CHAPTER 5

CONCEPT AND ACCOUNTING

OF DEPRECIATION
LEARNING OUTCOMES
After studying this chapter, you will be able to:
w Understand the meaning and nature of depreciation.
w Understand how to determine the amount of depreciation from the total value of Property, Plant
and Equipment and its useful life.
w Understand various methods of depreciation and learn advantages and disadvantages of such
methods.
w Understand how to calculate the amount of profit or loss resulting from the sale/disposal of Property,
Plant and Equipment.
w Familiarize with the accounting treatment for change in the method of depreciation from Straight
Line Method to Reducing Balance method.
w Familiarize with the accounting treatment for change in estimated useful life and residual value of
property, plant and equipment.

CHAPTER OVERVIEW Objectives of providing depreciation

To present To accumulate
To ascertain true and fair To ascertain
funds for the
true results view of the true cost
replacement
of operations financial of production
of assets
position

Factors affecting the amount of depreciation

Estimated
Expected
Cost of asset residual
useful life
value

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 5.2 PRINCIPLES AND PRACTICE OF ACCOUNTING

1. INTRODUCTION
1.1 Concept of Depreciation
Property, plant and equipment are tangible items that:

(a) are held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes; and
(b) are expected to be used during more than a period of twelve months.

These are also called fixed assets in common parlance. When a fixed asset is purchased, it is recorded in
books of account at it original or acquisition/purchase cost. However fixed assets are used to earn revenues
for a number of accounting periods in future with the same acquisition cost until the concerned fixed asset
is sold or discarded. It is therefore necessary that a part of the acquisition cost of the fixed assets is treated or
allocated as an expense in each of the accounting period in which the asset is utilized. The amount or value
of fixed assets allocated in such manner to respective accounting period is called depreciation. Value of such
assets decreases with passage of time mainly due to following reasons.

1. Wear and tear due to its use in business

2. Efflux of time even when it is not being used
3. Obsolescence due to technological or other changes
4. Decrease in market value
5. Depletion mainly in case of mines and other natural reserves
It is important to account for value of portion of property, plant and equipment utilized for generating
revenue during an accounting year to ascertain true income. This portion of cost of Property, Plant &
Equipment allocated to an accounting year is called depreciation.
As per Schedule II under the Companies Act, 2013, Depreciation is the systematic allocation of the
depreciable amount of an asset over its useful life. The depreciable amount of an asset is the cost
of an asset or other amount substituted for cost, less its residual value. The useful life of an asset
is the period over which an asset is expected to be available for use by an entity, or the number of
production or similar units expected to be obtained from the asset by the entity.

Thus there are 3 important factors for computing depreciation:

- Estimated useful life of the asset
- Cost of the asset
- Residual value of the asset at the end of the of its estimated useful life

Depreciation of an asset begins when it is available for use, i.e., when it is in the location and condition
necessary for it to be capable of operating in the manner intended by management. Thus it is not necessary
that an asset must be used to be depreciated. There is decrease in value of assets due to normal wear and
tear even when these are not physically used. Accordingly, value of such wear and tear should be estimated
and accounted for.

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 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.3

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.
The loss in the value of assets employed for carrying on a business being an essential element of business
expenditure, it is necessary to calculate the amount of such loss and to make a provision, and therefore,
arrive at the amount of profit or loss made by the business.
Basically, the cost of an asset used for purpose of business has to be written off over its economic (not
physical) life which necessarily must be estimated. A point to remember is that usually, at the end of the
economic life, an asset has some value as scrap or otherwise. The amount to be written off in each year
should be as such which will reduce the book value of the asset, at the end of its economic life, to its
estimated scrap value.
A pertinent question, of course, is the price likely to prevail at the time of replacement. That is why some
people advocate the calculation of depreciation on the basis of replacement price rather than cost.

1.2 Depreciation on components of an assets

It may be noted that Accounting Standards as well as the Companies Act, 2013 requires depreciation to
be charged on a component basis. Each part of an item of Property, Plant and Equipment with a cost
that is significant in relation to the total cost of the item should be depreciated separately. An enterprise
should allocate the amount initially recognised in respect of an item of property, plant and equipment to
its significant parts/components and should depreciate each such part separately based on the useful life
and residual value of each particular component. For Example- Aircraft is a classic example of such an asset.
The airframe (i.e. the body of the aircraft), the engines and the interiors have different individual useful lives.
If the life of the airframe (being the longest of the individual lives of the three major types of components)
is taken as the life of the aircraft, it is important that other two major components i.e. engine and interiors
are depreciated over their respective useful life and not over the life of airframe. Other components (usually
small and low value) which will require replacement very frequently may be depreciated over the useful
life of airframe and their frequent replacement cost may be charged to expense as and when it is incurred.
Here it is important to note that a part of Property, Plant & Equipment to be identified as a separate
component should have both
(a) significant cost when compared to overall cost of item of property, plant and equipment and
(b) and estimated useful life or depreciation method different from rest of the parts of the property
plant and equipment.
A significant part of an item of property, plant and equipment may have a useful life and a depreciation
method that are the same as the useful life and the depreciation method of another significant part of that
same item. Such parts may be grouped in determining the depreciation charge.

1.3 Objectives for Providing Depreciation

Prime objectives for providing depreciation are:
(1) Correct income measurement: Depreciation should be charged for proper estimation of periodic profit or
loss. In case an enterprise does not account for depreciation on Property, Plant & Equipment, it will not
be considering loss in value of property, plant & equipment due to their use in production or operations
of the enterprise and will not result in true profit or loss for the period.
(2) True position statement: Value of the Property, Plant & Equipment should be adjusted for depreciation

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 5.4 PRINCIPLES AND PRACTICE OF ACCOUNTING

charged in order to depict the actual financial position. In case depreciation is not accounted for
appropriately, the property, plant and equipment would be disclosed in financial statements at a value
higher than their true value.
(3) Funds for replacement: Generation of adequate funds in the hands of the business for replacement of
the asset at the end of its useful life. Depreciation is a good indication of the amount an enterprise
should set aside to replace a fixed asset after its economic useful life is over. However, the replacement
cost of a fixed asset may be impacted by inflation or other technological changes.
(4) Ascertainment of true cost of production: For ascertaining the cost of the production, it is necessary to
charge depreciation as an item of cost of production.
Further depreciation is a non-cash expense and unlike other normal expenditure (e.g. wages, rent, etc.) does
not result in any cash outflow. Further depreciation by itself does not create funds it merely draws attention
to the fact that out of gross revenue receipts, a certain amount should be retained for replacement of assets
used for carrying on operation.

2. FACTORS IN THE MEASUREMENT OF DEPRECIATION

Estimation of exact amount of depreciation is not easy. Generally following factors are taken into
consideration for calculation of depreciation.
1. Cost of asset including expenses for installation, commissioning, trial run etc.
2. Estimated useful life of the asset.
3. Estimated scrap value (if any) at the end of useful life of the asset.

