Accounting for Depreciation PDF

Study Note - 3 : Accounting For Depreciation STUDY NOTE – 3 ACCOUNTING FOR DEPRECIATION This Study Note includes: Introduction Certain Useful Terms Nature of Depreciation Causes of Depreciation...

Study Note - 3 : Accounting For Depreciation STUDY NOTE – 3 ACCOUNTING FOR DEPRECIATION This Study Note includes: Introduction Certain Useful Terms Nature of Depreciation Causes of Depreciation Characteristics of Depreciation Objective of and Necessity for providing Depreciation Measurement of Depreciation Methods of Charging Depreciation Provision for Depreciation Account Disposal of an asset Profit or Loss on sale of assets - Method of Depreciation Calculation Change of Method - Prospective and Retrospective Application of AS 6 - Depreciation Accounting Application of AS 10 - Accounting for Fixed Asset 3.1 INTRODUCTION A business or concern holds fixed assets for regular use and not for resale. The capability of a fixed asset to render service cannot be unlimited. Except land, all other fixed assets have a limited useful life. The benefit of a fixed asset is received throughout its useful life. So its cost is the price paid for the ‘Series of Services’ to be received or enjoyed from it over a number of years and it should be spread over such years. Depreciation means gradual decrease in the value of an asset due to normal wear and tear, obsolescence etc. In short, depreciation means the gradual diminution, loss or shrinkage in the utility value of an asset due to wear and tear in use, effluxion of time or introduction of technology in the market. A certain percentage of total cost of fixed assets which has expired and as such turned into expense during the process of its use in a particular accounting period. Indian Accounting Standard (AS 6) states that “Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset.” Certificate in Accounting Technicians (CAT) 177  Paper I: Fundamentals of Financial Accounting “Depreciation accounting is a system of accounting which aims to distribute the cost or other basic value of tangible capital assets, less salvage (if any), over the estimated useful life of the unit (which may be a group of assets) in a systematic and rational manner. It is a process of allocation, not of valuation. Depreciation for the year is the portion of the total charge under such a system that is allocated to the year. Although the allocation may properly take into account occurrences during the year, it is not intended to be the measurement of the effect of all such occurrences.” The above definition may be criticized as under: i. It does not classify properly what is meant by systematic and rational manner. The word ‘rational’ may mean that it should reasonably be related to the expected benefits in any case. ii. Historical cost and any other kind of cost should be allocated or not to be does not defined by this definition. iii. Some Accountants are in a belief that depreciation is nothing but an arbitrary allocation of cost. According to them, all the conventional methods say allocation of historical cost over a number of years arbitrarily. 3.2 CERTAIN USEFUL TERMS: Amortization - Intangible assets such as goodwill, trademarks and patents are written off over a number of accounting periods covering their estimated useful lives. This periodic write off is known as Amortization and that is quite similar to depreciation of tangible assets. The term amortization is also used for writing off leasehold premises. Amortization is normally recorded as a credit to the asset account directly or to a distinct provision for depreciation account; Though the write off of intangibles that have no limited life is not approved by some Accountants, some concerns do amortize such assets on the ground of conservatism. Depletion - This method is specially suited to mines, oil wells, quarries, sandpits and similar assets of a wasting character. In this method, the cost of the asset is divided by the total workable deposits of the mine etc. And by following the above manner rate of depreciation can be ascertained. Depletion can be distinguishable from depreciation in physical shrinkage or lessening of an estimated available quantity and the latter implying a reduction in the service capacity of an asset. Obsolescence - The term ‘Obsolescence’ refers to loss of usefulness arising from such factors as technological changes, improvement in production methods, change in market demand for the product output of the asset or service or legal or medical or other restrictions. It is different from depreciation or exhaustion, wear and tear and deterioration in that these terms refer to functional loss arising out of a change in physical condition. 178 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation Dilapidation - In one sentence Dilapidation means a state of deterioration due to old age or long use. This term refers to damage done to a building or other property during tenancy. 3.3 NATURE OF DEPRECIATION: Depreciation is a term applicable in case of plant, building, equipment, machinery, furniture, fixtures, vehicles, tools. These long-term or fixed assets have a limited useful life, i.e. they will provide service to the entity (in the form of helping in the generation of revenue) over a limited number of future accounting periods. Depreciation implies gradual decrease in the value of an asset due to normal wear and tear, obsolescence etc. In short, depreciation means the gradual diminution, loss or shrinkage in the utility value of an asset due to wear and tear in use, effluxion of time or introduction of technology in the market. It makes a part of the cost of assets chargeable as an expense in profit and loss account of the accounting periods in which the assets helped in earning revenue. Thus, International Accounting Standard (IAS)-4 provides that “Depreciation is the allocation of the depreciable amount of an asset over its estimated useful life.” In Accounting Research Bulletin No. 22, AICPA observed that “Depreciation for the year is the portion of the total charge under such a system that is allocated to the year. Although the allocation may properly take into account occurrences during the year, it is not intended to be the measurement of the effect of all such occurrences.” 