make an estimate of the units of output
In this method the case of a truck estimated
time. For example, in
the asset will produce in its life for stamping machine, number
terms of miles operated;
useful life may be in calculated at s0 much per
unit of output.
OI stampings. Depreciation is
rate is a s under:
for calculating the depreciation
Formula
Formula Application
Rs. 1.000-Rs. 100 Rs. 0.20 unit of output
r=C-S r=- 4.500
n units of output produced
amount of depreciation, assuming 2.000
The 1s as under:
uring the current period,
 units of output Rs. 0.20 x 2,000
=
Rs. 400
R
during current perlod where
is useful
The method
APpraisal of the method.
primary factor,
obsolescence is not a measured,
Doutput can be effectively related to its
productive u s e
is directly
utility of the asset
depreciation methoa
Reducing-charge methods or Accelarated
lt is common to find some assets which show declining efficien
ods.
ncy
old are in the
assets when they become quite normally
ter years of life. Such
for "down
Vngrading" assignment and hence result in impaired usef Sed
Locomotiv for example, when new, is used for "crack trains as against iSs
its use
n e shed for shunting purposes when it
and out
is old of date;. office buil
the
in old type--when
comparison to hen it
the rentgrows
it gro in number
of new of years-fetches
type of building.
less am
In all such cases it is fairly ing
mount of rent
es it is
Jastified to charge declining amount of depreciation. fairly
it can also be argued in favour this method that in the lateer
Further. of
combined years
of the life of asset when maintenance cost increases the
cost of
depreciation (when charged on reducing balance method) and maintenance
result in more equitable charge to operating periods for use of assets.ul
three commonly used reducing-charge methods reviewed in the There aro
are
follow. paragraphs to
(a
Fixed Written-down-value method (also commnonly referred to as WDMor
method,percentage-on-declining-base
depreciation
method. Under-the
is charged at fixed rate on the reducing balance
less
depreciation) every year. For example, if the assetreducing balance (i.e., cost
and
the depreciation
is to be is
purchased for Rs. 1,000
depreciation for the
charged at 10% p.a. on reducing balance
second year 10% on Rs. first year will be 10% on Rs. 1,000, i.e., system then
900 (ie., 1,000-Rs. Rs. 100; in the
on
Rs. 810 (Le., Rs.
900-Rs. 90) Rs. 81, 100) Rs. 90; in the third
can be
computed as under: and so on. The rate under year 10%
this method
Formulaa Application
r=l- r=l- 100= 0.536
V1000 or 53.6%
Calculation of can be
made with the
Appraisal of the method. (9
rate of
help of or logarithms
calculators.
depreciation
value, there must is Asset is never
(say) 10%, then even reduced to zero because if
value. remain the when asset is reduced the
( unwritten off balance to very
This
the asset. ismethod can be equal to 90% of that smai
is assumedIt impossble applied only
to be zero. to calculate the when there is
sImau
rate of some residual value of
(b)
method of Sum-of-years-digits depreciation residual
if the vaue
he residual alue
residua
on calculating
decreasingin the
method (also
depreclation where the to as SYD). This
referred
method. The rate future This is anoun
of years-the first amount of reciation anot er

Cost less scrap depreciation is determined

method being deprec is go
Written-down-v lue
value. by the writtern-aore
fraction
action where
wic the
the
 ton
Deprectatton Accourting
IL.2.15
d e n o m i n
change) the sum of the digits
nator (it does not is
asset and the
numerators representing the lfe
o ft h e
1sed in the life(note carefully that it changes
of assets taken
in the reverseevery year) are
vidual d i g i t s use

denominator (which isorder.

et is three
he l1fe ors is found byyears-then
an asset the Thus if
th
getting the the same for
all the ye sum of
erator is the digit picked digits from one to three)
i.e.,
1 + 2 + 3 .

up in the 1. order, L.e., for

reverse
the first year= 3; for the second year= 2; for the third year=
The depreciation for the three
years will be as under:
Year
Depreciation amount
2
3/6x Rs. 900° Rs. 450
3
2/6xRs. 900 Rs. 300
1/6xRs. 900 Rs. 150
(ol Double-declining balance method. This method is often used in the
ISA, Under this method the depreciation is charged on the
ethod but the rate of depreciation is determined by multiplyingreducing balance
the straight
ne rate (when residual value is ignored) by two. Using the
figures given earlier-
ast price Rs.1,000, residual value Rs. 100; life 3 years-the rate for double
declining balance method can be calculated as under:
Cost Rs. 1,000
Scrap zero (under this method scrap value is ignored)
Life 3 years

Straight-line amount per period 1,000-0 = Rs. 333.33

3

_333.33 x
Straight-line rate
1,000
100
33.33%
Double the straight line rate = 33.33%x2 = 66.67 =67%
Depreciation amount per period is as under
Year Book value Rate Depreciation
Rs. 1,000 67% Rs. 670
2 330 67% 221
109 67% 9
900
Residual value 100
Total cost Rs. 1000
C-ILLUSTRATIONS
lustration 2. Mahendra and Narendra Ld. purehased two assets. particulars of whieh are
given as under:
Cost Turn-in ualue Estimated Life
Rs. Rs.
Furniture 7,320 480 6 years
Plant 15,280 3,280 8 years
You are required to determine the amount of depreclation to be written off in each case.
ASSume the company has adopted straight-line method of depreciation.
Solutlon: The amount can be determined by the following formula:

Cost price-Scrap value

Estimated life
of depreciation in the above two cases would
By applying the above formula, the amount
be as under
Cost less scrap value.