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 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.5

The above mentioned factors can be explained, in detail, as follows:

Cost of a depreciable asset represents its money outlay or its
equivalent in connection with its acquisition, installation and
commissioning as well as for additions to or improvement
thereof for the purpose of increase in efficiency. We have
Cost of discussed this in more detail in coming paragraphs.
Asset
Historical ‘Useful Life’ is either (i) the period over which a depreciable
asset is expected to be used by the enterprise or (ii) the number
of production or similar units expected to be obtained from the
use of the asset by the enterprise. Determination of the useful
life is a matter of estimation and is normally based on various
Useful life of factors including experience with similar type of assets. Several
the asset other factors like estimated working hours, production capacity,
repairs and renewals, etc. are also taken into consideration on
demanding situation.
Estimated
Determination of the residual value is normally a difficult
matter. If such value is considered as insignificant, it is normally
Scrap regarded as nil. On the other hand, if the residual value is likely
(residual to be significant, it is estimated at the time of acquisition/
Estimated value)
installation, or at the time of subsequent revaluation of asset.
Depreciable amount of a depreciable asset is its historical cost,
or other amount substituted for historical cost in the financial
Depreciable statements, less the estimated residual value.
amount
For example, a machinery is purchased for ` 1,10,000. The
residual value is estimated at ` 10,000. It is estimated that the
machinery will work for 5 years. The cost to be allocated as
depreciation in the accounting periods will be calculated as:
`

Acquisition cost 1,10,000

Less: Residual value (10,000)

Depreciable amount 1,00,000

Estimated useful life of the asset 5 years

Depreciable amount
Depreciation = i.e. ` 1,00,000/ 5 = ` 20,000 per year
Estimated useful life

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5.6 PRINCIPLES AND PRACTICE OF ACCOUNTING

Cost of Property, Plant and Equipment comprises:

(a) its purchase price, including non-refundable import duties and purchase taxes, after deducting
trade discounts and rebates.
(b) any cost directly attributable to bring the asset to the location and condition necessary for it to be
capable of operating in a manner intended by the enterprise.
(c) the initial estimate of the costs of dismantling, removing, the item and restoring the site on which
an asset is located.

Examples of costs directly attributable costs are:

(a) cost of employee benefits arising directly from acquisition or construction of an item of property,
plant and equipment.
(b) cost of site preparation
(c) initial delivery and handling costs
(d) installation and assembly costs
(e) cost of testing whether the asset is functioning properly, after deducting the net proceeds from
selling the items produced while testing (such as samples produced while testing)
(f ) professional fees e.g. engineers hired for helping in installation of a machine

Thus all the expenses which are necessary for asset to bring it in condition and location of desired used will
become part of cost of the asset. However, following expenses should not become part of cost of asset:
(a) costs of opening new facility or business, such as inauguration costs;
(b) cost of introducing new product or service (for example cost of advertisement or promotional
activities).
(c) cost of conducting business in a new location or with a new class of customer (including cost of
staff training); and
(d) administration and other general overhead costs.

Once an asset has been brought to its intended condition and location of use, no cost should recognized as
part of cost of the asset unless there is major repair or addition which increases the useful life of the asset
or improves the production capacity of the asset. Accordingly, cost incurred while and item is capable of
operating in intended manner but it is not yet put to use or is used at less than full capacity should not be
capitalized as part of cost of the asset. Similarly, cost of relocation of an asset should not be capitalized.
Any additions made to a particular item of property, plant and equipment after it is initially put to use are
depreciated over the remaining useful life of the asset. Therefore, it is important to maintain an asset register
capturing asset wise details of cost, rate of depreciation, date of capitalization etc. All these details need to
be captured for any additions to existing assets as well. In the absence of the adequate information, it will
be very difficult to compute depreciation expense year on year. Also, at the time of disposal or discard of a
particular asset, it will not be possible to compute gain or loss on such disposal/discard.

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 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.7

3. METHODS FOR PROVIDING DEPRECIATION

Generally, methods for providing depreciation are based on formula, developed on a study of the behavior
of the assets over a period of years for readily computing the amount of depreciation suffered by different
forms of assets. Each of the methods, however, should be applied only after carefully considering nature of
the asset and the conditions under which it is being used.

Methods of Depreciation

Straight-line Method Diminishing Balance Units of Production

Method Method

Results in a constant
charge over the useful Results in a decreasing Results in a charge based
life if the residual value charge over the useful on the expected use or
of the asset does not life output
change

The Income Tax Rules, however, prescribe the Diminishing Balance Method except in the case of assets of an
undertaking engaged in generation and distribution of power.
3.1 Straight Line Method
According to this method, an equal amount is written off every year during the working life of an asset so
as to reduce the cost of the asset to nil or its residual value at the end of its useful life. The advantage of this
method is that it is simple to apply and gives accurate results especially in case of leases, and also in case of
plant and machinery. This method is also known as Fixed Instalment Method.
According to this method, an equal amount is written off every year during the working life of an asset so
as to reduce the cost of the asset to nil or its residual value at the end of its useful life. The advantage of this
method is that it is simple to apply and gives accurate results especially in case of leases, and also in case of
plant and machinery. This method is also known as Fixed Instalment Method.
Cost of Asset – Scrap Value
Straight Line Depreciation =
Useful life

Straight Line Depreciation

Straight Line Depreciation Rate = x 100
Cost of Asset

The underlying assumption of this method is that the particular tangible asset generates equal utility
during its lifetime. But this cannot be true under all circumstances. The expenditure incurred on repairs and
maintenance will be low in earlier years, whereas the same will be high as the asset becomes old. Apart
from this the asset may also have varying capacities over the years, indicating logic for unequal depreciation
provision. However, many assets have insignificant repairs and maintenance expenditures for which straight
line method can be applied.

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5.8 PRINCIPLES AND PRACTICE OF ACCOUNTING

While using this method the period of use of an asset in a particular year should also be considered. In
the year of purchase of an asset it may have been available for use for part of the year only, accordingly
depreciation should be proportioned to reflect the period for which it was available for use. For example,
if an asset was purchased on March 1, 2017 and the enterprise prepares financial statements for the year
ending on March 31, 2017 depreciation will be provided for a period of 1 month only. Similar situation
will arise in the year in which an asset is retired from its intended used or is sold. However, under income
tax rules depreciation is provided for full year if the asset was used for more than 180 days in a particular
financial year.

3.2 Reducing or Diminishing Balance Method

Under this system, a fixed percentage of the diminishing value of the asset is written off each year so as
to reduce the asset to its residual value at the end of its life. Repairs and small renewals are charged to
revenue. This method is commonly used for plant, fixtures, etc. Under this method, the annual charge for
depreciation decreases from year to year, so that the earlier years suffer to the benefit of the later years.
Also, under this method, the value of asset can never be completely extinguished, which happens in the
earlier explained Straight Line Method. However, it is very simple to operate. This method is based on the
assumption that cost of repairs will increase as the asset get old, therefore, depreciation in earlier years
should be high when the repair cost is expected to be low and depreciation in later years should be low
when the repair cost is expected to be high. Therefore, this method will result in almost equal burden in all
the years of use of the asset as depreciation will reduce with increase in repair costs will increase with every
passing year. On the other hand, under the Straight Line Method, the charge for depreciation is constant,
while repairs tend to increase with the life of the asset. Among the disadvantages of this method is the
danger that too low a percentage may be adopted as depreciation with the result that over the life of the
asset full depreciation may not be provided; also if assets are grouped in such a way that individual assets
are difficult to identify, the residue of an asset may lie in the asset account even after the asset has been
scrapped. The last mentioned difficulty could be, however, over come if a Plant register is maintained.
The rate of depreciation under this method may be determined by the following formula:
Residual Value
1– n × 100
Cost of asset

where, n = useful life

Similar to straight line method, in this method also period of use in a particular year e.g. year of purchase or
sale an item of property plant and equipment needs to be considered while computing the depreciation
amount.
Accounting Entries under Straight Line and Reducing Balance Methods:
There are two alternative approaches for recording accounting entries for depreciation.
First Alternative
A provision for depreciation account is opened to accumulate the balance of depreciation and the assets
are carried at historical cost.
Accounting entry
Depreciation Account Dr.
To Provision for Depreciation Account

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 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.9

Profit and Loss Account Dr.