3.4 CAUSES OF DEPRECIATION A. Internal Causes (i) Wear and tear : Plant & machinery, furniture, motor vehicles etc. suffer from loss of utility due to vibration, chemical reaction, negligent handling, rusting etc. (ii) Depletion (or exhaustion) : The utility or resources of wasting assets (like mines etc.) decreases with regular extractions. B. External or Economic Causes (i) Obsolescence : Innovation of better substitutes, change in market demand, imposition of legal restrictions may result into discarding an asset. (ii) Inadequacy : Changes in the scale of production or volume of activities may lead to discarding an asset. C. Time element : With the passage of time some intangible fixed assets like lease, patents. copy- rights etc., lose their value or effectiveness, whether used or not. The word “amortization” is a better term to speak for the gradual fall in their values. D. Abnormal occurrences : An accident, fire or natural calamity can damage the service potential of an asset partly or fully. As a result the effectiveness of the asset is affected and reduced. Certificate in Accounting Technicians (CAT) 179  Paper I: Fundamentals of Financial Accounting 3.5 CHARACTERISTICS OF DEPRECIATION The Characteristics of Depreciation are : i. It is a charge against profit. ii. It indicates diminution in service potential. iii. It is an estimated loss of the value of an asset. It is not an actual loss. iv. It depends upon different assumptions, like effective life and residual value of an asset. v. It is a process of allocation and not of valuation. vi. It arises mainly from an internal cause like wear and tear or depletion of an asset. But it is treated as any expense charged against profit like rent, salary, etc., which arise due to an external transaction. vii. Depreciation on any particular asset is restricted to the working life of the asset. viii. It is charged on tangible fixed assets. It is not charged on any current asset. For allocating the costs of intangible fixed assets like goodwill. etc, a certain amount of their total costs may be charged against periodic revenues. This is known as amortization. 3.6 OBJECTIVE OF AND NECESSITY FOR PROVIDING DEPRECIATION Eric Kohler defined depreciation as “the lost usefulness, expired utility, the diminution in service yield.” Its measurement and charging are necessary for cost recovery. It is treated as a part of the expired cost for an asset. For determination of revenue, that part or cost should be matched against revenue. The objects or necessities of charging depreciation are : (i) Correct calculation of cost of production: Depreciation is an allocated cost of a fixed asset. It is to be calculated and charged correctly against the revenue of an accounting period. It must be correctly included within the cost of production. (ii) Correct calculation of profits: Costs incurred for earning revenues must be charged properly for correct calculation of profits. The consumed cost of assets (depreciation) has to be provided for correct matching of revenues with expenses. (iii) Correct disclosure of fixed assets at reasonable value: Unless depreciation is charged, the depreciable asset cannot be correctly valued and presented in the Balance Sheet. Depreciation is charged so that the Balance Sheet exhibits a true and fair view of the affairs of the business. (iv) Provision of replacement cost: Depreciation is a non-cash expense. But net profit is calculated after charging it. Through annual depreciation cash resources are saved and accumulated to provide replacement cost at the end of the useful life of an asset. 180 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation (v) Maintenance of capital: A significant portion of capital has to be invested for purchasing fixed assets. The values of such assets are gradually reduced due to their regular use and passage of time. Depreciation on the assets is treated as an expired cost and it is matched against revenue. It is charged against profits. If it is not charged the profits will remain inflated. This will cause capital erosion. (vi) Compliance with technical and legal requirements: Depreciation has to be charged to comply with the relevant provisions of the Companies Act and Income Tax Act. Note: As per Companies Act 1956, a company have to provide for depreciation on fixed assets before declaration of dividends. 3.7 MEASUREMENT OF DEPRECIATION Measurement of depreciation is quite difficult to calculate the exact amount of depreciation since they depend on a number of factors. Some of the factors are; i. The actual cost of asset. ii. The additions, if any, made to the assets during the year taking into consideration the date of purchase. iii. The expected amount of interest of opportunity loss. iv. The estimated life of the asset. v. The scrap, break-up or the residual value of asset. vi. Obsolescence, i.e. the chance of the asset going out of fashion. vii. The renewals and repairment of the asset. viii. The legal provisions relating to the depreciation.(Provision of Companies Act , Income Tax Act and others) All the above said factors should be taken into consideration at the time of determining the amount of depreciation in such a way that a proper and reasonable estimate can be provided against the amount of depreciation. 3.8 METHODS OF CHARGING DEPRECIATION There are different concepts about the nature of depreciation. Moreover, the nature of all fixed assets cannot be the same. As a result, different methods are found to exist for charging depreciation. A broad classification of the methods may be summarized as follows : Capital/Source of Fund (i) Sinking Fund Method (ii) Annuity Method (iii) Insurance Policy Method Certificate in Accounting Technicians (CAT) 181  Paper I: Fundamentals of Financial Accounting Time Base (i) Fixed Installment Method (ii) Reducing Balance Method (iii) Sum of Years’ Digit Method (iv) Double Declining Method Use Base (i) Working Hours Method (ii) Mileage Method (iii) Depletion Service Hours Method Unit method Price Base (i) Revaluation Method (ii) Repairs Provision Method Some important Methods of Charging Depreciation are discussed as below : I. Fixed/Equal Installment OR Straight Line Method Features : (i) A fixed portion of the cost of a fixed asset is allocated and charged as periodic depreciation. (ii) Such depreciation becomes an equal amount in each period. (iii) The formula for calculation of depreciation is : Depreciation = (V-S)/n Where, V= Cost of the Asset S= Residual value or the expected scrap value n= estimated life of the asset Illustration 1. Calculate the Rate of Depreciation under Straight Line Method (SLM) in each of the following:- Machine Cost of Expenses incurred at the time Estimated Expected Useful No. Machine of purchase to be capitalized Residual Value Life in years 1 90,000 10,000 20,000 8 2 