Depreciation DEPRECIATION Depreciation is the reduction in the value by AmbrishSharma2


Depreciation is the reduction in the value of an asset due to wear and tear,
passage of time or obsolescence.

Presentation in Balance Sheet
Cost of the Asset: Rs. 1,00,000 Life 5 years
No Salvage value

   1st year depn.         Rs. 20,000               Net F.A. 80,000
   2nd yesr depn.            20,000
      (accumulated)         +20,000                         60,000
   3rd year depn.            60,000                         40,000
   4th year depn.            80,000                         20,000
   5th year depn.           1,00,000                          NIL
1. It assumes that a fixed asset gives equal service in each year of its life
   & depreciation, therefore, should be the same
2. Discrimination against any use period is hypothetical & incorrect
3. Depreciation per year =      A - S
Where A is Acquisition Cost
        S is Salvage Value
        n is Useful Life

1. Useful life of an asset depends on –

–   Repairs & Maintenance

–   Wear and tear, intensity of use.

–   Climatic & other Local conditions

–   Human behaviour

–   Technological changes & obsolescence

–   Salvage Value

–   Legal & other Limits on the use of asset
1. It assumes fixed assets have their maximum usefulness in their early
    period of life either because –

–   Their mechanical efficiency declines with age, or

–   Of the increasing likelihood of their obsolescence with age, or

–   Maintenance costs tend to increase with age.

2. It enables the user to write off Larger amounts in early years & smaller
    amounts in later years.

3. A CONSTANT RATE is applied to an unamortised cost (WDV) of the
    asset to determine the depreciation for the year.

       Cost Rs. 1,00,000 Life : 5 years. No Salvage Value
Year       SLM                          WDV

 1         20000      40%of Rs. 1,00,000               40000

 2         20000      40%of Rs.    60,000              24000

 3         20000      40%of Rs.    36000               14400

 4         20000      40%of Rs.    21600                    8640

 5         20000      40%of Rs.    12960                    5184

                                                     + 7776

Machine with eco. Life    : 5 years
                  cost    : Rs. 1,00,000
                Producing : 50000 Units
         Depreciation Rate : Rs. 2/ unit
Year     Units              Depreciation       Net Book
       Produced                                 Value
 1      10,000          10000 x 2 = 20,000      80,000
 2      12,000           12,000 x 2 = 24,000    56,000
 3      12,000           12,000 x 2 = 24,000    32,000
 4      9,000            9,000 x 2 = 18,000     14,000
 5      7,000            7,000 x 2 = 14,000      NIL
                      Units of Production Method

1. Activity may be measured by units of production, machine hours,
   man hours, mileage etc.

2. A rate per unit or per hour is computed by dividing the cost of asset
   (less salvage values, if any) by the estimated total units or hours life
   of the asset.

3. Depreciation is calculated by multiplying actual units produced or
   hours worked by the rate per unit or per hour
                   Profit/Loss on Sale of a Fixed Asset.
1.If a fixed asset is sold during its useful life for more than its book
value, the profit (excess provision of depreciation) is shown as a Non-
Operating revenue on the income statement.
2.Similarly, Loss on sale of fixed assets is treated as Non-Operating
Expense for the current year income statement.
3.If a machine (cost Rs. 50,000, life, 10 years) is sold in 9th year for Rs.
20,000, profit is Rs. 15,000 (50,000 – 45,000) = 5,000 (Rs. 20,000 –
5,000 = 15,000).
If sold for Rs. 2000 only, loss of Rs. 3000 (5000 – 2000) should be
charged as a Non-Operating Expense for the current year.
DEPRECIATION -Tax Implications

Tax Savings – How?
1. Planning the timing of the asset purchase
2. Leasing an asset rather than buying it. Lease rental is an expense.
   For the company receiving the rental, lease attracts lower tax
3. Categorizing assets such that these attract the highest depreciation
   allowance. e.g. Plant (25 %). Buildings and furniture attract lower
   depreciation rate.
   Plant can, e.g. include hotel building, chairs in a cinema hall,
   water tank, water pipes & sanitary fittings etc.

1. Legal provisions as per IT Act, 1961 & Cos. Act. 1956.
2. IT Act allows deduction of depreciation for determining the
   taxable income of an enterprise.
3. Cos. Act 56 allows a co. to adopt any method for corporate
   financial reporting.
4. Depn. to be calculated on historical cost & not replacement cost.
5. Depreciation is basically allocation of cost over a period.
   Replacement is not the objective.
6. Funds are generated by sales & not by accruing depreciation.
7. Tax implications are important.

Depreciation is important for tax purposes because –
1. Depreciation reduces tax liability without the business having to
   spend (non – cash expense) corresponding amounts;
2. Depreciation allowable on an asset (new business, particularly) is
   quite significant compared with the income out of the asset.
   Pollution control equipment, e.g. is eligible for 100% depreciation
   on purchase
3. Even one day’s use of the asset can earn depreciation allowance
   equivalent to use of the asset for six months

To top