Depreciation Accounting – CA Foundation, CPT notes, PDF

This article is about the Depreciation Accounting for CA foundation CPT students. we also provide PDF file at the end.

depreciation accounting

What we will study in this chapter:

♦     We will study in this chapter the meaning of depreciation and need of depreciation in accounting.

♦     We will study the various methods of depreciation in accounting, change in the method, special methods and also in brief the requirement of AS-10 ‘Property, Plant & Equipment’.

STUDY OF DEPRECIATION ACCOUNTING CAN BE CLASSIFIED UNDER FOLLOWING THREE SECTIONS :

♦     Meaning, and usual methods of calculation and accounting

♦     Changes in: method of depreciation, cost of asset, and life of asset.

♦     Special methods of depreciation in accounting.

DEPRECIATION : MEANING, USUAL METHODS OF CALCULATION AND ACCOUNTING

INTRODUCTION:

An expenditure which results into enduring benefit (long term benefit) are treated as capital expenditure/fixed assets. Fixed assets are those assets which are held for use in the business and not for sale or consumption in the course of production.

Fixed assets which have a limited useful life are known as depreciable asset like, building, plant and machinery, etc. land is a non-depreciable asset. Revenue expenses are charged to the years P&L a/c similarly depreciable fixed assets should be charged over (written off) over its useful life. This process of systematically allocating depreciable amount (cost less estimated scrap value) to the P&L accounts over its useful life is known as depreciation accounting. Amortization of assets which has specific life like patents etc. is also included in it.

Depreciation though accrues every day but for convenience it is calculated and accounted annually.

12.1 MEANING:

12.1.1  Fixed asset/Depreciable asset:

♦     fixed assets are those assets which are:

■     held for use in the business and not for sale or consumption in the course of production.

♦     Fixed assets which have a limited useful life are known as depreciable asset like, building, plant and machinery, etc.

♦     Land is a non-depreciable asset.

12.1.2  Depreciation:

♦     Depreciation is the reduction in the value of fixed assets due to:

■     its use,

■     passage of time and

■     obsolescence.

♦     Depreciation is the apportionment of cost of asset net of estimated scrap value over its estimated useful life.

12.1.3  Ascertainment of amount depreciation vs. physical verification and actual valuation:

♦     Depreciation is not ascertained by physical verification and actual valuation every year

♦     Depreciation is calculated by following certain method and rate.

♦     Physical verification may be done by management to confirm the existence of asset.

♦     Actual valuation may be done by management when it wishes to re-value the asset.

12.1.4  The elements relevant for deciding the rate/amount of depreciation are:

♦     The life of the asset,

♦     Estimated scrap value at the end of that life.

♦     Cost of acquisition (costs necessary to put an asset into usable condition).

12.1.5  Need/benefit of depreciation:

♦     The assets are shown at proper (reduced) value at every balance sheet.

♦     The Profit & Loss account shows true/proper profit or loss because some portion of fixed asset (in the form of depreciation) which are used for earning the income are debited to P&L A/c

♦     The depreciation reduces the profit, hence to that extent amount (funds) gets retained in the business, which can be used for replacement of this asset.

12.1.6  When depreciation starts:

♦     Depreciation starts once an asset is ready for use,

♦     even if it is not yet put to use,

♦     it is because depreciation is the reduction in value due to use, efflux (passage) of time and obsolescence etc.

12.1.7  Depreciation is a non-cash expenditure:

♦     Depreciation is charged/debited to profit and loss account like any other expenses.

♦     But other expenses results (sooner or later) into payment (credit to cash/bank)

♦     whereas depreciation results into reduction in value of fixed assets (credit to fixed asset a/c and not to cash bank a/c), hence known as non-cash expenditure.

Cash outflow results only once when fixed asset is purchased/acquired and later on everv year it is written off to I P&L a/c as depreciation.

12.2 METHOD OF DEPRECIATION CALCULATION:

12.2.1  The common methods of calculating depreciation:

(i) Straight line/fixed instalment/original cost method and

(ii) Written down value/diminishing/reducing balance method.

These are the most commonly followed methods as well as recognized by law and Accounting Standard for calculating depreciation.

12.2.2  Fixed instalment/straight line method:

♦ The amount of annual depreciation on a fixed asset are same every year.

♦ If the life of assets is given the depreciation will be calculated as follows.

■ Depreciation p.a. =

Illustration 12.1 : An asset costing Rs. 1,00,000 is estimated to have scrap value of Rs. 10,000 at the end of its life of 5 years. Calculate depreciation

Solution: Depreciation p.a. =  = Rs. 18,000

When scrap value is not given assume it to be Nil for straight line method.

■ If the % of Depreciation is given then every year that % will be applied on original cost of the assets.