24,000 7,000 1,000 6 3 95,000 15,000 20,000 3 4 2,20,000 80,000 50,000 5 182 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation Solution Machine Cost of Expenses incurred Total Cost of Estimated Expected Depreciation Rate of No. Machine at the time of Asset = (b+c) Residual useful Life = (d-e)/f Depreciation purchase to be Value in years under SLM= capitalized (g/d) × 100 (Rs.) (Rs.) (Rs.) (Rs.) (Rs.) a b c d e f g h 1 90,000 10,000 1,00,000 20,000 8 10,000 10% 2 24,000 7,000 31,000 3,100 6 4,650 15% 3 1,05,000 20,000 1,25,000 12,500 5 22,500 18% 4 2,50,000 30,000 2,80,000 56,000 10 22,400 8% Illustration 2 A machine is purchased for Rs. 7,00,000. Expenses incurred on its cartage and installation Rs. 3,00,000. Calculate the amount of depreciation @ 20% p.a. according to Straight Line Method for the first year ending on 31st March, 2020 if this machine is purchased on: (a) 1st April, 2020 (b) 1st July, 2020 (c) 1st October, 2020 (d) 1st January, 2021 Solution: Here, Total Cost of Asset = Purchased Price + Cost of Cartage and Installation = Rs. 7,00,000 + Rs. 3,00,000 = Rs. 10,00,000 Amount of Depreciation : Period from the date of purchase to date of closing accounts = Total Cost of Asset × Rate of Depreciation × 12 (a) The machine was purchased on 1st April, 2020: 12/12 = 2,00,000 Amount of Depreciation = Rs. 10,00,000 × 20% × 9/12 = 1,50,000 (b) 1st July, 2020 Amount of Depreciation = Rs. 10,00,000 × 20% × 6/12 = 1,00,000 (c) 1st October, 2020 Amount of Depreciation = Rs. 10,00,000 × 20% × 6/12 = 1,00,000 (d) 1st January, 2021 Amount of Depreciation = Rs. 10,00,000 × 20% × 3/12 = 50,000 Certificate in Accounting Technicians (CAT) 183  Paper I: Fundamentals of Financial Accounting II. Reducing / Diminishing Balance Method OR Written Down Value Method Features : (i) Depreciation is calculated at a fixed percentage on the original cost in the first year. But in subsequent years it is calculated at the same percentage on the written down values gradually reducing during the expected working life of the asset. (ii) The rate of allocation is constant (usually a fixed percentage) but the amount allocated for every year gradually decreases. Illustration 3. On 1.1.2018 a machine was purchased for Rs. 1,00,000 and Rs. 50,000 was paid for installation. Assuming that the rate of depreciation was 10% on Reducing Balance Method, calculate amount of depreciation upto 31.12.2020. Solution Year Opening Book Value Rate Depreciation Closing Book Value (Rs.) (Rs.) (Rs.) 2018 1,50,000 10% 15,000 1,35,000 2019 1,35,000 10% 13,500 1,21,500 2020 1,21,500 10% 12,150 1,09,350 Note: Cost of the machine (i.e. Opening Book Value for the year 2018) = Cost of Purchase + Cost of Installation = Rs. 1,00,000 + Rs. 50,000 = Rs. 1,50,000 Illustration 4. On 1.1.18 machinery was purchased for Rs. 80,000. On 1.7.19 additions were made to the amount of Rs. 40,000. On 31.3.2020, machinery purchased on 1.7.2019, costing Rs. 12,000 was sold for Rs. 11,000 and on 30.06.2020 machinery purchased on 1.1.2018 costing Rs. 32,000 was sold for Rs. 26,700. On 1.10.2020, additions were made to the amount of Rs. 20,000. Depreciation was provided at 10% p.a. on the Diminishing Balance Method. Show the Machinery Accounts for three years from 2018-2020. (year ended 31st December) Solution Statement of Depreciation Particulars Machines-I Machines-II Machines-III Total Cost = Rs. 80,000 Cost = Cost = Depreciation Rs. 40,000 Rs. 20,000 1.1.2018 Book Value 48,000 32,000 31.12.2018 Depreciation 4,800 3,200 8,000 01.01.2019 W.D.V. 43,200 28,800 184 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation 01.07.2019 28,000 12,000 31.12.2019 Depreciation 4,320 2,880 1,400 600 9,200 01.01.2020 W.D.V. 38,880 25,920 26,600 11,400 31.03.2020 Depreciation 285 W.D.V. 11,115 Sold For 11,000 Loss on sale 115 30.06.2020 Depreciation 1,296 W.D.V. 24,624 Sold for 26,700 Profit on Sale 2,076 01.10.2020 Purchase 20,000 31.12.2020 Depreciation 3,888 2,660 500 8,629 01.01.2021 WDV 34,992 23,940 19,500 Dr. Machinery Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 01.01.18 To, Bank A/c 80,000 31.12.18 By, Depreciation A/c 8,000 “ Balance c/d 72,000 80,000 80,000 01.01.19 To, Balance b/d 72,000 31.12.19 By, Depreciation A/c 9,200 01.07.19 “ Bank A/c 40,000 “ Balance c/d 1,02,800 1,12,000 1,12,000 01.01.20 To, Balance b/d 1,02,800 31.3.20 By, Bank (Sale) A/c 11,000 30.06.20 “ P & L A/c 2,076 “ Depreciation A/c 285 (Profit on Sale) “ Bank A/c 20,000 30.6.20 “ P & L A/c 115 (Loss on Sale) “ Bank A/c (Sale) 26,700 31.12.12 “ Depreciation A/c 1,296 “ Depreciation A/c 7,048 “ Balance c/d 78,432 1,24,876 1,24,876 Certificate in Accounting Technicians (CAT) 185  Paper I: Fundamentals of Financial Accounting III. Sinking Fund Method A sinking fund is a fund created with a specific purpose which may be : (i) To redeem or repay a long term liability, e.g., debenture, long-term loans, etc. or (ii) To replace a wasting asset, e.g., a mine; or (iii) To replace an asset of depreciable nature; or (iv) To renew a lease. When a sinking fund is created to provide for replacement of wasting assets, it is in effect depreciation; the installments are charged against profits. Under this method, the asset is kept in the books at its original cost. Every year during the estimated life of the asset, an equal amount of depreciation is charged to profit and loss account and credited to a Depreciation Fund or Sinking Fund Account. At the same time a provision for replacement of the asset is made by investing an amount equal to the depreciation charged, in securities outside the business by debiting Depreciation Fund Investment or Sinking Fund Investment Account and crediting Bank. Interest received on the investment is credited to the Depreciation Fund Account and is also reinvested likewise. The amount that is annually provided as depreciation is such that this, with compound interest will be sufficient to provide a sum equal to the cost of asset, less residual value (if any), by the time the asset is expected to become useless. At the end of the working life of the asset, the investment are sold away and the money realised therefrom is utilized for purchasing a new asset. Profit or Loss on such sale, if any, is transferred to the Depreciation Fund Account. The old asset account, standing in the books at original cost, is closed by setting it off against the Depreciation Fund Account. The formula for calculation of the depreciation amount is as follows : Ci D = (1+i)n-1 Where, D = Depreciation C = Cost of the asset i = Rate of Depreciation n = Life of the asset Journal