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
Current Liabilities and Current Assets
Related Pages
- Fixed Asset Entries
- Payroll Journal Entries
- Accrued Expenses
- Prepaid Income
- Accounting Basics
- Debits and Credits
- Chart of Accounts
- Bookkeeping
- Petty Cash
- Bank Reconciliation
- Accounts Payable Process
- Accounts Receivable Process
- Prepaid Expenses
- Discount Allowed and Discount Received
- Journal Entries
- Adjusting Entries
- Current Liabilities and Current Assets