UNIT - V

DEPRECIATION

DEPRECIATION

Depreciation is defined as the gradual andpermanent decrease in the value of an assetfrom any cause.

Cause for Depreciation

Wear and Tear – Result from friction.

Depletion – Decrease value of assets (mines,oilwell)

Obsolescence – loss due to change in demand (mobile, laptops)

Lapse of time – The value of asset goes down whether utilized or not.

Reason for providing Depreciation

To know the correct profitTo show the correct financial positionTo sell the asset in second handTo make replacement decision

METHODS OF DEPRICIATION CALCULATION

• STRAIGHT LINE METHOD • DIMINISING METHOD• SUM OF THE YEARS METHOD• SINKING FUND METHOD• SERVICE OUTPUT METHOD

STRAIGHT LINE METHOD

The depreciation is calculated on original cost ofthe assets and fixed amount is charged as thedepreciation amount throughout the lifetime ofan asset.

Let P = first cost of the assetF = salvage value of the assetN = life of the assetBt = Book value of the asset at the end of the period t.

Dt = Depreciation amount for the period t.

Formulae:Dt = (P – F)/N

Bt = Bt-1 - Dt

= P-t* ((P-F)/N)

Problem.1. A company purchased a machineryfor Rs.8000.The useful life of the machinery is 10years and the estimated salvage value of themachinery at the end of the lifetime isRs.800.Determine the depreciation charge andthe book value at the end of various year usingthe straight line method.

Given..

P = Rs.8000F = Rs.800N = 10 years

To find..Bt = Book value of the asset at the end of the period t.

Dt = Depreciation amount for the period t.

Solution ..Dt = (P – F)/N = (8000 – 800 )/10 = 720

End of year (t) Depreciation ( Dt ) Book valueBt = Bt-1 – Dt

0 - -- 8000

1 720 7280

2 720 6560

3 720 5840

4 720 5120

5 720 4400

6 720 3680

7 720 2960

8 720 2240

9 720 1520

10 720 800

DIMINISING METHOD

Under this method the depreciation is chargedat the fixed rate on decreasing the balance everyYear.

Let Let P = first cost of the assetF = salvage value of the assetN = life of the assetBt = Book value of the asset at the end of the period t.

Dt = Depreciation amount for the period t.

K = A fixed percentage.

Formulae:Dt = k * Bt-1

= K (1-K)t-1 * P

Bt = (1 – K) *Bt-1

= (1 – K)t * P

Problem.2. Calculate the depreciation and book value for period 5 using the declining balance method of depreciation by assuming 0.2 for K and Rs.1,20,000 for P and salvage value Rs.10,000. The useful life of the machinery is 10 years.

Given..

P = Rs.1,20,000F = Rs.10,000N = 10 yearsK = 0.2

To find..Bt = Book value of the asset at the end of the period 5.

Dt = Depreciation amount for the period 5.

Solution..Dt = K (1-K)t-1 * P

D5= 0.2 (1-0.2)5-1 * 120000

= Rs.9830.40

Bt = (1 – K)t * P

B5= (1 – 0.2)5 * 120000

= Rs.39,321.60Result….D5 = Rs.9830.40

B5 = Rs.39,321.60