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Depreciation

What is Depreciation?

 

In accounting term depreciation is a systematic reduction of value from fixed asset due to wear and tear.

 

Examples of fixed assets are land, buildings, furniture, plant & machinery and office equipment etc. The depreciation will not be calculated on land.

 

 

 

Example of depreciation

 

ABC company purchased machinery with the cost of Rs.1,20,000 and the expected usage of machinery is 6 years, you have to book depreciation expenses of Rs.20,000 ever year for a period of 6 years in ABC company books of accounts.

  

 

Depreciation Calculation

 

There are two depreciation methods used commonly to calculate the depreciation.

 

1. Straight-line depreciation method

2. Declining balance method

 

 

Straight-line depreciation method

 

Straight line depreciation method is the easiest method to allocate the depreciation on an asset over its useful life.

 

Example, purchased machinery with cost of Rs.1,10,000 and useful life of an asset is 5 years and residual value is Rs.10,000

 

 

Formula for straight line depreciation method is

 

Depreciation per annum = (Asset cost – Residual value)                                                           

                                                                  Useful life

                       = 1,10,000 – 10,000

                                      5 Years

 

                       = 1,00,000/5 years

 

                      = 20,000

  

 

Decline balance method

 

This is one of the common depreciation method is widely used form of accelerated depreciation, in other words depreciation is charged more during the beginning of the life time and less is charges during the end of the life time.

 

The reason for charging more depreciation during the beginning of the life time is the assets are usually more productive when they are new.

 

An asset generates more revenue during the beginning of its life time if you compare with last year revenue generated.

 

 

Examples

 

Cost of an asset value is Rs. 2,00,000 and estimated life is 5 years and salvage value is Rs.22,000.

 

Calculate the depreciation using double decline balance method.

 

 

First Year

 

Straight line depreciation rate = 1/5 years = 0.2 = 20%

Decline balance rate: 20%*2 = 40%

Depreciation = 40%  x 2,00,000 = 80,000

 

 

Second Year

 

Decline balance rate = 40%

Asset value – accumulated depreciation for First year = Book value

2,00,000 – 80,000 = 1,20,000

Depreciation = 40%  x 1,20,000 = 48,000

 

 

Third Year

 

Decline balance rate = 40%

Asset value – accumulated depreciation (First year and second year) = Book value

2,00,000 – 80,000 – 48,000 = 72,000

Depreciation = 40%  x 72,000 = 28,800

 

 

Fourth Year

 

Decline balance rate = 40%

Asset value – accumulated depreciation (First year second year and Third year) = Book value

2,00,000 – 80,000 – 48,000 – 28,800= 43,200

Depreciation = 40%  x 43,200 = 17,280

 

 

Fifth Year

 

Book value at the beginning of the 5th year

Asset value – accumulated depreciation = book value

2,00,000 – 1,74,080 (80,000 + 48,000 + 28,800 + 17,280) = 25,920

 

Depreciation for the fifth year

Book value – salvage value = depreciation

25,920 – 22,000 = 3,920

 

 

Depreciation entry

 

Depreciation Expenses a/c Dr

 

To Accumulated Depreciation A/c

 

 

 

 

Related Topics

 

Fixed Asset Entries

 

Current Liabilities and Current Assets

 

Bank Reconciliation

 

 

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