Entries under the Sinking Fund method : 186 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation At the end of first year (i) For annual depreciation Profit & Loss A/c Dr. To Depreciation Fund A/c (annual contribution) or To Sinking Fund A/c (ii) For investment of annual depreciation Sinking Fund Investment A/c Dr. To Bank A/c (invested amount) At the end of second/subsequent years (i) Profit & Loss A/c... Dr. To Sinking Fund A/c (annual contribution) (ii) Bank A/c Dr. To Interest on Investment A/c (annual interest) (iii) Interest on Investment A/c Dr. To Sinking Fund A/c (interest transferred) (iv) Sinking Fund Investment A/c Dr. To Bank A/c [amount invested usually = annual contribution + annual interest] When the working life of the asset ends (i), (ii) & (iii) same as above; (iv) not made in the last year (v) Bank A/c Dr. To Sinking Fund Investment A/c (vi) Sinking Fund Investment A/c Dr. To Sinking Fund A/c (Profit on Sale) (Investments sold out) OR (vii) Sinking Fund A/c………… Dr. To Asset A/c [Asset A/c closed] (viii) Sinking Fund A/c Dr. To Sinking Fund Investment A/c (Loss on Sale) Notes: (i) No investment is made in the last year as the investments are to be sold out. (ii) Sinking Fund Account may be called Depreciation Fund Account also. It is to be shown on the liability side of Balance Sheet. Certificate in Accounting Technicians (CAT) 187  Paper I: Fundamentals of Financial Accounting (iii) Sinking Fund Investments Account may be called Depreciation Fund Investments Account also. It is to be shown on the Asset side of the Balance Sheet. (iv) Annual Contribution (charged in lieu of annual depreciation) = Original Cost x Present Value of Rs. 1 at given interest rate. Illustration 5. On 1.7.2016 W Ltd. purchased a machinery 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 realize 5% interest. On 30.06.2020, the machine was sold off as scrap for Rs. 18,000 and the investments were retained at 5% less than the book value. On 1.7.2020, a new machine is installed at a cost of Rs. 1,25,000. Sinking Fund table shows that Rs. 0.2320 invested each year will produce Rs. 1 at the end of 4 years at 5%. Show the necessary ledger accounts in the books of W Ltd. Solution Sum required Annual contribution 1 0.2320 (Rs. 1,10,000 + Rs. 6,000 - Rs. 16,000) = Rs. 1,00,000 = 0.2320 x 1,00,000 = Rs. 23,200 In the Books of W Ltd. Dr. Sinking Fund Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 30.6.17 To Balance b/d. 23,200 30.6.17 By Profit and Loss A/c 23,200 23,200 23,200 30.6.17 To Balance c/d 47,560 30.6.18 By, Balance b/d 23,200 30.6.17 By, Bank (interest @ 5%) 1,160 A/c By, 23,200 Profit and Loss A/c 47,560 47,560 30.6.19 To Balance c/d 73,138 01.7.18 By, Balance b/d 47,560 30.6.19 By, Bank 2,378 (interest @ 5%) A/c By, Profit and Loss A/c 23,200 73,138 73,138 188 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation 30.6.19 To, Sinking Fund 01.7.19 By, Balance b/d 73,138 Investment A/c - Loss on sale 3,657 30.6.20 By, Bank interest @ 5% 3,657 To, Machinery A/c. 96,338 By, Profit and Loss A/c 23,200 - Transfer 99,995 99,995 Dr. Sinking Fund Investment Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 30.6.17 To, Bank A/c. 23,200 30.6.17 By, Balance c/d 23,200 23,200 23,200 01.07.17 To, Balance b/d 23,200 30.6.18 By, Balance c/d 47,560 30.6.18 To, Bank A/c. 24,360 (Rs.1,160 + Rs. 23,200) 01.7.18 To, Balance b/d 47,560 30.6.19 By, Balance c/d 73,138 30.6.19 To, Bank A/c. 25,578 (Rs.2,378 + Rs. 23,200) 73,138 73,138 01.7.20 To, Balance b/d 73,138 30.6.20 By, Bank A/c - Sales 69,481 By, Sinking Fund A/c 3,657 -Loss on sale (balancing figure) 73,138 73,138 IV. Annuity Method The annuity method considers that the business, besides losing the original cost of the asset also loses interest, on the amount used for buying the asset, which he would have earned in case the same amount would have been invested in some other form of investment. Thus, the asset account is debited with interest, which is ultimately credited with amount of depreciation which remains fixed year after year. The annual amount of depreciation is determined with the help of annuity table. The amount of depreciation is determined by adding the cost of the asset (i.e., purchase price) and interest thereon at an expected rate. The Journal entries are as follows : (i) Depreciation A/c Dr. To Asset A/c (for depreciation as calculated from annuity table) Certificate in Accounting Technicians (CAT) 189  Paper I: Fundamentals of Financial Accounting (ii) Asset A/c Dr. To Interest A/c (for charging interest to asset as calculated on diminishing values) (iii) Profit & Loss A/c Dr. To Depreciation A/c (for transfer of depreciation to P/L A/c) (iv) Interest A/c Dr. To Profit & Loss A/c (for transfer of interest to P/L A/c) Illustration 6. Sri Tirthankar takes a lease for 5 years for Rs. 10,000. He decides to write off the lease by annuity method charging 5% interest p.a. Show the lease account for 5 years. The annuity table shows that annual amount necessary to write off Rs.1 in 5 years at 5% p.a. is Rs.0.230975. Solution: Present Value Annual Depreciation 1 0.230975 10,000 0.230975 x 10,000 = Rs. 2309.75 or Day Rs. 2310 (approx) Dr. Sinking Fund Investment Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) Year- I Year- I Opening To, Bank A/c 10,000 Closing By, Depreciation A/c 2,310 Closing “ Interest A/c 500 “ Balance c/d 8,190 10,500 10,500 Year- II Year-II Opening To, Balance b/d 8,190 Closing By, Depreciation A/c 2,310 Closing “ Interest A/c 410 “ Balance c/d 6,290 8,600 8,600 Year- III Year-III Opening To, Balance b/d 6,290 Closing By, Depreciation A/c 2,310 Closing “ Interest A/c 315 “ Balance c/d 4,295 6,605 6,605 190 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation Year- IV Year-IV Opening To, Balance b/d 4,295 Closing By , Depreciation A/c 2,310 Closing “ Interest A/c 215 “ Balance c/d 2,200 4,510 4,510 Year- V Year-V Opening To, Balance b/d 2,200 Closing By, Depreciation A/c 2,310 Closing “ Interest A/c 110 2,310 2,310 V. Revaluation Method This method should be adopted only where the asset is represented by a large number of small and diverse items of small unit cost, e.g., hand tools, live-stock, sacks etc. in such cases it is not possible to attempt to depreciate each individual item. In this method the following steps to be taken : 1st, at the end of financial year, all items, which are in good condition and can serve well, are valued at cost. 2nd, the cost, as calculated above, is compared with the opening balance and the difference is charged as depreciation. 