To Depreciation Account

Second Alternative

Amount of Depreciation is credited to the Asset Account every year and the Asset Account is carried at
historical cost less depreciation.
Accounting entries:
Depreciation Account Dr.
To Asset Account
Profit and Loss Account Dr.
To Depreciation Account

? ILLUSTRATION 1

Jain Bros. acquired a machine on 1st July, 2015 at a cost of ` 14,00,000 and spent ` 1,00,000 on its installation.
The firm writes off depreciation at 10% p.a. of the original cost every year. The books are closed on 31st December
every year.
Required

Show the Machinery Account and Depreciation Account for the year 2015 and 2016.
Machinery Account
` `
2015 2015
July 1 To Bank A/c 14,00,000 Dec. 31 By Depreciation A/c
July 1 To Bank A/c - 10% on ` 15,00,000 for 75,000
Installation 1,00,000 6 months
Expenses Dec. 31 By Balance c/d 14,25,000
15,00,000 15,00,000
2016 2016
Jan. 1 To Balance b/d 14,25,000 Dec. 31 By Depreciation A/c
10% on ` 15,00,000 1,50,000
Dec. 31 By Balance c/d 12,75,000
14,25,000 14,25,000

Depreciation Account
` `
2015 2015
Dec. 31 To Machinery A/c 75,000 Dec. 31 By Profit & Loss A/c 75,000
2016 2016
Dec. 31 To Machinery A/c 1,50,000 Dec. 31 By Profit & Loss A/c 1,50,000

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5.10 PRINCIPLES AND PRACTICE OF ACCOUNTING

? ILLUSTRATION 2

Jain Bros. acquired a machine on 1st July, 2015 at a cost of ` 14,00,000 and spent ` 1,00,000 on its installation.
The firm writes off depreciation at 10% p.a. every year. The books are closed on 31st December every year.
Required
Show the Machinery Account on diminishing balance method for the year 2015 and 2016.

 SOLUTION

As per Reducing Balance Method

Machinery Account
` `
2015 2015
July 1 To Bank A/c 14,00,000 Dec. 31 By Depreciation A/c 75,000
July 1 To Bank A/c - 1,00,000 (` 15,00,000 x 10% x 6/12) for
6 months
Dec. 31 By Balance c/d 14,25,000
15,00,000 15,00,000
2016 2016
Jan. 1 To Balance b/d 14,25,000 Dec. 31 By Depreciation A/c 1,42,500
(` 14,25,000 x 10%)
Dec. 31 By Balance c/d 12,82,500
14,25,000 14,25,000

3.3 Sum of Years of Digits Method

It is variation of the “Reducing Balance Method”. In this case, the ansnual depreciation is calculated by
multiplying the original cost of the asset less its estimated scrap value by the fraction represented by:

The number of years (including the present year) of remaining life of the asset
Total of all digits of the life of the asset (in years)

Suppose the estimated life of an asset is 10 years; the total of all the digits from 1 to 10 is 55 i.e.,10 + 9 + 8 +
7 + 6 + 5 + 4 + 3 + 2 + 1, or by the formula:
n (n + 1) 10 × 11
= = 55
2 2
The depreciation to be written off in the first year will be 10/55 of the cost of the asset less estimated scrap
value; and the depreciation for the second year will be 9/55 of the cost of asset less estimated scrap value
and so on.
The method is not yet in vogue; and its advantages are the same as those of the Reducing Balance Method.

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 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.11

? ILLUSTRATION 3

M/s Akash purchased a machine for ` 10,00,000. Estimated useful life and scrap value were 10 years and `
1,20,000 respectively. The machine was put to use on 1.1.2010.

Required
Show Machinery Account and Depreciation Account in their books for 2015 by using sum of years digits method.

 SOLUTION

In the books of M/s Akash

Machinery Account

` `
2015 2015
Jan. 1 To Balance b/d (w.n.2) 3,60,000 Dec. 31 By Depreciation A/c (w.n.3) 80,000
Dec. 31 By Balance c/d 2,80,000
3,60,000 3,60,000
2016
Jan.1 To Balance b/d 2,80,000

Depreciation Account

` `
2015 2015
Dec. 31 To Machinery A/c 80,000 Dec. 31 By Profit and Loss A/c 80,000
80,000 80,000

Working Notes:

(1) Total of sum of digit of depreciation for 2010-2014

10 + 9 + 8 +7 + 6
= (` 10,00,000 - ` 1,20,000) ×
10 (10 + 1)
40 2
= ` 8,80,000 × = ` 6,40,000
55
(2) Written down value as on 1-1-2015
` 10,00,000 – ` 6,40,000 = ` 3,60,000
(3) Depreciation for 2015
5
(` 10,00,000 – ` 1,20,000) × = ` 80,000.
55

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5.12 PRINCIPLES AND PRACTICE OF ACCOUNTING

3.4 Annuity Method

This is a method of depreciation which also takes into account the element of interest on capital outlay and
seeks to write off the value of the asset as well as the interest lost over the life of the asset. It assumes that
the amount laid out in acquiring asset, if invested elsewhere, would have earned interest which must be
reckoned as part of the cost of asset. On that basis, the amount of depreciation to be annually provided in
the accounts is ascertained from the Annuity Tables, to write off each year interest on the capital outlay as
well as part of the capital sum at a rate that the whole of the capital sum and interest accruing thereon would
be written off over the life of the asset. Though the amount written off annually is constant, the interest in
the earlier years being greater, only small amount of the capital outlay is written off. This proportion is
reversed with the passage of time. This method is eminently suitable for writing off the amounts paid for
long leases which involve a considerable capital outlay. It is not practicable to adopt this method for writing
off depreciation of plant and machinery on account of frequent changes in the value of such assets which
would necessitate the recalculation of the amount of depreciation to be written off annually.

Relevant Journal entries are:

(1) For charging interest on asset account
Asset Account Dr.
To Interest Account
(2) For charging depreciation on asset
Depreciation Account Dr.
To Asset Account or Provision for Depreciation Account
(3) For transferring depreciation to Profit and Loss Account
Profit and Loss Account Dr.
To Depreciation Account
(4) For transferring interest to Profit and Loss Account
Interest Account Dr.
To Profit and Loss Account

? ILLUSTRATION 4

A lease is purchased on 1st April, 2012 for 4 years at a cost of ` 2,00,000. It is proposed to depreciate the lease by
the annuity method charging 5 percent interest. A reference to the annuity table shows that to depreciate ` 1 by
annuity method over 4 years charging 5% interest, one must write off a sum of ` 0.282012 [To write off ` 2,00,000
one has to write off every year ` 56,402.40 i.e. 0.282012 × 2,00,000].
Required
Show the Lease Account for four years and also the relevant entries in the profit and loss account.