Illustration 12.2 : Assets costing Rs. 1,00,000 to be depreciated at 10% by straight line method.

Total depreciation charged on any asset cannot exceed its original cost. This precaution should be taken in case of Straight line method.

12.2.3 Reducing Balance Method/Written down value method :

♦     The % of depreciation will be applied in 1st year on original cost and

♦     Thereafter every year on the written down value at the beginning of that year.

♦     W.D.V. rate for charging depreciation can be worked out by following formula, to be solved with the help of log tables. (It is not expected that such calculation can be asked in exam at Foundation level)

♦     W.D.V. Rate = 1 (-)

♦     Where ‘N’ is life of Asset in years.

♦     If scrap value is not given it can be taken as 5% of cost or a token amount like Rs. 100, etc. for calculating rate because otherwise this formula cannot work.

Illustration 12.3 : Assets of Rs. 1,00,000 to be depreciated @10% on W.D.V.

12.2.4 Period of depreciation:

♦     Depreciation is calculated on the basis of time for which the asset was used in that year.

♦     Therefore in case of opening balance of assets, depreciation is calculated for whole year.

♦     Whereas on the Assets which are added during the year depreciation is calculated for the period from the date of purchase to the end of the year.

♦     If the date of purchase is not given then we assume the middle of year & accordingly depreciation is taken for 6 months only.

♦     On assets sold during the year depreciation is calculated from the beginning of the year to the date of sale.

When with the Depreciation rate p a.’ is not mentioned, then even on additions you (as student)can take full years depreciation.

It is not mandatory, hence even in such cases depreciation on periodic basis can be taken specially when date of purchase/sale is specified.

Similarly in case of a new business (i.e. 1st year) full year’s depreciation can be charged even if rate p.a. is given, it is so because asset must have been acquired when the business commenced i.e. at the start of the year.

12.3 METHODS OF DEPRECIATION ACCOUNTING:

12.3.1  Methods of Depreciation Accounting:

♦     The Depreciation is calculated as above (i.e. by SLM or WDV method) and

♦     is accounted at the end of every financial year, in either of the following ways.

1. Depreciation is credited to the assets account.
2. Depreciation is credited to Depreciation reserve account.

12.3.2  Depreciation is credited to the assets account:

♦     Depreciation is credited to the assets concerned every year & hence the balance of asset will reduce from year to year.

♦     ENTRY:   Depreciation a/c Dr.                …..

To Assets a/c                                      …..

12.3.3  Depreciation is credited to Depreciation reserve account:

♦     Depreciation will be credited to Depreciation reserve a/c/Depreciation fund a/c/depreciation provision a/c & not to Assets A/c

♦     Hence the assets will always appear in the books at its original cost & the Depreciation Reserve a/c will show the accumulated Depreciation till that year.

♦     W^rhile preparing Balance Sheet we show on the assets side Fixed assets less depreciation reserve.

♦     ENTRY:   Depreciation a/c Dr.                …..

To Depreciation Reserve a/c              …..

Depreciation a/c represents an expense hence it will be transferred (Debited) to manufacturing a/c or P<&L A/c in both the above cases.

12.3.4  Depreciation reserve/depreciation provision/depreciation fund account:

♦     Every year when depreciation is charged it is credited to depreciation provision account. Thus it keeps on increasing every year.

♦     At the end of every year this accumulated balance is shown as a deduction from the cost of asset in the balance sheet.

♦     W/hen an asset is sold, discarded or retired the accumulated depreciation of that asset is transferred from depreciation provision account to that asset account (or asset disposal a/c if prepared) and

♦     Then profit/loss on that asset’s disposal is ascertained.

♦     Students should clearly identify the distinction that SI .M and W’DV are methods for calculating depreciation {i.e. it tells how much to write off)

♦     Whereas crediting to asset a/c or depreciation provision a/c are the methods of accounting (i.e. it tells how to account)

12.3.5  Accounting treatment of the asset sold:

♦     When the fixed Asset is sold, sale value is credited to asset A/c and the profit or loss on sale is ascertained.

♦     The accumulated depreciation of the asset sold is transferred from depreciation provision account (if you are maintaining asset account at its original cost) to that asset account.

♦     The profit or loss is the difference between sale value & written down value of that asset.

♦     This profit or loss is transferred as follows :

(i) If profit, entry will be –

Assets a/c Dr. …..

To Profit on sale of asset a/c/P & L a/c …..

(ii) If loss, entry will be –

Loss on sale of asset a/c/P & L a/c Dr. …..

To Assets a/c …..

On the Assets sold, depreciation will be calculated for the period from the beginning of the year to the date of sale & then profit or loss will ascertained.

This whole accounting can alternatively be done by preparing asset disposal a/c explained below.