3rd, purchases of asset are debited to asset account in a normal manner. It is very important to note that under this method the total amount to be written off as depreciation is directly credited to asset account (not an accumulated depreciation account) Illustration 7. On 1.1.2020, A Ltd. has a stock of bottles valued at Rs. 8,000. On 1.7.20, they purchased additional bottles which amounted to Rs. 5,000. On Dec. 31, 2020, the entire stock of bottles was revalued at Rs. 10,500. Show the Bottle Account for the year 2020. In the book of A. Ltd. Dr. Bottle Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 2020 2020 Jan. 1 To, Balance b/d 8,000 Dec. 31 By Depreciation A/c 2,500 (bal. fig.) July 1 “ Bank A/c 5,000 “Balance C/d 10,500 13,000 13,000 Certificate in Accounting Technicians (CAT) 191  Paper I: Fundamentals of Financial Accounting VI. Depletion Unit Method This method is specially suited to mines, oil wells, quarries, sandpits and similar assets of a wasting character. The cost of the natural resources is the price paid for its acquisition plus price paid for the development of such asset in order to bring it to a state suitable for production. The periodic depletion is better not calculated in terms of year. Rather it is better to calculate the cost per unit and then multiply the cost of units produced in that particular year. Depletion for each unit extracted is determined as follows : Acquisition cost (C) - Residual value (S) Depletion per unit (U) = ___________________________________________ Estimated life in terms of production units (n) Illustration 8. In 2018, a company acquired a mine at a cost of Rs. 5,00,000. The estimated reserve of minerals is 50,00,000 tonnes, of which 80% is expected to be realised. The first three years raisings are 1,50,000; 2,00,000 and 2,50,000 tonnes, respectively. Show the Mines Account, charging depreciation under Depletion Method. Solution : Total quantity expected to be realized --- 80% of 50,00,000, i.e. 40,00,000 tonnes. Cost of the mine Rs. 5,00,000 Rs. 5,00,000 Hence, Charge per tonne ____________ = Rs. 0.125 or 1/8. 40,00,000 Therefore, Depreciation for 2018 = 1,50,000 × 1/8 = Rs. 18,750 for 2019 = 2,00,000 × 1/8 = Rs. 25,000 for 2020 = 2,50,000 × 1/8 = Rs. 31,250 192 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation Dr. Mines Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 2018 To Bank A/c 5,00,000 2018 Dec. 31 By, Depreciation A/c 18,750 “ Balance c/d 4,81,250 5,00,000 5,00,000 2019 Jan.1 To Balance b/d 4,81,250 2019 Dec.31 By, Depreciation A/c 25,000 “ Balance c/d 4,56,250 4,81,250 4,81,250 2020 Jan. 1 To Balance b/d 4,56,250 2020 Dec. 31 By, Depreciation A/c 31,250 “Balance c/d 4,25,000 4,56,250 4,56,250 2021 Jan.1 To Balance b/d 4,25,000 3.9 PROVISION FOR DEPRECIATION ACCOUNT Provision of depreciation is the collected value of all depreciation. Provision of depreciation account is the account of provision of depreciation. With making of this account we are not credited depreciation in asset account. But transfer every year depreciation to provision of depreciation account. Every year we adopt this procedure and when assets are sold we will transfer sold asset ‘total depreciation’ to credit side of asset account, for calculating correct profit or loss on fixed asset. This provision uses with any method of calculating depreciation. There are following features of provision for depreciation account : – Fixed asset is made on its original cost and every year depreciation is not transfer to fixed asset account. – Provision of depreciation account is Conglomerated value of all old depreciation. – This system can be used both in straight line and diminishing method of providing depreciation. The journal entries will be : (i) For purchase of asset Asset’s A/c Dr. To Cash/Bank A/c (ii) For providing depreciation at end of year Depreciation A/c Dr. To Provision for depreciation A/c Certificate in Accounting Technicians (CAT) 193  Paper I: Fundamentals of Financial Accounting (iii) For sale of assets Cash/Bank A/c Dr. To Asset Sales A/c (iv) Cost of assets sold transferred from Assets Account to Sale of Assets Account. Assets Sales A/c Dr. To Asset’s A/c. (v) Total depreciation on asset sold transferred from provision for depreciation account. Provision for depreciation A/c Dr. To Asset Sales A/c (vi) Profit or loss on sale of assets will be transferred from asset sale account to Profit or Loss Account. 3.10 DISPOSAL OF AN ASSET When an asset is sold because of obsolescence or inadequacy or any other reason, the cost of the asset is transferred to a separate account called “Asset Disposal Account”. The following entries are to be made: (i) When the cost of the asset is transferred: Asset Disposal A/c Dr. To, Asset A/c (original cost) (ii) When depreciation provided on the asset is transferred: Provision for Depreciation A/c Dr. To, Asset Disposal A/c (iii) For charging depreciation for the year of sale: Depreciation A/c Dr. To, Asset Disposal A/c (iv) When cash received on sale of asset: Bank/Cash A/c Dr. To, Asset Disposal A/c (v) When loss on disposal is transferred to Profit & Loss A/c: Profit & Loss A/c Dr. To, Asset Disposal A/c (vi) When profit on disposal is transferred to Profit & Loss A/c: Asset Disposal A/c Dr. To, Profit & Loss A/c 194 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation Illustration 9. S & Co. purchased a machine for Rs. 1,00,000 on 1.1.2018. Another machine costing Rs. 1,50,000 was purchased on 1.7.2019. On 31.12.2020, the machine purchased on 1.1.2018 was sold for Rs. 50,000. The company provides depreciation at 15% on Straight Line Method. The company closes its accounts on 31st December every year. Prepare - (i) Machinery A/c, (ii) Machinery Disposal A/c and (iii) Provision for Depreciation A/c. Solutions: S & Co. Dr. Machinery Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 1.1.2018 To, Bank A/c 1,00,000 31.12.2018 By, Balance c/d 1,00,000 1,00,000 1,00,000 1.1.2019 To, Balance b/d 1,00,000 1.7.2019 To Bank A/c 1,50,000 21.12.2019 By, Balance b/d 2,50,00 2,50,000 2,50,000 1.1.2020 To Balance b/d 2,50,00 21.12.2020 By, Machinery 1,00,000 Disposal A/c 31.12.2020 By, Balance c/d 1,50,000 2,50,000 2,50,000 1.1.2021 To, Balance b/d 1,50,000 Dr. Provision for Depreciation Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 31.12.2018 To, Balance c/d 15,000 31.12.2018 By, Depreciation A/c 15,000 15,000 15,000 31.12.2019 To, Balance c/d 41,250 1.1.2019 By, Balance b/d 15,000 31.12.2019 By, Depreciation A/c 26,250 (Rs. 15,000 + Rs. 11,250) 41,250 41,250 31.12.2020 To, Machinery 30,000 