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 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.13

 SOLUTION
Lease Account
` `
2012- 13 2012-13
April. 1 To Bank A/c 2,00,000.00 Mar. 31 By Depreciation A/c 56,402.40
Mar. 31 To Interest A/c By Balance c/d 1,53,597.60
(5% on ` 2,00,000) 10,000.00
2,10,000.00 2,10,000.00
2013-14 2013-14
April. 1 To Balance b/d 1,53,597.60 Mar..31 By Depreciation A/c 56,402.40
Mar. 31 To Interest A/c By Balance c/d 1,04,875.08
(5% on ` 1,53,597.60) 7,679.88
1,61,277.48 1,61,277.48
2014-15 2014-15
April. 1 To Balance b/d 1,04,875.08 Mar. 31 By Depreciation A/c 56,402.40
Mar. 31 To Interest A/c 5,243.75 Mar. 31 By Balance c/d 53,716.43
1,10,118.83 1,10,118.83
2015-16 2015-16
April. 1 To Balance b/d 53,716.43 Mar. 31 By Depreciation A/c 56,402.25
Mar. 31 To Interest A/c 2,685.82
56,402.25 56,402.25

Profit and Loss Account

` `
2012-13 2012-13
Mar. 31 To Depreciation A/c 56,402.40 Mar. 31 By Interest A/c 10,000.00
2013-14 2013-14
mar. 31 To Depreciation A/c 56,402.40 Mar. 31 By Interest A/c 7.679.88
2014-15 2014-15
Mar. 31 To Depreciation A/c 56,402.40 Mar. 31 By Interest A/c 5,243.75
2015-16 2015-16
Mar. 31 To Depreciation A/c 56,402.40 Mar. 31 By Interest A/c 2,685.82

3.5 Sinking Fund Method

If a large sum of money is required for replacement of property, plant and equipment at the end of its
effective life, it may not be advisable to leave in the amount of depreciation set apart annually, for it may or
may not be available in the form of the readily realisable assets to the enterprise at the time it is required.
To safeguard this position, the amount annually provided for depreciation may be placed to the credit of
the Sinking Fund Account, and at the same time an equivalent amount may be invested in Government
securities. The interest on these securities, when received, would be re-invested and the amount thereof
would be credited to the Sinking Fund Account. The amount of annual provision for depreciation in such
a case is calculated after taking into account interest, that the amounts annually invested shall be earning
over the period these will remain invested. When the asset is due for replacement, the securities are sold

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5.14 PRINCIPLES AND PRACTICE OF ACCOUNTING

and the new asset is purchased with the proceeds of their sale. The book value of the old asset, at the time,
is transferred to the Sinking Fund Account. Any amount realised on sale of the old asset, as well as the profit
or loss on sale of securities, is transferred to the Sinking Fund Account and it is closed off by transfer of the
balance of the Profit and Loss Account or General Reserve.
The amount to be set apart annually by way of depreciation is ascertained from Sinking Fund tables. They
readily show the amount which must be invested each year to accumulate to ` 1 at a given rate of interest
within the stated period.

Relevant Journal entries are:

(1) For transfer of depreciation to Sinking Fund

Depreciation Account Dr.
To Sinking Fund (S.F. )Account
(2) For charging depreciation to profit and loss account
Profit and Loss Account Dr.
To Depreciation Account
(3) For investment of amount of depreciation
Sinking Fund Investment Account Dr.
To Bank Account
(4) In subsequent years, for interest earned on sinking fund investment and on investment of the interest
and depreciation
Bank Account Dr.
To Interest on Sinking Fund Investment Account
Interest on Sinking Fund Investment Account Dr.
To Sinking Fund Account
(In addition to these entries, entries (1) and (2) will also be passed in subsequent years for transfer of
depreciation to sinking fund and for charging it to profit and loss account)
Sinking Fund Investment Account Dr.
To Bank Account
(yearly depreciation + interest earned)
(5) For sale of sinking fund investment at the end of useful life of the asset
Bank Account Dr.
To Sinking Fund Investment Account
If sales is at a profit
Sinking Fund Investment Account Dr.
To Sinking Fund Account

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 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.15

If sales is at loss
Sinking Fund Account Dr.
To Sinking Fund Investment Account
(6) For transfer of the amount to the extent of book value of the asset from asset account to sinking fund
account
Sinking Fund Account Dr.
To Asset Account
(7) Any surplus in Sinking Fund Account may be transferred to General Reserve Account and if any deficit,
that may be transferred to Profit and Loss Account
Sinking Fund Account Dr.
To General Reserve Account
OR
Profit and Loss Account Dr.
To Sinking Fund Account
The aforementioned method may also be operated a little differently. The amount set apart on account of
depreciation, instead of being invested annually in the purchase of government securities may be paid out
as premium on a policy maturing at the end of the life of the asset, for an amount equal to the sum that will
be required for its replacement. In that case the amount of the premium when paid will be debited to the
Policy Account instead of the Investment Account.

? ILLUSTRATION 5

On 1st April, 2013, Z Limited purchased the lease of property for ` 10,00,000. The lease would expire on 31st March,
2016. Z Ltd., decided to set up a sinking fund. The Sinking Fund was to be credited (or debited) with an annual
contribution from profit, the interest on the investments and any profits (or losses) made on the realisation of the
sinking fund investments. The sinking fund was to be represented by specific investment, and any sums made
available to the sinking fund were to be immediately invested, except at the termination of the fund.
During the three years following transactions took place:
2014 31st March: A contribution from profits of ` 3,20,000 was made and this sum was invested.
2014 13th Oct.: Investments which originally costed ` 1,10,000 were sold for ` 1,20,000 and the proceeds of sale
were re-invested.
2015 31st March: A contribution from profits of ` 3,20,000 was made; interest on investments of ` 16,000 was
received and these amounts were reinvested.
2015 9th August: Investments which originally costed ` 2,10,000 were sold at a profit of ` 20,000 and
proceeds of sale were re-invested.
2016 31st March: Interest on investments ` 48,000 was received which was not invested. All existing investments
were sold for ` 6,60,000. A contribution from profit of an amount required to make up the sinking fund to
` 10,00,000 was made and this amount was not invested.

© The Institute of Chartered Accountants of India

5.16 PRINCIPLES AND PRACTICE OF ACCOUNTING

Required
Prepare Sinking Fund and Sinking Fund Investment Account for the years 2013-14, 2014-15, 2015-16.

 SOLUTION
Sinking Fund Account
` `
2014 2014
March 31 To Balance c/d 3,20,000 March 31 By Depreciation A/c 3,20,000
3,20,000 3,20,000
2015 2015
March 31 To Balance c/d 6,66,000 April 1 By Balance b/d 3,20,000
Oct. 13 By S.F. Investment A/c 10,000
March 31 By Interest on S.F 16,000
Investment A/c
By Depreciation A/c 3,20,000
6,66,000 6,66,000
2015 2015
March 31 To S.F. Investment A/c 26,000 April 1 By Balance b/d 6,66,000
To Lease A/c 10,00,000 August 9 By S.F. Investment A/c 20,000
March 31, By Interest on S.F. 48,000
2016 Investment A/c
By Depreciation A/c 2,92,000
(Balancing Figure)
10,26,000 10,26,000

Sinking Fund Investment Account

` `
2014 2014
March 31 To Bank A/c 3,20,000 March 31 By Balance c/d 3,20,000
3,20,000 3,20,000
2014 2014
April 1 To Balance b/d 3,20,000 Oct. 13 By Bank A/c (sale) 1,20,000
Oct. 13 To S.F.A/c 10,000 March 31 By Balance c/d 6,66,000
(profit on sale)
Oct. 13 To Bank A/c 1,20,000
(investment of sale
proceed)
2015 To Bank A/c 3,36,000
March 31 (investment of
depreciation amount
and interest)
7,86,000 7,86,000
2015 2015
April 1 To Balance b/d 6,66,000 August 9 By Bank A/c 2,30,000

© The Institute of Chartered Accountants of India

 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.17

August 9 To S.F. A/c 20,000 2016 By Bank A/c 6,60,000

(profit on sale) March 31 By S.F. A/c
August 9 To Bank A/c 2,30,000 (loss on sale) 26,000
(investment of sale
proceeds)
9,16,000 9,16,000

? ILLUSTRATION 6

On the basis of the data given in the illustration 5,

Required
Prepare Lease Account and Depreciation Account for the years 1st April, 2013 to 31st March, 2016.

