Depreciation.pdf

DEPRECIATION PROF NIDHI SHAH DAMANI INTRODUCTION TO DEPRECIATION  In daily life, we use many assets that are either tangible or intangible, such as buildings, furniture, and machinery. These assets have a specific useful life. The process of allocating the cost of these assets over their us...

DEPRECIATION PROF NIDHI SHAH DAMANI INTRODUCTION TO DEPRECIATION  In daily life, we use many assets that are either tangible or intangible, such as buildings, furniture, and machinery. These assets have a specific useful life. The process of allocating the cost of these assets over their useful life is known as depreciation. MEANING AND DEFINITION OF DEPRECIATION  Depreciation is derived from the Latin word 'depretium,' meaning reduction. It refers to the reduction in the value of fixed assets over time due to wear and tear, usage, or obsolescence.  R.N. Carter: “Depreciation is the gradual decrease in the value of an asset from any cause.” CAUSES OF DEPRECIATION Depreciation can occur due to multiple reasons: 1. Normal and Natural Wear and Tear 1. As assets are used regularly, their value decreases due to physical deterioration. For instance, a delivery truck will experience mechanical wear from daily use, requiring repairs, which reduces its overall value. 2. Example: A machine used continuously in a factory will wear out over time, and its efficiency will drop, leading to a reduction in its book value. 2. Passage of Time 1. Even when assets are not in active use, they lose value simply because time passes. This is especially true for intangible assets such as patents, trademarks, copyrights, or leases, which expire after a certain period. 2. Example: A patent registered for 20 years loses value every year until it eventually expires. 3. Obsolescence 1. Due to technological advancements or changes in production techniques, older assets become outdated. Newer, more efficient technology often replaces older assets, reducing their value. 2. Example: A desktop computer bought five years ago may still function but has lost significant value because of newer, faster models with advanced features. 4. Depletion 1. Depletion refers to the reduction in value of natural resources as they are consumed or extracted. This applies to wasting assets like oil wells, mines, or forests, which diminish over time. 2. Example: An oil well loses value as its resources are extracted, with fewer reserves remaining as time  CAUSES OF DEPRECIATION 5.Natural Calamities/Impairment of an Asset  Natural disasters like earthquakes, floods, or storms can cause significant damage to assets, leading to a decrease in their value.  Example: A factory damaged by a flood may experience a sharp decline in its asset value due to the extensive repairs required. 6. Invention  The introduction of new technology or products can make existing assets less valuable. This is often due to innovation in the market, leading to reduced utility for the old assets.  Example: When a new smartphone model is released, the older models drop in value, even though they still function. 7. Market Value Changes  Changes in market conditions can cause the value of an asset to fluctuate. When market demand decreases or supply increases, the price of the asset can decline, affecting its book value.  Example: A property’s value may drop if the real estate market in its area weakens due to economic factors. IMPORTANCE OF DEPRECIATION 1. Depreciation helps ascertain the true profit of the business. 2. It ensures correct valuation of assets in the financial statements. 3. Helps in tax calculation. METHODS OF DEPRECIATION There are two main methods to calculate depreciation: 1. **Straight Line Method (SLM)** – A fixed amount is depreciated every year. 2. **Diminishing Balance Method** – A percentage of the asset’s value is depreciated. EXAMPLE: STRAIGHT LINE METHOD  A machine costing ₹15,000 is purchased. Installation charges of ₹3,000 are paid. The estimated life of the machine is 10 years, with a scrap value of ₹2,000.  Depreciation per year: (₹15,000 + ₹3,000 - ₹2,000) / 10 = ₹1,600 per year  ‘SIDDHI’ Ltd Ratnagiri purchased a Machinery costing ` 2,00,000 on 1st April, 2015. Depreciation is charged @10% on Original Cost each year on 31st March. Give Journal entries, Machinery A/c and Depreciation A/c for the years 2015-16, 2016-17, 2017-18 On 1st April 2016 M/s Punawala & Co. Latur. Purchased Equipments of ` 50,000 against cheque. They decided to follow Fixed Instalment Method of depreciation. The life of the Equipments is estimated as 8 years and scrap-value of the Equipments at the end of its life is estimated as ` 2,000. On 1st Jan 2019 entire Equipment is sold for ` 35,000. The firm closes its Books of Accounts on 31st March, each year Prabhune and Sons Kolhapur, made Furniture for their own office on 1st October 2015. For this they had spent ` 72,000 on Materials and ` 32,000 on Wages. The estimated life of the Furniture is to be for 10 years and its expected scrap value at the end of it would be ` 24,000. They sold the entire Furniture for ` 80,000 on 1st October 2018. They close the books of accounts on 31st March every year. Show the Furniture A/c and Depreciation A/c for first four years.  M/s Rubina Traders, Sindhudurg, bought Furniture worth ` 30,000 on 1st April 2016 and additional Furniture on 1st October 2016 worth ` 20,000. They charged depreciation at 15% p.a. on Fixed Instalment Basis.  On 1st October 2018 they sold one Cupboard for ` 5,000 Original cost of which on 1st April 2016 was ` 10,000. On the same date , a new Cupboard was purchased for ` 15,000.  Show the Furniture A/c and Depreciation A/c for the years 2016-17, 2017-18 and 2018-19 assuming that the financial year closes on 31st March every year. WRITTEN DOWN VALUE METHOD  Diminishing Balance / reduced Balance Sangam Trading Co. Buldhana purchased Vehicle on 1st April 2016 costing ` 85,000 and spent ` 5,000 on its registration. On 30th Sept 2016 additional Vehicle is purchased for ` 10,000. On 31st March 2018,a Vehicle was sold for ` 12,000 the Original Cost of which was ` 20,000 on 1st April 2016 Prepare Vehicle A/c for the years 2016-17, 2017-18 and 2018-19 and pass the Journal Entries for theyear 2017-18 assuming that Vehicle is depreciated at 10% p.a. on Diminishing Balance Method on 31st March each year