1.1.2020 By, Balance b/d Disposal A/c 31.12.2020 To, Balance c/d 33,750 31.12.2020 By, Depreciation A/c 22,750 63,750 63,750 1.1.2021 By, Balance b/d 33,750 Certificate in Accounting Technicians (CAT) 195  Paper I: Fundamentals of Financial Accounting Dr. Machinery Disposal Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 1.12.2020 To, Machinery A/c 1,00,000 31.12.2020 By, Provision for 30,000 Depreciation A/c 31.12.2020 By, Depreciation A/c 15,000 31.12.2020 By, Bank A/c 50,000 31.12.2020 By, Profit & Loss A/c 5,000 (Loss on Sale) 1,00,000 1,00,000 Working Notes 1. Depreciation for the machine purchased on 1.7.2019 6 For the year 2019 (used for 6 months) = Rs. 1,50,000 × 15% × = Rs. 11,250 12 For the year 2020 (used for full year) = Rs. 1,50,000 × 15% = Rs. 22,500 2. Depreciation for the machine purchased on 1.1.2018 Depreciation = Rs. 1,00,000 × 15% = Rs. 15,000 So, Depreciation for 2 years = Rs. 15,000 × 2 = Rs. 30,000 3.11. PROFIT OR LOSS ON SALE OF ASSETS - METHOD OF DEPRECIATION CALCULATION Sometimes an asset is sold before the completion of its useful life for some unavoidable circumstances (due to obsolescence etc.) including a part of the asset which is no longer required in future. If the sale price is less than the WDV, there will be loss, and vice versa. The profit & loss on sale of asset is adjusted in the year of Sale in Profit & Loss Account. Accounting Treatment a. Where no provision for depreciation account is maintained: WDV of the amount sold will be transferred to ‘Assets Disposal Account’. The entries will be as follows: (i) WDV of asset has been transferred to Asset Disposal A/c-- Asset Disposal A/c Dr. To Asset A/c (ii) In case of Sale of an Asset--- Cash/Bank A/c Dr. To Asset Disposal A/c 196 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation (iii) For depreciaion (if any )--- Depreciation (P & L A/c) Dr. To Asset Disposal A/c (iv) In case of Profit on Sale of Asset Asset Disposal A/c Dr. To Profit & Loss A/c (v) In case of Loss on Sale of Asset Profit & Loss A/c Dr. To Asset Disposal A/c b. Alternative Approach In this situations, all adjustments are to be prepared through the assets account. The entries are as follows: (i) In case of Assets sold Cash/Bank A/c Dr. To Assets A/c (ii) In case of Depreciation Depreciation (Profit & Loss ) A/c Dr. To Assets A/c (iii) In case of Profit on Sale Assets A/c Dr. To Profit & Loss (iv) In case of Loss on Sale Profit & Loss A/c Dr. To Assets A/c Illustration 10. On 1st April, 2018, Som Ltd. purchased a machine for Rs.66,000 and spent Rs.5,000 on shipping and forwarding charges, Rs.7,000 as import duty, Rs.1,000 for carriage and installation, Rs.500 as brokerage and Rs.500 for an iron pad. It was estimated that the machine will have a scrap value of Rs. 5,000 at the end of its useful life which is 15 years. On 1st January, 2019 repairs and renewals of Rs. 3,000 were carried out. On 1st October, 2020 this machine was sold for Rs. 50,000. Prepare Machinery Account for the 3 years. Certificate in Accounting Technicians (CAT) 197  Paper I: Fundamentals of Financial Accounting Solutions: In the books of Som Ltd. Dr. Machinery Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 1.04.2018 To, Bank A/c 66,000 31.03.2019 By, Depreciation A/c 5,000 01.04.2018 To, Bank A/c 14,000 31.03.2019 By, Balance c/d 75,000 80,000 80,000 01.04.2019 To, Balance b/d 75,000 31.03.2020 By, Depreciation A/c 5,000 31.03.2020 By, Balance c/d 70,000 75,000 75,000 01.04.2020 To, Balance b/d 70,000 01.10,2020 By, Depreciation A/c 2,500 01.10.2020 By, Bank A/c (Sale) 50,000 01.10.2020 By, Profit & Loss A/c 17,500 (Loss) 70,000 70,000 Working Note : 1. Total Cost = Rs.66,000 + Rs.5,000 + Rs.7,000 + Rs.1,000 + Rs.500 + Rs.500 = Rs.80,000 Total Cost – Scrap Value 80,000 – 5,000 Depreciation = ________________________ = _______________ = 5,000 Expected life 15 The amount spent on repairs and renewals on 1st January, 2019 is of revenue nature and hence, does not form part of the cost of asset. 3.12. CHANGE OF METHOD - PROSPECTIVE AND RETROSPECTIVE As per AS-6, the depreciation method selected should be applied consistently from period to period. Change in depreciation method should be made only in the following situations : (i) For compliance of statute. (ii) For compliance of accounting standards. (iii) For more appropriate presentation of the financial statement. The change in method may be made possible in two ways : (i) With prospective effect, and (ii) With retrospective effect 198 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation (i) With prospective effect - Under this method, the change in method is to be taken into consideration for the rest of the useful life of the asset commencing from the year in which such change is effected and not from the beginning of the year. Illustration 11. Rise Ltd. purchased a machinery for Rs. 1,00,000 on 1.1.2017. The machine was depreciated at 10% p.a. under the Straight Line Method. On 1.1.2020, the company decided to change the method of depreciation from Straight Line Method to Diminishing Balance Method without retrospective effect. Prepare Machine A/c from 2017 to 2020. Solutions: In the books of Rise Ltd. Dr. Machinery Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 01.01.17 To, Bank A/c 1,00,000 31.12.17 By, Depreciation A/c 10,000 By, Balance c/d 90,000 1,00,000 1,00,000 01.01.18 To, Balance b/d 90,000 31.12.18 By, Depreciation A/c 10,000 By, Balance c/d 80,000 90,000 90,000 01.01.19 To, Balance b/d 80,000 By, Depreciation A/c 10,000 By, Balance c/d 70,000 80,000 80,000 31.12.20 By, Depreciation A/c 7,000 – 10% on Rs. 70,000 01.01.20 To, Balance b/d 70,000 By, Balance c/d 63,000 70,000 70,000 Illustration 12. A second hand machine was purchased on 1.1.2015 for Rs. 4,00,000 overhauling and installation expenses for the same machine amounted to Rs. 1,00,000. Another machine was purchased for Rs. 2,00,000 on 1.7.2015. On 1.7.2017, the machine installed on 1.1.2015 was sold for Rs. 2,50,000. Dismantling charges for the machine sold on 1.7.2017 was Rs.10,000. On the same date, another machine was purchased for Rs. 8,00,000 and was commissioned on 30.9.2017. The company had adopted calendar year as its financial year. Under the existing practice, the company provides depreciation @10% p.a. on Certificate in Accounting Technicians (CAT) 199  Paper I: Fundamentals of Financial Accounting original cost. In 2018, it has been decided that depreciation will be charged on the overhauling balance @ 15% p.a.. The change is not to be made with retrospective effect. Show Plant Account for 2015-2019. Solutions: Statement of Depreciation Particulars Machine-I Machine-II Machine-III Total Depreciation (Rs.) (Rs.) (Rs.) (Rs.) 1.1.2015 Bank 5,00,000 (including expenses) 1.7.2018 Bank 2,00,000 31.12.2016 Depreciation 50,000 10,000 60,000 @10% 1.1.2016 WDV 4,50,000 1,90,000 31.12.2016 Dep. @10% 50,000 20,000 70,000 1.1.2015 W.D.V. 4,00,000 1,70,000 8,00,000 1.7.2015 Dep.