Accounting For Depreciation:
Learning Objectives:
-
Define and explain the term
"depreciation".
-
Why does depreciation
calculated and charged?
-
What are the different methods
for providing depreciation?
Definition and
Explanation of Depreciation:
The value of assets gradually reduces on
account of use. Such reduction in value is known as depreciation.
Different authors have given different definitions of depreciation.
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Causes
of Depreciation:
The main causes of
depreciation may be divided into two categories, namely:
-
Internal Cause and
-
External Causes
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Need
for Depreciation:
Depreciation is a loss. So Unless it is considered like all other expenses
and losses, true profit or loss cannot be ascertained. In other words,
depreciation must be considered in order to find out true profit or loss of
a business.
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Depreciation,
Depletion and Amortization:
The term depreciation is used with reference to tangible
fixed assets because the permanent continuing and gradual fall in book value
is possible only in the case of fixed asset.
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Difference
Between Depreciation and Fluctuation:
Depreciation of asset and fluctuation in
its market value are not the same. For example, a businessman purchase a
machine the life of which is estimated at 10 years and charges
depreciation accordingly each year. If for certain reasons the market
value of the machine decreases by say 20%, the businessman need not
consider this decrease at all.
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Basic Factors of Determination of
Depreciation:
Read about the
basic factors for the calculation of depreciation.
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Depreciation Methods / Methods for
Providing Depreciation:
Fixed assets differ from each
other in their nature so widely that the same depreciation methods
cannot be applied to each.
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Fixed Installment Method / Straight Line Method / Original Cost Method:
Fixed installment method
is also know as straight line method or original cost method. Under this
method the expected life of the asset or the period during which a
particular asset will render service is the calculated.
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Diminishing balance/written
Down Value/Reducing Installment Method of Depreciation:
Diminishing balance method is also
known as written down value method or reducing installment
method. Under this method the asset is depreciated at fixed
percentage calculated on the debit balance of the asset which is
diminished year after year on account of depreciation.
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Annuity Method of
Depreciation:
According to this method, the purchase of the asset
concerned is considered an investment of capital, earning interest at
certain rate. The cost of the asset and also interest thereon are written
down annually by equal installments until the book value of the asset is
reduced to nil or its bread up value at the end of its effective life.
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Depreciation Fund Method or Sinking Fund Method:
Depreciation fund method
is also know as sinking fund method or amortization fund method. Under this
method, a fund know as depreciation fund or sinking fund is created.
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Insurance Policy
Method of Depreciation:
Insurance policy method is a slight modification of the
depreciation fund method or sinking
fund method. Under this method the amount represented by the
depreciation fund, instead of being used to buy securities, is paid to
an insurance company as premium. The insurance company issues a policy
promising to pay a lump sum at the end of the working life of the asset
for its replacement.
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Revaluation Method of
Depreciation:
As the name
implies under revaluation
method, the assets are valued at the end of each period so that the
difference between the old value and the new value, which represents the
actual depreciation can be charged against the profit and loss account.
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Sum of the Years' Digits
Method of Depreciation:
Sum of the Years' Digits Method an accelerated method of depreciation
which is also based on the assumption that the loss in the value of the
fixed asset will be greater during the earlier years and will go on
decreasing gradually with the decrease in the life of such asset.
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Double Declining Balance
Method of Depreciation:
Double declining balance method is another type of accelerated
depreciation method followed generally in USA. The depreciation expense
is computed by multiplying the asset cost less accumulated depreciation
by twice the straight line rate expressed in percentage.
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Depletion Method of Depreciation:
Depletion method of depreciation is especially
suited to mines, quarries, sand pits, etc. According to it the cost of the
asset is divided by the total workable deposits. In this way, rate of
depreciation per unit of output is ascertained. Depreciation in any
particular year is charged on the basis of the output during that year.
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Basis of Use System of
Depreciation:
One of the
chief factors causing depreciation is use. For example in case of plant
and machinery, it is the total number of hours for which the machines
work is the main factor and not their life.
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Depreciation Of Various
Assets:
We discuss the
problem of depreciating some given assets.
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Depreciation Accounting
- General Questions and Answers:
Find answers of some of the general
questions about depreciation.
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