12.3.6  Accounting of the asset sold through Asset Disposal Account:

♦     When the fixed Asset is sold, we can account it through Asset account itself as explained above or by preparing an Asset Disposal A/c (Asset Sold A/c).

♦     Cost of the asset sold/balance of asset sold is transferred from asset a/c to asset disposed a/c.

♦     The accumulated depreciation of the asset sold is transferred from depreciation provision account (if vou are maintaining asset account at its original cost) to asset disposal a/c.

♦     Sale value is credited to asset disposal A/c and the profit or loss on sale is ascertained.

♦     The balance in the asset disposal a/c is the profit (if credit balance) or loss (if debit balance).

♦     This profit or loss is transferred as follows :

(i) If profit entry will be –

Assets Disposal a/c Dr. …..

To Profit on sale of asset a/c/P&L a/c …..

(ii) If loss entry will be –

Loss on sale of asset a/c/P&L a/c Dr. …..

To Assets Disposal a/c …..

On Assets sold, depreciation will be calculated for the period from the beginning of the year to the date of sale & then profit or loss will ascertained. This depreciation can be either credited to Asset a/c/Depreciation Provision a/c or directly to Asset disposal a/c.

ILLUSTRATIONS

Depreciation: Calculation by WDV and Accounting by credit to Asset a/c

Illustration 12.4 : On 1.1.03 machinery was purchased l or Rs. 80,000. On 1.7.04 addition were made to the amount of Rs. 40,000. On 31.3.05 machine purchased on 1.7.04 costing Rs. 12,000 was sold for Rs. 11,000 & on 30.6.05 machinery purchased on 1.1.03 costing Rs. 32,000 was sold for Rs. 26,700. On 1.10.05 addition were made to the amount of Rs. 20,000.

Show Machinery a/c & Depreciation a/c for 3 years 2003, 04, 05. Depreciate Machinery at 10% p.a. by W.D.V. method.

Solution :

Machines A/c (W.D.V. 10%)

Depreciation A/c

Working notes

Depreciation: Calculation by SLM and Accounting by credit to Asset a/c

Illustration 12.5 : On 1.1.03 machinery was purchased for Rs. 80,000. On 1.7.04 addition were made to the amount of Rs. 40,000. On 31.3.05 machine purchased on 1.7.04 costing Rs. 12,000 was sold for Rs. 11,000 & on 30.6.05 machinery purchased on 1.1.03 costing Rs. 32,000 was sold for Rs. 26,700. On 1.10.05 addition were made to the amount oi Rs. 20,000.

Show Machinery a/c & Depreciation a/c for 3 years 2003, 04, 05. Depreciate Machinery at 10% p.a. by S.LM.

Solution :

Machinery A/c (SLIM 10%)

Depreciation A/c

Working notes

Depreciation: Calculation by WDV and Accounting by credit to Depreciation Provision a/c

Illustration 12.6 : On 1.1.03 machinery was purchased for Rs. 80,000. On 1.7.04 addition were made to the amount of Rs. 40,000. On 31.3.05 machine purchased on 1.7.04 costing Rs. 12,000 was sold for Rs. 11,000 & on 30.6.05 machinery purchased on 1.1.03 costing Rs. 32,000 was sold for Rs. 26,700. On 1.10.05 addition were made to the amount of Rs. 20,000.

Show Machinery a/c, Depreciation provision a/c and Asset disposal a/c for 3 years 2003, 04, 05. Depreciate Machinery at 10% p.a. by W.D.V. method (for calculation refer Illustration 12.4)

Solution :

Machinery A/c

Provision for Depreciation A/c (WDV 10%)

Depreciation A/c

♦     Depreciation upto the date of disposal is directly credited to asset disposal a/c alternatively it can be routed through depreciation provision a/c.

♦     Similarly asset sold can be accounted through asset Disposal account in earlier illustration also.

Depreciation: Calculation by SLM and Accounting by credit to Depreciation Provision a/c

Illustration 12.7 : On 1.1% machinery was purchased for Rs. 80,000. On 1.7.97 addition were made to the amount of Rs. 40,000. On 31 3.98 machine purchased on 1.7.97 costing Rs. 12.000 was sold for Rs. 11.000 & on 30.6.98 machinery purchased on 1.1.% costing Rs. 32.000 was sold for Rs. 26,700. On 1.10.98 addition were made to the amount of Rs. 20,000.

Show Machinery a/c & Depreciation provision a/c for 3 years 96. 97. 98. Depreciate Machinery at 10* pa. by S LM (for calculation refer Illustration 12.5)

Solution:

Alternatively sale of asset can be routed through asset disposal a/c as done in earlier illustration.