 SOLUTION
Lease Account
` `
2013 2014
April 1 To Bank A/c 10,00,000 March 31 By Balance c/d 10,00,000
10,00,000 10,00,000
2014 2015
April 1 To Balance b/d 10,00,000 March 31 By Balance c/d 10,00,000
10,00,000 10,00,000
2015 2016
April 1 To Balance b/d 10,00,000 March 31 By Sinking Fund A/c 10,00,000
10,00,000 10,00,000

Depreciation Account
` `
2014 2014
March 31 To Sinking Fund A/c 3,20,000 March 31 By Profit & Loss A/c 3,20,000
3,20,000 3,20,000
2015 2015
March 31 To Sinking Fund A/c 3,20,000 March 31 By Profit & Loss A/c 3,20,000
3,20,000 3,20,000
2016 2016
March 31 To Sinking Fund A/c 2,92,000 March 31 By Profit & Loss A/c 2,92,000
2,92,000 2,92,000

3.6 Machine Hour Method

Where it is practicable to keep a record of the actual running hours of each machine, depreciation may
be calculated on the basis of hours that the concerned machine worked. The machine hour rate of the
depreciation, is calculated after estimating the total number of hours that machine would work during
its whole life; however, it may have to be varied from time to time, on a consideration of the changes in

© The Institute of Chartered Accountants of India

5.18 PRINCIPLES AND PRACTICE OF ACCOUNTING

the economic and technological conditions which might take place, to ensure that the amount provided
for depreciation corresponds to that considered appropriate in the changed circumstances. It would be
observed that the method is only a slight variation of the Straight Line Method under which depreciation is
calculated per year. Under this method it is calculated for each hour the machine works.
Schedule II to the Companies Act 2013, prescribes estimated useful life of different assets for companies,
also recognizes this method to some extent. It prescribes that depreciation should be charged using
estimate useful life suggested in it, however, in certain category of plant and machinery it prescribes to
charge higher amount of depreciation if these assets are used for 2 shifts or 3 shifts. In a way, schedule II
combines straight line method and machine hour method.

? ILLUSTRATION 7
A machine was purchased for ` 30,00,000 having an estimated total working of 24,000 hours. The scrap value is
expected to be ` 2,00,000 and anticipated pattern of distribution of effective hours is as follows :
Year
1–3 3,000 hours per year
4-6 2,600 hours per year
7 - 10 1,800 hours per year

Required

Determine Annual Depreciation under Machine Hour Rate Method.

 SOLUTION

Statement of Annual Depreciation under Machine Hours Rate Method

Year Annual Depreciation

1-3 3,000
× (` 30,00,000 - ` 2,00,000) = ` 3,50,000
24,000
4-6 2,600
× (` 30,00,000 - ` 2,00,000) = ` 3,03,333
24,000
7 - 10 1,800
× (` 30,00,000 - ` 2,00,000) = ` 2,10,000
24,000
3.7 Production Units Method

Under this method depreciation of the asset is determined by comparing the annual production with the
estimated total production. The amount of depreciation is computed by the use of following method:

Production during the period

Depreciation for the period = Depreciable Amount X
Estimated total production.

The method is applicable to machines producing product of uniform specifications.

© The Institute of Chartered Accountants of India

 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.19

? ILLUSTRATION 8
A machine is purchased for ` 20,00,000. Its estimated useful life is 10 years with a residual value of ` 2,00,000.
The machine is expected to produce 1.5 lakh units during its life time. Expected distribution pattern of
production is as follows:
Year Production
1-3 20,000 units per year
4-7 15,000 units per year
8-10 10,000 units per year

Required
Determine the value of depreciation for each year using production units method.

 SOLUTION

Statement showing Depreciation under Production Units Method

Year Annual Depreciation

1-3 20,000
× (` 20,00,000 - ` 2,00,000) = ` 2,40,000
1,50,000
4-7 15,000
× (` 20,00,000 - ` 2,00,000 ) = ` 1,80,000
1,50,000
8-10 10,000
× (` 20,00,000 - ` 2,00,000) = ` 1,20,000
1,50,000

3.8 Depletion Method

This method is used in case of mines, quarries etc. containing only a certain quantity of product. The
depreciation rate is calculated by dividing the cost of the asset by the estimated quantity of product likely
to be available. Annual depreciation will be the quantity extracted multiplied by the rate per unit.

? ILLUSTRATION 9

M/s Surya took lease of a quarry on 1-1-2013 for ` 1,00,00,000. As per technical estimate the total quantity of
mineral deposit is 2,00,000 tonnes. Depreciation was charged on the basis of depletion method. Extraction
pattern is given in the following table:
Year Quantity of Mineral extracted
2013 2,000 tonnes
2014 10,000 tonnes
2015 15,000 tonnes

© The Institute of Chartered Accountants of India

5.20 PRINCIPLES AND PRACTICE OF ACCOUNTING

Required
Show the Quarry Lease Account and Depreciation Account for each year from 2013 to 2015.

 SOLUTION

Quarry Lease Account

` `
2013 2013
Jan. To Bank A/c 1,00,00,000 Dec. 31 By Depreciation A/c 1,00,000
[(2,000/2,00,000) ×
` 1,00,00,000]
Dec. 31 By Balance c/d 99,00,000
1,00,00,000 1,00,00,000
2014 2014
Jan. 1 To Balance b/d 99,00,000 Dec. 31 By Depreciation A/c 5,00,000
Dec. 31 By Balance c/d 94,00,000
99,00,000 99,00,000
2015 2015
Jan. 1 To Balance b/d 94,00,000 Dec. 31 By Depreciation A/c 7,50,000
Dec. 31 By Balance c/d 86,50,000
94,00,000 94,00,000

Depreciation Account
` `
2013 2013 `
Dec. 31 To Quarry lease A/c 1,00,000 Dec. 31 By Profit & Loss A/c 1,00,000
1,00,000 1,00,000
2014 2014
Dec. 31 To Quarry lease A/c 5,00,000 Dec. 31 By Profit & Loss A/c 5,00,000
5,00,000 5,00,000
2015 2015
Dec. 31 To Quarry lease A/c 7,50,000 Dec. 31 By Profit & Loss A/c 7,50,000
7,50,000 7,50,000

4. PROFIT OR LOSS ON THE SALE/DISPOSAL OF PROPERTY, PLANT

AND EQUIPMENT
Whenever any depreciable asset is sold during the year, depreciation is charged on it for the period it has
been used in the sale year. The written down value after charging such depreciation is used for calculating
the profit or loss on the sale of that asset. The resulting profit or loss on sale of the asset is ultimately
transferred to profit and loss account.
For example: The book value of the asset as on 1st January, 2015 is ` 50,00,000. Depreciation is charged on
the asset @10%. On 1st July 2015, the asset is sold for ` 32,00,000. In such a situation, profit or loss on the
sale will be calculated as follows:

© The Institute of Chartered Accountants of India

 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.21

`
Book value as on 1st Jan., 2015 50,00,000
Less: Depreciation for 6 months @10% (from 1st Jan., 2015 to 30th June, 2015) (2,50,000)
Written down value as on 1st July, 2015 47,50,000
Less: Sale proceeds as on 1st July, 2015 (32,00,000)
Loss on sale of the asset 15,50,000

? ILLUSTRATION 10

A firm purchased on 1st January, 2015 certain machinery for ` 5,82,000 and spent ` 18,000 on its erection. On
July 1, 2015 another machinery for ` 2,00,000 was acquired. On 1st July, 2016 the machinery purchased on 1st
January, 2015 having become obsolete was auctioned for ` 3,86,000 and on the same date fresh machinery was
purchased at a cost of ` 4,00,000.
Depreciation was provided for annually on 31st December at the rate of 10 per cent p.a. on written down value.
Required
Prepare machinery account.

