Financial Accounting Depreciation Why Depreciation

 Permanent decline in the value of asset  Due to its nature and usage the gradual decrease both in value and usefulness  Process of spreading the cost of fixed assets over the different accounting period  allocating the cost of a tangible asset over its useful life and is used to account for declines in value Definition According to Spicer and Pegler “Depreciation is the measure of the exhaustion of the effective life of an asset from any cause during a given period” Institute of charted accountants of India “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 change” Need for Depreciation

 An asset is bound to undergo wear and tear over a period of time  The purpose of accounting itself, and giving you a clear value of your assets  For tax purposes, you can claim depreciation on an asset as an expense Objective of depreciation

 Ascertain the true profit  To show the asset at its reasonable value  To maintain original monetary investment of the asset intact  Presentation of true financial statement  Replacement of an asset  Depreciation is permitted to be deducted from profit for tax purposes Factors affecting depreciation

 Original cost of the asset (Invoice price less any trade discount plus essential to bring the asset to an usable condition Example: Company purchases Car for business use for 8lakhs,received discount for 45000 and purchased Accessories for 10000.hence depreciation must be calculated for 7,65,000.  Residual value is the estimated sale value of the asset Causes of depreciation

 Use : Wear and tear is an important cause in case of tangible assets  Lapse of time: “Amortisation” for intangible assets  Obsolescence: Loss of usefulness due to improves production method  Accidents: Asset may reduce in value because of accidents  Disuse: Machine remaining ideal. Causes of depreciation

 Inadequacy : Termination of use of asset due to growth in firm  Depletion: Asset that gets exhausted ,these assets are known as wasting assets Methods of providing depreciation

 Straight line method or Fixed instalment method or Original cost method  Written down value method or Diminishing value method or Reducing instalment method Straight line method

 Depreciation is charged evenly every year throughout the effective life of an asset  Formula: Depreciation = Cost of FA – Estimated Scrap value ------No of years of expected life Example: A company purchased a plant for Rs.50,000.The useful life of the plant is 10 years and the residual value is Rs.10,000.Find out rate of depreciation under SLM. Value

Plant price(Book Value Beginning Plant price(Book Value end of Year of the year) Dereciation the year)

1 50000 4000 46000

2 46000 4000 42000

3 42000 4000 38000

4 38000 4000 34000

5 34000 4000 30000

6 30000 4000 26000

7 26000 4000 22000

8 22000 4000 18000

9 18000 4000 14000

10 14000 4000 10000