Depreciation A/c

Depreciation: Calculation by SLM and Accounting by credit to Depreciation Provision a/c

Illustration 12.8: On 1 st January 2002 Hari Om purchased 6 machines for Rs. 15,000 each. His accounting year ends on 31st December. Depreciation at the rate of 1096 on initial cost has been charged to profit and loss account and credited to a separate depreciation provision account.

On 1st January 2003 one machine was sold for Rs. 12,500 and on 1st January 2004 a second machine was sold for Rs. 12,500. An improved model which cost Rs. 28,000 was purchased on 1st July, 2003. The same rate of depreciation was decided for the new machine was well. You are required to show:

1. The asset account 2. The asset disposal account 3. The depreciation provision account.

Solution

Note: The balance in the asset account at any time represents the cost of assets retained by the firm.

Machinery Disposal A/c

Note: Machinery disposal account is not a continuous account like machinery account. It must be prepared separately for each year.

Note: The balance in the provision account at any time shows the balance of accumulated depreciation in respect of retained assets.

Depreciation: Calculation by WDV and Accounting by credit to Asset a/c

Illustration 12.9 : Rajeev commenced business in March, 2004. He acquired some machines for Rs. 2,00,000 on 1.4.04. He acquired another machine for Rs. 50,000 on 1.3.2006. He sold machines, original cost of which was Rs. 60,000, for Rs. 35,000 on 31.10.2005. Assuming depreciation @15% under WDV basis, compute the depreciation for the year ended 31.3.2005 and 31.3.2006 and prepare machinery a/c.

Depreciation to be calculated to the nearest rupee. _t

Solution

Machinery A/c (WDV 15%)

Working notes:

CHANGE IN : METHOD OF DEPRECIATION, COST OR LIFE OF ASSET

The principle of consistency requires that same methods should be followed from year to year. But in case of permissible situation an enterprise can change the method.

12.4 IMPORTANT POINTS OF AS-10 DEPRECIATION ACCOUNTING’ ISSUED BY ICAI :

12.4.1  Rate and Method prescribed by AS-10:

♦     AS-10 does not prescribe any method or rates.

♦     It states that depreciable amount should be written off systematically over its useful life.

♦     It refers that SLM and WDV arc commonly followed method.

♦     It also permits different methods for different class of assets like for building a SLM whereas for plant and machinery WDV may be followed by an enterprise.

12.4.1.1 AS-10 & change in method:

♦     Depreciation method should be followed consistently, that means usually previous years method should be followed in this year also.

♦     But in following cases change in method is permitted by AS-5.

■     due to change in statute or

■     to comply with an AS (Accounting Standard) or

■     to give a better presentation and true and fair picture of performance and financial position.

12.4.2 Change in cost of asset:

♦     The cost of a depreciable asset may change (increase or decrease) due to

■     charge or refund of duties, taxes etc.,

■     receipt or refund (cancellation) of Govt. grants,

■     change in foreign exchange liability etc.

♦     As per AS-10 the revised un-amortized balance should be written off over its remaining useful life l.e. prospective adjustment is required.

Illustration 12.10: An asset costing Rs. 1,00,000 having useful life 10 years being depreciated by SLM. In 3rd year Rs. 20,000 Govt. grant for this asset is received.

Solution : Depreciation charged in 1st and 2nd years = 1,00,000/10 = 10,000 p.a.

Remaining useful life 8 years

Revised depreciation p.a. from 3rd year onward = 60,000/8 = Rs. 7,500

12.4.3 Revaluation of assets:

♦     AS-10: ‘Property, plant and equipment” permits the revaluation of all or a systematically selected class of assets.

♦     As per AS-10 the depreciation shall be charged on revised (revalued) amount so as to write it off over its remaining useful life l.e. prospective adjustment is required.

Illustration 12.11 : An asset costing Rs. 1,00,000 having useful life 10 years being depreciated by SLM. In 3rd year there is an upward revaluation of asset by Rs. 20,000/-

Solullon: Depreciation charged in 1st and 2nd years – 1,00,000/10 – 10,IKK) p.a.

Remaining useful life 8 years

Revised depreciation p.a. for 3rd year onward 1,00,000/8 = Rs. 12,500

♦     On upward revaluation asset a/c is debited and revaluation reserve a/c is credited and

♦     In case of decrease in value (i.e. downward revaluation) profit and loss a/c is debited and asset a/c is credited.

♦     Further details of AS-10 in this regard are not relevant for foundation level.

12.4.4 Change in life of asset:

♦     The depreciation is calculated by estimating its useful life which may be revised in future.

♦     If the life of assets re-estimated (the life may increase or decrease) then the unamortized balance should be written off over its remaining (revised) useful life l.e. prospective adjustment.

Illustration 12.12 : An asset costing Rs. 2,00,000 life 10 years, SLM followed. In 5th year it is estimated that total life is 12 years (i.e. remaining life is 8 years).