@10% 25,000 3,75,000 Add : Dismantling Charges 10,000 3,85,000 Sold for 2,50,000 Loss on sale 1,35,000 31.12.2017 Dep. @10% 20,000 40,000 85,000 1.1.2018 WDV 1,50,000 7,60,000 (20,000+40,000+25,000) 31.12.2018 Dep. @15% 22,500 1,14,000 1,36,500 1.1.2019 WDV 1,27,500 6,46,000 31.12.2019 Dep. @15% 19,125 96,900 1,16,025 1.1.2020 WDV 1,08,375 5,49,100 Dr. Machinery Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 01.01.15 To Bank A/c 4,00,000 31.12.15 By Depreciation A/c 60,000 01.01.15 To Bank A/c 1,00,000 31.12.15 By Balance c/d 6,40,000 (Expenses) 01.01.15 To Bank A/c 2,00,000 7,00,000 7,00,000 200 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation 01.01.16 To Balance b/d 6,40,000 31.12.16 By Depreciation A/c 70,000 31.12.16 By Balance c/d 5,70,000 6,40,000 6,40,000 01.01.17 To Balance b/d 5,70,000 01.07.17 By Bank A/c (Sale) 2,50,000 01.07.17 To Bank A/c 8,00,000 By Depreciation A/c 25,000 01.07.17 To Bank A/c 10,000 By P&L A/c 1,35,000 (Expenses) 31.12.17 By Depreciation A/c 60,000 By Balance c/d 9,10,000 13,80,000 13,80,000 01.01.18 To Balance b/d 9,10,000 31.12.19 Depreciation A/c 1,36,500 By Balance c/d 7,73,500 9,10,000 9,10,000 1.01.19 To Balance b/d 7,73,500 31.12.19 By Depreciation A/c 1,16,025 By Balance c/d 6,57,475 7,73,500 7,73,500 01.02.20 To Balance b/d 6,57,475 (ii) With retrospective effect Procedure to be followed in this case : (i) Depreciation should be recalculated applying the new method from the date of its acquisition/ installation till the date of change of method. (ii) Difference between the total depreciation under the new method and the accumulated depreciation under previous method till the date of change may be surplus/ deficiency. (iii) The said surplus is credited to Profit & Loss account under the head “depreciation written Back”. (iv) Deficiency is charged to profit & Loss account. (v) The journal entries will be : (a) If old value is less Profit and Loss A/c. Dr. To, Assets A/c. (b) If old value is more Asset A/c. Dr. To, Profit and Loss A/c. (vi) The above change of depreciation method should be treated as change in accounting policy and its post effect should be disclosed and quantified. Certificate in Accounting Technicians (CAT) 201  Paper I: Fundamentals of Financial Accounting Illustration 13. Ram Ltd. which depreciates its machinery at 10% p.a. on Diminishing Balance Method, had on 1st January, 2020 Rs. 9,72,000 on the debit side of Machinery Account. During the year 2020 machinery purchased on 1st January, 2018 for Rs. 80,000 was sold for Rs. 45,000 on 1st July, 2020 and a new machinery at a cost of Rs. 1,50,000 was purchased a nd installed on the same date, installation charges being Rs. 8,000. The company wanted to change the method of depreciation from Diminishing Balance Method to Straight Line Method with effect from 1st January, 2017. Difference of depreciation up to 31st December, 2020 to be adjusted. The rate of depreciation remains the same as before. Show Machinery Account. Solution In the books of Ram Ltd. Dr. Machinery Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 01.01.20 To, Balance b/d 01.07.20 By, Depreciation A/c 3,240 [W.N.3] 9,07,200 By, Bank A/c-Sale 45,000 64,800 9,72,000 By, Loss on sale of 1,58,000 Machine A/c (W.N.4) 16,560 01.07.20 To, Bank A/c (1,50,000 + 8,000) 31.12.20 By, Depreciation A/c: - For the year 2020 1,12,000 31.12.20 - For ½ year 7,900 By, Profit & Loss A/c : Adjustment 11,200 By, Balance c/d : - M (9,07,200 - 1,12,000 7,84,000 - 11,200) -M Nil - M (1,58,000 - 7,900) 1,50,100 11,30,000 11,30,000 202 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation Working Notes : (1) At 10% depreciation on Diminishing Balance Method : Rs. If balance of machinery in the beginning of the year is 10 Depreciation for the year is 1 Balance of Machinery at the end of the year 9 By using the formula, balance of asset on 1st January 2017 will be calculated as follows : Balance as on 1st January, 2020 9,72,000 10 Balance as on 1st January, 2019 is 9,72,000 × 9 = 10,80,000 Balance as on 1st January, 2018 is 10,80,000 × 10 = 12,00,000 9 This balance, Rs. 12,00,000 is composed of 2 machines, one of Rs. 11,20,000 and another of Rs. 80,000. Depreciation at 10% p.a. on Straight Line Method on Rs. 11,20,000 1,12,000 Total Depreciation for 2018 and 2019 (Rs. 1,12,000 x 2) 2,24,000 Total Depreciation charged for 2018 and 2019 on Diminishing Balance Method (1,12,000 + 1,00,800) 2,12,800 Balance to be charged in 2020 to change from Diminishing Balance Method to Straight Line Method 11,200 (2) Machine purchased on 1st January, 2018 for Rs. 80,000 shows the balance of Rs. 64,800 on 1st January 2020 as follows : Purchase price 80,000 Less : Depreciation for 2018 8,000 72,000 Less : Depreciation for 2019 7,200 Balance as on Jan. 1, 2020 64,800 (3) On second machine (original purchase price Rs. 80,000), depreciation at 10% p.a. on Rs. 64,800 for 6 months, viz., Rs. 3,240 has been charged to the machine on July 1 2020 i.e., on date of sale. (4) Loss on sale of (ii) machine has been computed as under : Balance of the machine as on 1.1.2020 64,800 Less : Depreciation for 6 months up to date of sale 3,240 Balance on date of sale 61,560 Less : Sale proceeds 45,000 Loss on sale 16,560 Certificate in Accounting Technicians (CAT) 203  Paper I: Fundamentals of Financial Accounting Illustration 14 M/s. Hot and Cold commenced business on 01.07.2015. When they purchased a new machinery at a cost of Rs. 8,00, 000. On 01.01.2017 they purchased another machinery for Rs. 6,00,000 and again on 01.10.2019 machinery costing Rs. 15,00,000 was purchased. They adopted a providing of charging @ 20% p.a. on diminishing balance basis. On 01.07.2019, they changed the method of providing depreciation and adopted the method of writing off the Machinery Account at 15% p.a. under straight line method with retrospective effect from 01.07.2015, the adjustment being made in the accounts for the year ended 30.06.2020. The depreciation has been charged on time basis. You are required to calculate the difference in depreciation to be adjusted in the Machinery on 01.07.2019, and show the Machinery Account for the year ended 30.06.2020. Solution In the books of M/s Hot and