chapter 7 -- fixed assets and depreciation accounting

8/8/2019 Chapter 7 -- Fixed Assets and Depreciation Accounting

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INSTRUCTOR:

Prof. (Dr.) Paresh ShahF.I.C.W.A.,Ph.D.(Finance).,F.D.P.(IIMA)

FIXED ASSETS AND

DEPRECIATIONACCOUNTING

11/15/2010 1Prof. (Dr.) Paresh Shah



IDENTIFICATION OF FIXED

ASSETS Fixed assets are long-term assets whose

usefulness in the operation of the f irm is

lik

ely to ex

tend beyond one accounti

ngper iod. They are not for resale

It is an expenditure on asset, which is not

written off completely against income in

the accounting period in which it is

incurred




DETERMINING THE COST OF A FIXED

ASSET OR ACQUISITION COST OF A

FIXED ASSET The gross book value of an asset is the

histor ical cost or the cost at which the

asseti

s actually acqui

red. The cost of an asset compr ises the

purchase pr ice (including import duties

and other taxes or levies) and any directly

attr ibutable cost of br inging the asset to

the wor king status.




Particulars Amount Rs.

Purchase price of the asset

Add: Import duties

Octroi duties

Loading and Unloading Expenses

Installation and commissioning expenses

Erection Expenses

Technical consultancy fees

Less: Trade Discount

Cost of a Procured fixed asset

DETERMINATION OF COST OF A PROCURED FIXED ASSET




REVALUATION OF ASSETS

Fixed assets may be restated in value,

with the help of appraisal undertaken by

competent and approved valuers. Suchchange in the value of the assets is called

revaluation.




DEPLETION COST

Depletion is the portion of the cost of

natural resources that is allocated to

extraction or production of the resourcesover time




Depletion rate per = Acquisition and Development costs ± Residual value

unit of production Estimated recoverable units




AMORTISATION COST

The cost of intangible long-term operating

assets is allocated over the life of the

asset to reflect the decline in its service

potentiality.

The allocated cost of services given up

dur ing each per iod of the asset¶s life is

called Amortisation




Amortisation per per iod

=Cost of an intangible asset

expected life in per iods




DEPRECIATION EXPENSES

The cost of using long-term operatingasset, which is called depreciation, isrecorded piecemeal as the assets are

used. Depreciation is an allocation of the cost

that is calculated using an asset¶s

acquis

ition cost,

its e

xpected l

ife andexpected residual value, and one of the

several accepted depreciation methods





The Institute of Chartered Accountants of India def inesdepreciation as follows in accounting standard AS-6 on³Depreciation Accounting´.

³Depreciation is a measure of wear ing out, consumption

or other loss of value of depreciable asset ar ising fromuse, affluxion of time or obsolescence throughtechnology and mar ket changes. Depreciation isallocated so as to charge a fair proportion of thedepreciable amount in each accounting per iod dur ing the

expected useful life of the asset. Depreciation includesamortisation of assets whose useful life is pre-determined´.





In short, depreciation is the allocated cost

of services given up by a tangible long-

term operating asset (other than land)

during a period of time.

It can be said that amount of depreciation

recorded in books of account is only an

estimate.




CAUSES OF DEPRECIATION

Wear and Tear

Obsolescence

Effluxion of time Accidents




OBJECTIVES OF PROVIDING

DEPRECIATION Correct income measurement

True position statements

Funds for replacement




EFFECTS OF NOT PROVIDING

FOR DEPRECIATION Per iodic expenses will be understated,

Prof its will be overstated;

Asset valuat

ion w

ill be overstated;

Capital depletion will take place;

Cost of production will be understated;

Pr ice determination will be inappropr iate; and

Net worth will be overstated.




DEPRECIATION IS A PROCESS

OF ALLOCATION Accumulated depreciation is that part of the cost of af ixed asset, which is not recoverable when the asset isf inally put out of use.

The depreciation is the value of the benef it the asset has

provided dur ing a given accounting per iod. Depreciation accounting attempts to allocate in a rational

and systematic manner the difference betweenacquisition cost and estimated residual value (estimatedsalvage value) over the useful life of the asset.

Depreciation accounting is helpful to ascertain the trueprof it the entity, and to present the true f inancial positionof the entity




DEPRECIATION IS A PROCESS

OF ALLOCATION Original cost of the asset

Salvage values

Useful life Depreciable cost

Written down value




DEPRECIATION METHODS

The different depreciation methods aim to

allocate the cost of an asset to different

accounting per iod in a systematic and

rational manner. Each method produces a

different pattern of expenses over the

time.