Solution :

Balance of asset in 5th year Rs. 2,00,000 – (20,000 × 4)                  = Rs. 1,20,000

Revised balance life 8 years

Depreciation p.a. from 5th year onward (1,20,000 ÷ 8)                     = Rs. 15,000               p.a.

12.4.5  Additions to existing assets:

♦     Addition/extension/modification to an existing asset may be made in any year which are of capital nature.

♦     If addition has its separate identity, it should be depreciated as an independent asset over its useful life ix. without relating to original asset.

♦     Otherwise addition will be clubbed with original asset and

■     depreciated over its remaining life or

■     depreciated at same rate.

12.4.6  Depreciation Rate: estimated by management and that given by statute:

♦     An enterprise may estimate the rate of depreciation considering the useful life of an asset or apply the rate prescribed by the statute/law governing it.

♦     If managements estimated depreciation rate and rate prescribed by the applicable statute (like Companies Act in case of companies) are different then the rate which is higher should be applied.

ILLUSTRATIONS

Change in life, cost and revaluation

Illustration 12.13 : M/s Kapur & Sons purchased machinery on 1.1.1999 for Rs. 10,00,000. The machine was put to use on 1.7.1999. The expected useful life of the machine was 10 years and estimated scrap value was Rs. 2,00,000. They followed straight line depreciation. On 1.1.2002 the government grant received for the said machine ⁹1,00,000, they upward revalued the machinery by Rs. 4,00,000, and on the same date and re-estimated the total useful life as 11.5 years. On 15.5.2005 the machine was destroyed by fire. As per terms and conditions the insurance company paid 70% of the W.D.V. as on the date of destruction. Show Machinery Account in the books of M/s Kapur & Sons.

Solution :

In the books of M/s Kapur & Sons

Machinery A/c (SLM)

Working Notes :

(1) SLM depreciation 1999-01 =  = Rs. 80,000 per annum.

(2) SLM depreciation 2002 and thereafter =  = Rs. 1,00,000

As per AS-6 (Revised), the revised book value (balance Rs.8,00,000 + revaluation addition Rs. 4,00,000 – Govt. grant received Rs. 1,00,000 = Rs. 11,00,000) has been written off over the remaining revised useful life prospectively.

(3)   On the date of destruction, 4.5 months depreciation is chargeable while computing loss.

(4)   Insurance claim (Rs. 8,00,000 – Rs. 37,500) × 70/100 = Rs. 5,33,750.

OTHER METHODS OF DEPRECIATION

What we have studied earlier are usual and commonly followed methods by most of the enterprises. But in specific situations and for specific purposes, some different methods can also be followed. These methods may have different basis or method of calculation, or something new in accounting or both.

12.5 SPECIAL/OTHER METHODS FOR DEPRECIATION:

Special/Other Methods for Depreciation Accounting are as follows:

(1)   Sinking Fund/Depreciation Fund Investment Method.

(2)   Insurance Policy Method.

(3)   Annuity Method.

(4)   Depletion Method.

(5)   Machine Hour Method, Production Unit Method, Km Method.

(6)   Sum of Digits Method.

(7)   Revaluation method.

This method may have some different basis of calculation or something new in accounting or both.

12.5.1  Sinking Fund Method:

♦     In Sinking Fund Method in addition to charging of depreciation, every year an equal amount together with interest earned is invested outside the business.

♦     This method is followed for depreciation accounting with an objective to arrange the sufficient funds (Finance) for the replacement of the Asset, when its useful life will be over.

♦     It serves dual purpose of charging depreciation as well as saving an equal amount for future replacement of asset.

♦     It is also known as depreciation fund investment method.

♦     Amount of Annual Instalment (Depreciation) is ascertained by using Annuity table which takes into consideration the interest to be realised on the investment.

12.5.1.1 The detailed accounting under sinking fund method:

12.5.2  Insurance Policy Method:

♦     It is similar to Sinking Fund Method. The purpose is same to arrange for the funds for replacement of asset.

♦     Only difference is that instead of purchasing Investment, a Insurance Policy for the replacement of asset will be taken.

♦     There will be no interest receipt like in case of Sinking Fund method.

♦     Full policy amount will be realized, even if the asset is destroyed/damaged any time, because it is a insurance policy and not a simple investment.

♦     Policy is taken at the beginning of the 1st year so that insurance cover is available in the 1st year also.

12.5.2.1 The detailed accounting under insurance policy method:

(a)   At the beginning of every year when premium is paid, the entry will be:

Insurance policy a/c Dr. …..

To Cash/Bank a/c …..

(b)   At the end of every year to give the effect of depreciation following entry will be passed with the amount equal to premium: (Alternatively this entry can be routed through depreciation a/c as seen in Sinking Fund Method)

P&L a/c Dr. …..