 SOLUTION

Machinery Account
` `
2015 2015 `
Jan. 1 To Bank A/c 5,82,000 Dec. 31 By Depreciation A/c 70,000
Jan. 1 To Bank A/c –
erection charges 18,000 By Balance c/d 7,30,000
July 1 To Bank A/c 2,00,000
8,00,000 8,00,000
2016 2016
Jan. 1 To Balance b/d 7,30,000 July 1 By Depreciation on
sold machine 27,000
July 1 To Bank A/c 4,00,000 By Bank A/c 3,86,000
By Profit and Loss A/c 1,27,000
Dec. 31 By Depreciation A/c 39,000
By Balance c/d 5,51,000
11,30,000 11,30,000

Working Note:
Book Value of Machines

Machine Machine Machine

I II III
` ` `
Cost 6,00,000 2,00,000 4,00,000
Depreciation for 2015 (60,000) (10,000)

© The Institute of Chartered Accountants of India

5.22 PRINCIPLES AND PRACTICE OF ACCOUNTING

Written down value 5,40,000 1,90,000

Depreciation for 2016 (27,000) (19,000) (20,000)
Written down value 5,13,000 1,71,000 3,80,000
Sale Proceeds (3,86,000)
Loss on Sale 1,27,000

5. CHANGE IN THE METHOD OF DEPRECIATION

The depreciation method applied to an asset should be reviewed at least at each financial year-end and, if
there has been a significant change in the expected pattern of consumption of the future economic benefits
embodied in the asset, the method should be changed to reflect the changed pattern. Whenever any change
in depreciation method is made. Such change in method is treated as change in accounting estimate as per
Accounting Standards. Its effect needs to be quantified and disclosed. A change in an accounting estimate
may affect the current period only or both the current period and future periods.

Example :
Cost of Machine ` 10,50,000
Residual Value ` 50,000
Useful life 10 years.

The company charges depreciation on straight line method for the first two years and thereafter decides to
adopt written down value method by charging depreciation @ 25%. (calculated based on useful life). You
are required to calculate depreciation for the 3rd year.
Depreciation already charged for the first 2 years as per straight line method is ` 2,00,000. Therefore, WDV
for 2nd year is ` 8,50,000
Therefore in the profit and loss account of the 3rd year, the depreciation of ` 2,12,500 (25% of ` 850,000)
should be debited.

? ILLUSTRATION 11

M/s Anshul commenced business on 1st January 2011, when they purchased plant and equipment for ` 7,00,000.
They adopted a policy of charging depreciation at 15% per annum on diminishing balance basis and over the
years, their purchases of plant have been:

Date Amount
`
1-1-2012 1,50,000
1-1-2015 2,00,000

On 1-1-2015 it was decided to change the method and rate of depreciation to straight line basis. On this date
remaining useful life was assessed as 6 years for all the assets purchased before 1.1.2015 and 10 years for the
asset purchased on 1.1.2015 with no scrap value.

© The Institute of Chartered Accountants of India

 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.23

Required
Calculate the difference in depreciation to be adjusted in the Plant and Equipment Account for the year ending
31st December, 2015.

 SOLUTION

Depreciation on written down value basis

Purchased on Purchased on Total
Jan. 1, 2011 Jan. 1, 2012 Depreciation
` ` `
2011 Cost 7,00,000
Depreciation (1,05,000) 1,05,000
Written Down Value (WDV) 5,95,000
2012 Cost - 1,50,000
Depreciation ( 89,250) (22,500) 1,11,750
W.D.V. 5,05,750 1,27,500
2013
Depreciation (75,863) (19,125) 94,988
W.D.V. 4,29,887 1,08,375
2014
Depreciation (64,483) (16,256) 80,739
W.D.V. 3,65,404 92,119
2015
Depreciation (60,900) (15,353) 76,253
W.D.V. 3,04,504 76,766

Plant and Equipment Account

` `
2015 2015
Jan. 1 To Balance b/d 4,57,523 Dec. 31 By Depreciation 96,253
(60,900+15,353+20,000)

By Balance c/d 5,61,270

To Bank 2,00,000
6,57,523 6,57,523
2016
Jan. 1 To Balance b/d 5,61,270

© The Institute of Chartered Accountants of India

5.24 PRINCIPLES AND PRACTICE OF ACCOUNTING

6. REVISION OF THE ESTIMATED USEFUL LIFE OF PROPERTY, PLANT

AND EQUIPMENT
The residual value and the useful life of an asset should be reviewed at least at each financial year-end and,
if expectations differ from previous estimates, the change(s) should be accounted for as a change in an
accounting estimate in accordance with Accounting Standards.
Whenever there is a revision in the estimated useful life of the asset, the unamortised depreciable amount
should be charged over the revised remaining estimated useful life of the asset.

? ILLUSTRATION 12

A Machine costing ` 6,00,000 is depreciated on straight line basis, assuming 10 years working life and Nil residual
value, for three years. The estimate of remaining useful life after third year was reassessed at 5 years.
Required
Calculate depreciation for the fourth year.

 SOLUTION

Depreciation per year = ` 6,00,000 / 10 = ` 60,000

Depreciation on SLM charged for three years = ` 60,000 x 3 years = ` 1,80,000
Book value of the computer at the end of third year = ` 6,00,000 – ` 1,80,000 = ` 4,20,000.
Remaining useful life as per previous estimate = 7 years
Remaining useful life as per revised estimate = 5 years
Depreciation from the fourth year onwards = ` 4,20,000 / 5 = ` 84,000 per annum
In case the entity would have continued with estimate of 7 years of remaining useful life, depreciation for
4th year would have been ` 64,000.

7. REVALUATION OF PROPERTY, PLANT AND EQUIPMENT

If there is an upward revision in the value of asset for the first time, then the amount of appreciation is
debited to Asset Account and credited to Revaluation Reserve Account. If there is downward revision in the
value of asset then Profit and Loss Account is debited and Asset Account is credited. If an asset was earlier
revalued downward and later on revalued upward then the appreciation to the extent of earlier downfall is
credited to profit and loss account. If an asset was earlier revalued upward and then later on it was revalued
downward then the downfall to the extent of earlier appreciation is debited to Revaluation Reserve Account.
In case the revaluation has a material effect on the amount of depreciation, the same should be disclosed
separately in the year in which revaluation is carried out.

© The Institute of Chartered Accountants of India

 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.25

Revaluation

Increase Decrease

Credited Exception Charged to Exception:

directly to When it is the Statement When it is
owners’ subsequent of profit and subsequent
interests loss
Increase Decrease
under the
heading of (Initially (Initially
Revaluation Decrease) Increase)
surplus
Recognised in the Statement of Decrease should be
Profit and loss to the extent that debited directly to
it reverses a revaluation decrease owners' interests
of the same asset previously under the heading of
recognised in the Statement of Revaluation surplus to
profit and loss the extent of any credit
balance existing in the
Revaluation surplus in
respect of that asset

? ILLUSTRATION 13

A machine of cost ` 12,00,000 is depreciated straight-line assuming 10 year working life and zero residual value
for three years. At the end of third year, the machine was revalued upwards by ` 60,000 the remaining useful life
was reassessed at 9 years.
Required
Calculate depreciation for the fourth year.