Straight Line Method (SLM) or

Fixed Installment method

nnual depreciation = Cost of the asset ± Residual value

Estimated economical life

Or:

Depreciation per unit output = Cost of asset ± Residual value

Estimated output dur ing the economical life

and Annual depreciation = Depreciation per unit of output x Number of units

produces dur ing an accounting per iod. i.e., year




1000

A

m

o

u

n

tR

s

.

900

800700

600

500

400

300 Annual Depreciation

200100

0

1 2 3 4 5 6 7 8 9 10

Useful life (years)

Fig. 7.2 Straight Line Method ± Annual Depreciation Charge.




r = 1 ± n s

c

Where r = Rate of depreciation or a f ixed percentage.

n = Number of years of asset¶s useful life.

s = Salvage Value or residual value.

c = Acquisition cost of the asset

Reducing or Diminishing or Declining

balance Method or wr itten down

value Method (WDV)




GRAPHICAL PRESENTATION OF REDUCING BALANCE METHOD11/15/2010 22Prof. (Dr.) Paresh Shah



Double Declining Method

This method charging larger amounts of

depreciation to the early years of an

assets life.

In this method, a constant rate is applied

to the asset balance, i.e., acquisition cost

less accumulated depreciation.




Usage Method

Usage method of depreciation allocates

the cost of an asset over its expected life

in direct proportion to the actual use made

of the asset , e.g., the miles travelled by a

delivery truck.

Usage depreciation is computed by

multiplying as assets depreciable cost by ausage ratio, as in the following equation.




Usage depreciation =usage ratio x

acquisition cost less residual value.

Usage ratio = Actual usage dur ing the per iod

Total expected usage




Machine Hour Method

Where it is practicable to keep a record of

the actual running hours of each machine,

depreciation may be calculated on the

basis of hours that the concerned machine

wor ked




Depreciation for the per iod =

Depreciable amount x No. of hours machine wor ksEstimated total machine hours




Production Units Method

Depreciation for the per iod =

Depreciable Amount x Production dur ing the per iod.

Estimated total Production.




Repair Provision Method

Repairs and maintenance cost over the life

of an asset is to be added to the or iginal

cost of the asset to get a total capital

outlay, which is apportioned over the life of

the asset.




Revaluation Method

Assets are revalued per iodically and the

decline in their value is considered as

depreciation.




PROVISION OR FUNDS

METHODS

Annutity Method.

Sinking Fund Method.




FACTORS INFLUENCING SELECTION

OF DEPRECIATION METHOD

Depreciation has a signif icant effect in

determining the f inancial position and result of

operations of an entity via calculating net income

as well as deduction from taxable income. A combination of more than one method is

sometimes used. In respect of depreciable

assets, which do not have mater ial value,

depreciation is often allocated fully in theaccounting per iod in which it is acquired.




FACTORS INFLUENCING SELECTION

OF DEPRECIATION METHOD

Disclosure

± The Accounting Standard VI has provided that

depreciation method used, and depreciation

rates or the useful life of the assets, if they are

different from the pr incipal rates specif ied in

the statute gover ing the entity should also be

closed in the f inancial statements along with

the disclosure of other accounting policies.




METHOD OF RECORDING

DEPRECIATION There are two ways of recording depreciation in

the books, i.e., when no provision for depreciation account is maintained, and whenprovision for depreciation account is maintained.

When no provision for depreciation accountis maintained ± Under this method, depreciation is directly charged to

an asset account, and in the balance sheet, the assetshown at its wr itten-down value (acquisition cost less

depreciation provided to-date.). At the end of theaccounting per iod, depreciation account is closed bytransferr ing it to the income statement or prof it andloss account.




METHOD OF RECORDING

DEPRECIATION

When provision for depreciationaccount is maintained

± Under this method, depreciation is not directly

charged to the asset account, but credited toµAccumulated Depreciation Account¶ or µProvision for Depreciation Account¶ or µDepreciation Fund Account¶ or µAccumulated

Depreciat

ion Account¶. Deprec

iat

ion accountis closed by transferr ing it to the prof it and

loss account.




METHOD OF RECORDING

DEPRECIATION

Exchange of Used Asset with NewAsset

± When a new f ixed asset is acquired in

exchange for another old asset (already usedand depreciated) of the same kind or other,the entity is to pay only the difference, i.e., thedifference between the cost of a new asset

and the value of the old asset granted by theseller. This value of old asset is known as³Trade-in-Allowance´, which becomes a partof the cost of the new asset




DEPRECIATOIN METHOD: IMPACT

ON PROFIT MEASUREMENT

Depending on the method used, a

difference amount is charged for annual

depreciation.

It may also be noticed that over the entire

life of an asset the total amount of

depreciation charge cannot be different.

Thus, the difference is only in terms of

annual apportionment .


chapter 7 -- fixed assets and depreciation accounting

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