To Insurance Policy Reserve a/c …..

(c)   At the end of last year policy amount will be received:

Bank a/c Dr. …..

To Insurance policy a/c …..

(d)   The balance if any in Insurance Policy a/c will be transferred to Insurance Policy Reserv e a/c

(e)   Insurance Policy Reserves a/c balance will be transferred to Asset a/c

(f)    Scrap value if any to be credited to Asset a/c

(g)   The balance in the asset a/c then, will be transferred to P&L a/c

Refer illustration 12.19

The Sinking Fund a/c and Insurance policy reserve a/c are just the substitute of Depreciation fund/reserve provision a/c.

12.5.3  Annuity method:

♦     In this method the fixed asset is treated like an investment which earns interest.

♦     It is not actual interest received it’s notional interest.

♦     The depreciation amount is calculated with the help of Annuity Tables so as to write off the cost of Asset & interest over its useful life.

♦     It may be followed for leased asset where lump-sum amount is paid but effect like annual rent is to be given.

12.5.3.1 Accounting under annuity method:

(a) Every year interest is calculated on the opening balance of asset at specified % St is accounted.

Asset a/c Dr. …..

To Interest a/c …..

(b)   Depreciation which will be equal amount (annuity) every year will be charged.

Depreciation a/c Dr. …..

To Asset a/c …..

(c)   Every year the Interest a/c & depreciation a/c will be transferred to profit & loss a/c

This is the only method where total depreciation is more than the cost of asset because it is writing off of cost plus the notional interest added to it.

Refer illustration 12.20

12.5.4 Depletion method:

♦     This method is followed in case of exhaustive (wasting) assets e.g., mines.

♦     For charging depreciation on such item the life of the Asset (lease period) is not very important because it can be used (i.e., Mineral can be extracted) only till it contains minerals.

♦     As soon as the mineral is exhausted the mine becomes useless.

♦     Therefore depreciation is calculated in proportion of the mineral extracted in a particular year to the total extractable mineral contained in it.

♦     Depreciation (per – ton, etc.) =

Refer illustration 12.21

12.5.5 Machine Hour Method:

♦ In this case the life of the machine will be given in terms of effective/productive machine hours.

♦ Depreciation per Machine Hour =

♦ The depreciation for a particular year will be the machine hours used in that year multiplied by Machine hour rate.

Illustration 12.14 : A machine costing Rs. 5,00,000 has an effective life of 1 lac machine hours. It was used for 10,000,20,000 & 18,000 hours in the year 2003,04 & 05 respectively.

Solution: The amount of depreciation for these years will be*

Depreciation per Machine Hour =  = 5 per hour

Depreciation for 2003 :10,000 × 5 = Rs. 50,000

Depredation for 2004: 20,000 × 5 = Rs. 1,00,000

Depreciation for 2005 : 18,000 × 5 = Rs. 90,000

Similarly production units can be used in place of machine hour. In case of assets like vehicles, depreciation can be calculated on the basis of life in terms of kilometres.

12.5.6 Sum of Digits Method:

♦ In this method the depreciation is calculated in the ratio of the remaining life of the asset in the beginning of that year to the sum of digits of the life remaining for all the year.

Illustration 12.15 : An asset costing 11,00,000 having a life of 4 years. Calculate depreciation by the sum of digits method:

Solution: Sum of digits of life remaining at the beginning of each year from 1st to the 4th = 4+3+2+1=10

1st year Depreciation = × 4 = 40,000              2nd year Depreciation = × 3 = 30,000

3rd year Depreciation = × 2 = 20,000             4th year Depreciation = × 1 = 10,000

Depreciation has reducing trend like WDV method but unlike WDV method here the book value will become nil at the end of the last year.

12.5.7     Revaluation method:

♦         Revaluation method is applied for writing off an asset to its current value.

♦    Under this method, the assets are valued at their current values and the depreciation is calculated by finding out the difference between the current value and the book value.

♦    Any such decrease in the book value of the asset as compared with its current value is written off as depreciation at the end of each accounting period.

♦    This method is considered to be appropriate for the assets which are of small values such as loose tools or where the life of the asset can’t be determined with certainty, e.g. livestock etc.

Illustration 12.16 : Tools purchased during the year 2003 are Rs.50,000, year 2004 Rs.10,000 and year 2005 Rs.15,000. The tools were valued at the end of the year 2003 at Rs.40,000, year 2004 Rs.35,000 and year 2005 Rs.25,000. Calculate depreciation by the revaluation method:

Solution: Depreciation for the year = Op. balance + Addition during the year – Sold during the year – Cl. Valuation.