 SOLUTION

Depreciation per year charged for three years = ` 12,00,000 / 10 = ` 1,20,000

WDV of the machine at the end of third year = ` 12,00,000 – ` 1,20,000 × 3 = ` 8,40,000.
Depreciable amount after revaluation = ` 8,40,000 + ` 60,000 = ` 9,00,000
Remaining useful life as per previous estimate = 7 years
Remaining useful life as per revised estimate = 9 years
Depreciation for the fourth year onwards = ` 9,00,000 / 9 = `1,00,000.

© The Institute of Chartered Accountants of India

5.26 PRINCIPLES AND PRACTICE OF ACCOUNTING

8. PROVISION FOR REPAIRS AND RENEWALS

Expenditure incurred for repairs, renewals and maintenance on plant and machinery may vary over the
years during the working life. Thus, for equalising the charge of repairs and renewals, sometimes a Provision
for Repairs and Renewals Account is opened. Total of such expenses that may be incurred over the working
life is estimated beforehand. Average of this expenditure is debited to Profit and Loss Account and credited
to Provision for Repairs and Renewals Account irrespective of actual expenses incurred. Every year Provision
for Repairs and Renewals Account is debited and Repairs Account is credited for actual expenses incurred.
The balance in provision for Repairs and Renewals Account is carried forward and in the end or on sale of
the asset, the account is closed by transfer to the Asset Account for any balance left.

? ILLUSTRATION 14

The following particulars are available from the books of a public company having a large fleet of vehicles:

`
Balance in Provision for Repairs and Renewals Account as on 31.3.2016 11,50,000
Actual repairs charged/incurred during the year ended
31.3.2016 7,50,000
31.3.2017 3,20,000
The company makes an annual provision of ` 4,00,000 on repairs and renewals.

Required
Draw up the Provision for Repairs and Renewals Account for the years 2015-2016 and 2016-2017.

 SOLUTION

Provision for Repairs and Renewal Account

` `
31.3.2016 To Repairs A/c 7,50,000 1.4.2015 By Balance b/d 15,00,000
31.3.2016 To Balance c/d 11,50,000 (Balancing figure)
31.3.2016 By Profit and Loss A/c 4,00,000
19,00,000 19,00,000
31.3.2017 To Repairs A/c 3,20,000 1.4.2016 By Balance b/d 11,50,000
31.3.2017 To Balance c/d 12,30,000 31.3.2017 By Profit and Loss A/c 4,00,000
15,50,000 15,50,000
1.4.2017 By Balance b/d 12,30,000

© The Institute of Chartered Accountants of India

 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.27

SUMMARY
w Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.
w Objectives for providing depreciation are:
ª Correct income measurement
ª True position statement
ª Funds for replacement
ª Ascertainment of true cost of production.
w Factors in the measurement of depreciation:
ª Cost of asset
ª Estimated useful life of the asset
ª Estimated scrap value (if any) at the end of useful life of the asset.
w Methods for providing depreciation:
ª Straight line method
ª Reducing balance method
ª Sum of years of digits method
ª Annuity method
ª Sinking fund method
ª Machine hour method
ª Production units’ method
ª Depletion method

w The resulting profit or loss on sale of the tangible asset is ultimately transferred to profit and loss
account.
w The depreciation method residual value & useful life applied to an asset should be reviewed at least
at each financial year-end and, if there has been a significant change in the expected pattern of
consumption of the future economic benefits embodied in the asset, on account of the above, they
should be changed to reflect the changed pattern.
w Whenever there is a revision in the estimated useful life of the asset, the unamortised depreciable
amount should be charged to the asset over the revised remaining estimated useful life of the asset.
w Whenever the depreciable asset is revalued, the depreciation should be charged on the revalued
amount on the basis of the remaining estimated useful life of the asset.

© The Institute of Chartered Accountants of India

5.28 PRINCIPLES AND PRACTICE OF ACCOUNTING

TEST YOUR KNOWLEDGE

Multiple Choice Questions

1. Original cost = ` 12,60,000; Salvage value = Nil; Useful life = 6 years. Depreciation for the first year under
sum of years digits method will be
(a) ` 3,60,000 (b) ` 1,20,000 (c) ` 1,80,000

2. Obsolescence of a depreciable asset may be caused by:

I. Technological changes.
II. Improvement in production method.
III. Change in market demand for the product or service output.
IV. Legal or other restrictions.
(a) Only (I) above
(b) Both (I) and (II) above
(c) All (I), (II), (III) and (IV) above

3. The number of production of similar units expected to be obtained from the use of an asset by an
enterprise is called as
(a) Unit life (b) Useful life (c) Production life

4. If a concern proposes to discontinue its business from March 2015 and decides to dispose of all its
plants within a period of 4 months, the Balance Sheet as on March 31, 2015 should indicate the plants
at their
(a) Historical cost (b) Net realizable value (c) Cost less depreciation

5. In the case of downward revaluation of a plant which is for the first time revalued, the account to be
debited is
(a) Plant account (b) Revaluation Reserve (c) Profit & Loss account

6. The portion of the acquisition cost of the tangible asset, yet to be allocated is known as
(a) Written down value (b) Accumulated value (c) Realisable value

7. The main objective of providing depreciation is to

(a) Create secret reserve (b) Reduce the book value of assets
(c) Allocate cost of the assets

© The Institute of Chartered Accountants of India

 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.29

8. Original cost of a machine was ` 25,20,000 salvage value was ` 1,20,000, useful life was 6 years.
Annual depreciation under Straight Line Method
(a) ` 4,20,000 (b) ` 4,00,000 (c) ` 3,00,000

9. The cost of a machine is ` 20,00,000. Two years later the book value is ` 10,00,000. The Straight-line
percentage depreciation is
(a) 50% (b) 33-1/3% (c) 25%

10. Original cost `13,00,000, Salvage value ` 40,000, Useful life 6 years. Depreciation for the first year under
sum-of-years digit methods will be
(a) ` 60,000 (b) ` 1,20,000 (c) ` 3,60,000

11. Which of the following assets does not depreciate?

(a) Machinery and equipment
(b) Patents
(c) Land
12. A company purchased a machinery on April 01, 2010, for ` 15,00,000. It is estimated that the machinery
will have a useful life of 5 years after which it will have no salvage value. The depreciation charged
during the year 2014-15 was
(a) ` 5,00,00 (b) ` 4,00,000 (c) ` 3,00,000

13. If the equipment account has a balance of ` 22,50,000 and the accumulated depreciation account has a
balance of ` 14,00,000, the book value of the equipment is
(a) ` 36,50,000 (b) ` 8,50,000 (c) ` 14,00,000

Theory Questions
1. Distinguish between Straight line method of depreciation and Written down value method of
depreciation.
2. Write short notes on:
(i) Depletion method of depreciation
(ii) Sinking fund method.
3. What factors are considered for calculation of depreciation of a plant?

© The Institute of Chartered Accountants of India

5.30 PRINCIPLES AND PRACTICE OF ACCOUNTING

Practical Questions
1. A firm’s plant and machinery account at 31st December, 2015 and the corresponding depreciation
provision account, broken down by year of purchase are as follows:

Year of Purchase Plant and Machinery at cost Depreciation Provision

` `
1998 2,00,000 2,00,000
2004 3,00,000 3,00,000
2005 10,00,000 9,50,000
2006 7,00,000 5,95,000
2013 5,00,000 75,000
2014 3,00,000 15,000
30,00,000 21,35,000

Depreciation is at the rate of 10% per annum on cost. It is the Company’s policy to assume that all
purchases, sales or disposal of plant occurred on 30th June in the relevant year for the purpose of
calculating depreciation, irrespective of the precise date on which these events occurred.

