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DEPRECIATION ACCOUNTING (AS-6)

Concept decrease in the value or the expired portion of the cost of fixed asset is called as “Depreciation”. a process of allocating the cost of a fixed asset over its estimated useful life in a rational and systematic manner. AICPA- “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 and not of valuation

Depreciable Assets expected to be used during more than one accounting Depreciable period have a limited useful life held by an enterprise for Assets’ use in the production or supply of goods and services for rental to others or for administrative purposes and not for the purpose of sale in the ordinary course of business.

Causes Wear & Tear Time effluxion (Passage of time) Obsolescence (Technological changes) Depletion (Natural resources)

Objectives Calculating Net Profit/Loss Correct financial position Funds for Replacement correct cost of production Tax benefit Legal requirements. ( Companies & Income Tax Act)

Notes of Depreciation Depreciation: a Non-Cash expense a charge against profit Depreciation : a Source of Fund for replacing the asset Depreciation is calculated using the Cost of the fixed asset (Market Value is ignored)

Interchangeable terms of Depreciation “Depreciation” is for Fixed Asset “Amortization” is for Intangible & Fictitious assets “Depletion” is for Natural Resources or Wasting Assets.

Factors to calculate Depreciation Cost of asset including Capital expenses for installation, commissioning, trial run etc. Estimated useful life of the asset Estimated scrap value (if any) at the end of useful life of the asset [Also called as Salvage Value, Residual Value, Terminal Value] Note : The Cost of the asset Less Estimated Scrap Value is called as “Depreciable Value” which is to be written off during the useful life

Methods of charging Depreciation Straight Line Method Written Down Value method Annuity Method Sinking Fund Method Sum of year’s digits method Machine hour method Production units method

Straight Line Method Also called as ““Fixed Instalment”, “Original Cost” Method The depreciable value is written off over the useful life & reduced to Nil. An equal amount is charged as depreciation in P&L A/c. Assumption : The usage/utility of the asset is equal in every accounting period.

Straight Line Method Depreciation Amount = Cost – Scrap Value Useful Life Depreciation rate = Depreciation Amount * 100 Cost of Asset Applicable for assets that have insignificant repairs & maintenances.

Written Down Value Method Also called as “Reducing Balance”, “Diminishing Balance” or “Fluctuating Instalment” method Annual depreciation decreases every year The asset Reduced value never touches Zero Depreciation rate =

Written Down Value Method Depreciation is high, when repairs are negligible. As repair increases, Depreciation gets lesser. Income Tax Act mandates WDV method Part C of Schedule II (Companies Act, 13) specifies depreciation rates (SLM/WDV) Schedule XIV (Companies Act,1956) First Year-Depreciation same (under SLM/WDV) Subsequent years- Lesser Depreciation as per WDV

Sum of year’s digits method Variation of the “Reducing Balance Method” Depreciable Value (Original Cost Less Scrap Value) multiplied by The number of years (including present year) of remaining life of the asset Total of all digits of the life of the asset (in years)

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