Cold Dr. Machinery Account Cr. Date Particulars Amount Date Particulars Amount (Rs.) (Rs.) 01.07.19 To, Balance b/d 6,73,280 30.6.20 By Depreciation A/c 3,78,750 To, Profit and Loss A/c 21,720 By Balance c/d 18,16,250 (Depreciation Overcharged) 01.10.19 To, Bank A/c 15,00,000 (Purchase) 21,95,000 21,95,000 Workings : 1. Statement of Depreciation: Date Particulars Machine - I Machine - II Total Depreciation 01.07.2015 Book Value 8,00,000 30.06.2016 Depreciation @ 20% 1,60,000 1,60,000 01.07.2016 W.D.V. 6,40,000 01.01.2017 Bank (Purchase) 6,00,000 30.06.2017 Depreciation @ 20% 1,28,000 60,000 1,88,000 01.07.2017 W.D.V. 5,12,000 5,40,000 30.06.2018 Depreciation @ 20% 1,02,400 1,08,000 2,10,400 01.07.2018 W.D.V. 4,09,600 4,32,000 30.06.2019 Depreciation @ 20% 81,920 86,400 1,68,320 3,27,680 3,45,600 6,73,280 7,26,720 204 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation 2. Depreciation Overcharged: Now depreciation under Straight Line Method On Rs. 8,00,000 @ 15% = Rs. 1,20,000 x 4 years = Rs. 4,80,000 (from 01.07.2015 to 30.06.2019) ? On Rs. 6,00,000 @ 15% = Rs. 90,000 x 2 years = Rs. 2,25,000 (from 01.01.2017 to 30.06.2019) Rs. 7,05,000 Depreciation overcharged = Reducing Balance Basis - Straight Line Basis = Rs. (7,26,720 - 7,05,000) = Rs. 21,720 3.Depreciation for the year: On Rs. 14,00,000 @ 15% for the year = Rs. 2,10,000 On Rs. 15,00,000 @ 15% for the 9 months = Rs. 1,68,750 Rs. 3,78,750 3.13. APPLICATION OF AS 6- DEPRECIATION ACCOUNTING “Depreciation Accounting” (AS 6) (Revised) The Accounting Standard regarding depreciation was issued at first in 1982. But it was revised in 1994. The revised standard (AS 6) is now mandatorily applicable to all concerns in India for accounting periods commencing on or after 1.4.1995. The important matters to be noted from (AS 6) are : What is Depreciation as per AS-6? Depreciation is a measure of wearing out, consumption or other loss of value of a depreciable asset arising from use and passage of time. Depreciation is nothing but distribution of total cost of assets over its useful life. “Depreciable Assets” are the assets which : - (a) are expected to be used for more than one accounting period; (b) have limited useful life; (c) are held by an enterprise for use in production or supply of goods and services, for rental to others or for administrative purposes but not for sale in the ordinary course of business. AS-6 is not applicable to the following assets: Forests, Plantations Wasting Assets, Minerals and Natural Gas Certificate in Accounting Technicians (CAT) 205  Paper I: Fundamentals of Financial Accounting Expenditure on research and development Goodwill Live stock - Cattle, Animal Husbandry. How to calculate Depreciation? Following are required to ascertain the depreciation of a Depreciable Asset Historical cost or other amount in place of historical cost like revalued amount Estimated useful life of depreciable assets Estimated residual or scrap value of depreciable assets Computation of Depreciation: Cost (Residual Value of the end of useful life Estimated useful in No. of years How to ascertain the cost of depreciable assets? Cost of depreciable assets is the total cost spent in connection with the acquisition; installation and commissioning of the assets as well as for add item or improvement of the depreciable assets. “Useful Life” of a depreciable asset is the period over which the assets are expected to be used by the enterprise, which is generally shorter than the physical life. Useful Life of a Depreciable asset depends on the following factors - Predetermined by legal contractual limits Depends upon the number of shifts for which the asset is to be used Repair and Maintenance policy of enterprise The theological obsolescence Innovation/improvement in the production method Change in demand of output Legal or other restrictions. Estimated residual or scrap value: This is the estimated value of a depreciable asset at the end of its useful life. Change in Method of Depreciation: The method selected for charging depreciation should be consistently followed. However, if situations demand (like change of statute, compliance with Accounting Standard, etc.) a 206 Certificate in Accounting Technicians (CAT)  Study Note - 3 : Accounting For Depreciation change of method may be made, that would result in change in accounting policy (which may be required by statute or for compliance with an Accounting Standards or for more appropriate presentation of financial statement), In that case - (i) if the change affects the state of affairs of Balance Sheet and Profit and Loss account of the current period or the Financial Statements of later period, then such change must be disclosed in financial statement. The amount, by which the financial statement is affected, should be disclosed to the extent it is ascertainable. (ii) the depreciation should be recalculated under the new method with effect from the date of the asset coming into use till the date of change of method, that is, with retrospective effect. Difference between the total depreciation under new method and the accumulated depreciation under the old method till the date of change of method should be computed first. Then the resultant surplus or deficiency is to be charged to credit and debit side of the Profit and Loss A/c respectively. Change in Useful Life: If there is a change in useful life of an asset, outstanding depreciable amount on the date of change in estimated useful life of asset is required to be allocated over the revised remaining useful life. Any addition or extension essential for an existing asset, should be depreciated over the remaining life of the asset. If the historical cost of an asset changes due to exchange fluctuations, price adjustments, etc. the depreciation on the revised unamortized depreciable amount should be provided prospectively for the rest of the life of the asset. For any asset revalued, the provision for depreciation should be made on the revalued amount for the remaining useful life of the asset. In the financial statements, the matters to be disclosed are- (i) The historical cost or any amount substituting it; (ii) Total depreciation for the period for each (iii) The related accumulated depreciation. The method of charging depreciation should also be disclosed. 3.14. APPLICATION OF AS 10- ACCOUNTING FOR FIXED ASSET Accounting Standard for Fixed Assets (AS 10) Accounting Standard 10 is related with accounting of Fixed Assets. The important matters to be noted from (AS 10) are : Certificate in Accounting Technicians (CAT) 207