Depreciation for 2003 = Nil + 50,000 – Nil – 40,000 = Rs.10,000

Depreciation for 2004 = 40,000 + 10,000 – Nil – 35,000 = Rs.15,000

Depreciation for 2005 = 35,000 + 15,000 – Nil – 25,000 = Rs.25,000

ILLUSTRATIONS

Sinking Fund Investment Method

Illustration 12.17: On 1.7.01 Wise limited purchased a machinery for 1,10,000 & spend Rs. 6,000 on its installation. The expected life of machine is four years at the end of which the estimated scrap value will be Rs. 16,000. Desiring to replace the machine on the expiry of its life, the company established a sinking fund. Investments are expected to realise 5% interest. On 30.6.05, the machine was sold off as scrap for Rs. 18,000 & investments were realised at 596 less than the book value. On 1.7.05 the new machine is installed at cost of Rs. 1,25,000.

Sinking Fund table shows that, 0.2320 invested each year will produce Re. 1 at the end of 4 years at 5%. Show the necessary ledger a/c for all years.

Solution:

Annual amount = 1,00,000 × 0.2320 = 23,200

Machinery A/c

Sinking Fund (Depreciation fund) A/c

Sinking Fund (Investment) A/c

Interest on Sinking Fund (Investment) A/c

(1)   Annual instalment (which represents depreciation) Rs. 23,200 can instead of directly by debiting to P&L a/c, be debited to depreciation a/c, and then depreciation a/c, will be transferred to P&L a/c

(2)   Alternatively Rs. 1,00,000 can be transferred from S. F. to Machinery a/c. The balance then left in S. F. a/c will be transferred to P&L a/c

(3)   The above alternatives are implemented in the next illustration

Sinking Fund Investment Method through Depreciation Account

Illustration 12,18 : A company purchased a 3 years lease on January 1, 2003 for Rs. 25,000. It decided to provide for the replacement of the lease at the end of 3 years by setting up a Depreciation Fund. It is expected that investment will fetch interest at 5%. Sinking Fund tables show that to provide the requisite sum at 5% at the end of 3 years, an investment of Rs. 7,932.22 is required every year. Investments are made to the nearest rupee. On 31st December, 2005, the investments are sold for Rs. 15,250. On 1st January, 2006, the same lease was renewed for a further period of 3 years by payment of Rs. 30,000. Prepare lease Account, Depreciation Fund Account, Depreciation Fund Investment Account, Depreciation Account and New lease Account.

Solution:

Insurance Policy Method

Illustration 12.19: An asset costing Rs. 1,00,000 having a life of 3 years with estimated scrap value Rs. 10,000 is purchased on 1.1.2003. It is decided to take an asset replacement policy having premium of Rs. 28,000 p.a. At the end of its life asset was scraped for Rs. 12,000. Prepare necessary accounts.

Solution

Machinery A/c

Insurance Policy Reserve A/c

Insurance Policy A/c

Annuity Method

Illustration 12.20: A lease was purchased on 1 -4-2001 for a five year at a cost of Rs.50,000. It is proposed to depreciate the lease by annuity method charging 5% interest. Show the lease account for 5 years and also the relevant entries in the Profit and Loss Account. The reference to the annuity table shows that to depreciate Re. 1 by annuity method over 5 years by charging interest at 5% one must write off a sum of Re. 0.230975 every year.

Solution

Lease A/c

P&L A/c (Extract) Y.E. 31.3.02

Note: Similar presentation in P&L can be shown for other year also.

Depletion method

Illustration 12.21 : B & Co. took a Mine on lease on 1.1.02 for 10 years for Rs. 10 lacs. It is estimated to contain 50 lac tons of Coal of which 20% has to be left un-extracted as bottom layer. Coal extracted in 1st four years is (In lacs tons): 3, 5, 6, 4. Prepare Mine a/c

Solution:

Depreciation per ton = 10/40=0.25 or 10,00,000/40,00,000=0.25

Mines A/c

Note : After 4th year similar accounting will continue until any of the following 3 factors whichever occurs first.

1. 10 years over
2. Actual coal is over
3. 40 lac book value is over (Le. WDV nil)

If (a) or (b) occurs 1st the balance in mines account will be written off to P&L a/c as loss.

If (c) occurs 1st then mine, will continue to be used until (a) or (b) takes place, but no depreciation will be charged.

PRACTICE PROBLEMS

(Answers & Hints given at the end of the Chapter)

P.1 : On 1st April, 2010, Moon Ltd. purchased a plant for Rs. 10,00,000.

On 1st October, 2010 an additional plant was purchased costing Rs. 5,00,000.

On 1st October, 2011, the plant purchased on 1st April, 2010 was sold off for Rs. 7,00,000.

On 1st July, 2012, a new plant was purchased for Rs. 12,00,000 and the plant purchased on 1st October, 2010 was sold for Rs. 4,20,000 on 1st October, 2012.

Depreciation is to be provided at 15% per annum on the written down value on 31st March every year.

Prepare the Plant account for three years ended 31st March, 2013.

P.2 : Using the information of P.1. above, Depreciation is to be provided at 15% per annum on the written down value on 31st March every year. Prepare the Plant account & Depreciation Provision account for three years ended 31st March, 2013.

P.3 : Using the information of P.1. above, Depreciation is to be provided at 10% per annum by SLM on 31st March every year. Prepare the Plant account for three years ended 31st March, 2013.

P.4 : Using the information of P.1. above, Depreciation is to be provided at 10% per annum by SLM on 31st March every year. Prepare the Plant account & Depreciation Provision account for three years ended 31st March, 2013.

P.5 : On 1st April, 2010 a firm purchased a machinery for Rs. 2,00,000.

On 1st July in the same accounting year, additional machinery costing Rs. 1,00,000 was purchased.

On 31st December, 2011, the machinery purchased on 1st April, 2010, having become obsolete, was sold off for Rs. 90,000. On 1st October, 2012, new machinery was purchased for Rs. 2,50,000 while the machinery purchased on 1st July, 2010 was sold for Rs. 85,000 on the same day.

The firm provides depreciation on its machinery @10% per annum on original cost on 31st March every year.

Show Machinery account, Machinery Sold account, Provision for depreciation account and Depreciation account for the period of three accounting years ending 31st March, 2013.

P.6 : The cost of the machinery in use with a firm on 1st April, 2012 was Rs. 6,25,000 against which the depreciation provision stood at Rs. 2,69,220 on that date; the firm provided depreciation at 10% of the diminishing value.

On 31st December, 2012, machines costing Rs. 40,000, purchased on 1st October, 2009, had to be discarded because of damage and had to be replaced by new machines costing Rs. 90,000. The discarded machines is expected to realise Rs. 20,000 on 31st March 2013.

Show the relevant accounts in the ledger of the firm for the year ended 31st March, 2013.

P.7 : CAPS Education Pvt. Ltd. purchased Projectors on 1.1.2008 for Rs. 10,00,000/– having life of 10 years to be depreciated by SLM. In the year 2011 it receives Grant from government for Projectors purchased in 2008 Rs. 1,40,000/-.

Calculate Depreciation before and after the change in cost.

P.8 : A firm, which depreciates its machinery at 10% per annum on SLM basis, had on 1st April, 2008 purchased Machinery for Rs. 5,00,000. In the year 2011-12 it revises the useful life of the Machine from 10 years to 8 years.

Calculate Depreciation before and after the change in useful life.

P.9 : On 1st July, 2007, Glory Ltd. purchased a machine for Rs. 1,10,000 and spent Rs. 6,000 on its installation. The expected life of the machine is 4 years at the end of which the estimated scrap value will be Rs. 16,000.

Desiring to replace the machine on the expiry of its life, the company establishes a sinking fund. Investments are expected to realise 12% interest.

On 30th June, 2011, the machine sold off as scrap for Rs. 18,000 and the investments were realised at 5% less than the book value.

On 1st July, 2011, a new machine was installed at a cost of Rs. 1,25,000.

Sinking fund tables show that Re. 0.2092 invested each year will produce Re. 1 at the end of 4 years at 12%.

Show the necessary ledger accounts in the books of Glory Ltd. for all the years.

P.10 : CAPS Pvt. Ltd. purchased a Machinery on 1.1.2008 for Rs. 1,00,000 having life of 3 years. Estimated scrap value Rs. 20,000/-.

To replace the machine company has taken Insurance Policy for replacement with annual premium of Rs. 25,000. Prepare necessary accounts, assuming that machinery was scraped at the end of third year for Rs. 22,000.

P.11 : A building is taken on lease on 1.1.2010 for 4 years for Rs. 50,000.

Depreciate it by Annuity method. Annuity factor at 10% is 0.315457.

P.12 : On 1,1.2011 a coal mine is taken on lease for 10 years at a cost of Rs. 5,00,000.

Estimated coal contained is 25 lac tons with extraction loss expected at 20%.

Coal extracted in 1st three years is 3, 5 & 4 lac tons.

Depreciate lease by Depletion method.

P.13 : A machine costing Rs. 5,00,000 has an effective life of 1 lacs machine hours at the end of which it is expected to realize Rs.1,00,000. It was used for 10,000, 20,000 & 18,000 hours in the year 2011, 12 & 13 respectively. Depreciate it by Machine hour method.

P.14 : A Machine is taken on lease on 1.1.2011 for 3 years for Rs. 60,000. Calculate Depreciation by Sum of Digits method.

P.15 : A Car Repair Company has following details. Calculate Depreciation on tools by Revaluation method.

ANSWERS AND HINTS FOR Practice Problems