During 2015 the following transactions took place:

1. Purchase of plant and machinery amounted to ` 15,00,000
2. Plant that had been bought in 2004 for ` 170,000 was scrapped.
3. Plant that had been bought in 2005 for ` 90,000 was sold for ` 5,000.
4. Plant that had been bought in 2006 for ` 2,40,000 was sold for ` 15,000.

You are required to:

Calculate the provision for depreciation of plant and machinery for the year ended 31st December,
2015. In calculating this provision you should bear in mind that it is the company’s policy to show
any profit or loss on the sale or disposal of plant as a completely separate item in the Profit and Loss
Account. You are also required to prepare the following ledger accounts during 2015.
(i) Plant and machinery at cost;
(ii) Depreciation provision;
(iii) Sales or disposal of plant and machinery.
2. The Machinery Account of a Factory showed a balance of ` 19,00,000 on 1st January, 2015. Its accounts
were made up on 31st December each year and depreciation is written off at 10% p.a. under the
Diminishing Balance Method.
On 1st June 2015, a new machinery was acquired at a cost of ` 2,80,000 and installation charges incurred
in erecting the machine works out to ` 8,920 on the same date. On 1st June, 2015 a machine which had
cost ` 4,37,400 on 1st January 2013 was sold for ` 75,000. Another machine which had cost ` 4,37,000
on 1st January, 2014 was scrapped on the same date and it realised nothing.

© The Institute of Chartered Accountants of India

 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.31

Write a plant and machinery account for the year 2015, allowing the same rate of depreciation as in the
past calculating depreciation to the nearest multiple of a Rupee.

3. M/s. Prabha Pharmaceuticals has imported a machine on 1st July, 2014, for Pound 8,000, paid custom
duty and freight ` 80,000 and incurred erection charges ` 60,000. Another local machinery costing
`1,00,000 was purchased on 1st Jan 2015. On 1st July, 2016, a portion of the imported machinery (value
one-third) got out of order and was sold for ` 1,34,800. Another machinery was purchased to replace
the same for ` 50,000. Depreciation is to be calculated at 20% p.a on cost. Show the machinery account
for 2014, 2015, and 2016. Exchange rate is ` 80 per pound.

4. The LG Transport company purchased 10 trucks at ` 45,00,000 each on 1st April 2014. On October
1st, 2016, one of the trucks is involved in an accident and is completely destroyed and ` 27,00,000 is
received from the insurance in full settlement. On the same date another truck is purchased by the
company for the sum of ` 50,00,000. The company write off 20% on the original cost per annum. The
company observe the calendar year as its financial year.
Give the motor truck account for two year ending 31 Dec, 2017.

ANSWERS/HINTS
MCQs
1. (a) 2. (c) 3. (b) 4. (b) 5. (c) 6. (a)
7. (c) 8. (b) 9. (c) 10. (c) 11. (c) 12. (c)
13. (b)

Theoretical Questions
1. Under straight line method an equal amount is written off each year throughout the working life of
the depreciable tangible asset so as to reduce the cost of the asset to nil or to its scarp value at the
end. Under reducing balance method, a fixed percentage is charged on the diminishing balance of the
asset each year so as to reduce the value of the asset to its scarp value at the end of useful life. The basic
distinction between these two methods are as follows:
Under straight line method, annual depreciation charge is equal throughout the life of the asset; but
under reducing balance method, depreciation charge is reduced over the years as the asset grows old.
Under straight-line method, the asset can be fully depreciated but under reducing balance method
asset can never be fully depreciated.
Under straight line method the charge for depreciation is constant while repair charges increase with
the life of the asset, so the total charge throughout the life of the asset will not be uniform. To the
contrary, under reducing balance method, depreciation charges become high in the initial years but
generally repair remains low. As the asset grows old depreciation charge reduces but repair expenses
increase. Thus under reducing balance method depreciation and repairs are more or less evenly
distributed throughout the life of the asset.

© The Institute of Chartered Accountants of India

5.32 PRINCIPLES AND PRACTICE OF ACCOUNTING

2. (i) Natural resources include physical assets like mineral deposits, oil and gas resources and timber.
These natural resources exhaust by exploitation.
Depletion per unit is calculated as
Acquisition cost-Residual value
Estimated life in terms of production units

(ii) Sinking fund method of providing depreciation is used where the aim is not only to charge depreciation
but also to replace the asset. In case a large sum of money is required for the replacement of an asset
at the end of its effective life, it may not be advisable to leave in the amount of depreciation set apart
annually, for it may or may not be available in the form of concern itself the readily realisable assets
at the time it is required. To safeguard this position, the amount annually provided for depreciation
may be placed to the credit of the Sinking Fund account, and at the same time an equivalent amount
may be invested in government securities. The book value of the old asset, at the time, is transferred
to the Sinking Fund Account. Any amount realised on sale of the old asset, as well as the profit or loss
on sale of securities, is transferred to the Sinking Fund Account and it is closed off by transfer of the
balance to the profit and loss account or general reserve.
3. The factors considered for calculation of depreciation are as: (i)Cost of asset including expenses for
installation, commissioning, trial run etc. (ii) Estimated useful life of the asset and (iii) Estimated scrap
value (if any) at the end of useful life of the asset.

Practical Questions
Answer 1
Calculation of provision for depreciation of plant and machinery for the year ended 31st
December, 2015.
Plant purchased in: ` `
1998 nil
2004 nil
2005 50,000
2006 1/2 year at 10% on ` 2,40,000 12,000
1 year at 10% on ` 4,60,000 46,000 58,000
2013 10% on ` 5,00,000 50,000
2014 10% on ` 3,00,000 30,000
2015 1/2 year at 10% on ` 15,00,000 75,000
2,63,000

© The Institute of Chartered Accountants of India

 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.33

Plant and Machinery Account (for 2015) at Cost

` `
To Balance b/d 30,00,000 By Disposals account:
To Purchases A/c 15,00,000 Scrapped 1,70,000
Sold 3,30,000
By Balance c/d 40,00,000
45,00,000 45,00,000

Depreciation Provision Account (for 2015)

` `
To Disposal Account : By Balance b/d 21,35,000
Scrapped - 2004 assets 1,70,000 By Profit and Loss Account 2,63,000
Sold - 2005 assets 90,000
Sold - 2006 assets 2,16,000 4,76,000
To Balance c/d 19,22,000
23,98,000 23,98,000

Sale or disposal of Plant and Machinery Account (for 2015)

` `
To Plant and Machinery : By Provision for Depreciation 4,76,000
Scrapped 1,70,000 By Cash-Sales Proceeds 20,000
Sold 3,30,000 By Loss on sales 4,000
5,00,000 5,00,000
Answer 2
Plant and Machinery Account
` `
2015 2015
Jan. 1 To Balance b/d 19,00,000 June 1 By Bank (Sales) 75,000
June. 1 To Bank (2,80,000 + 2,88,920 By Depreciation 14,762
8,920) (on sold machine)
By Loss on sale 2,64,532
By Loss on scrapping 3,76,912
the machine
By Depreciation (on 16,388
scrapped machinery)
By Depreciation (Note iii) 1,32,094
By Balance c/d 13,09,232
21,88,920 21,88,920

© The Institute of Chartered Accountants of India

5.34 PRINCIPLES AND PRACTICE OF ACCOUNTING

Working Note :
(i) Calculation of loss on sale of machine on 1-6-2015
`
Cost on 1-1-2013 4,37,400
Less : Depreciation @ 10% on ` 4,37,400 (43,740)
W.D.V. on 31-12-2013 3,93,660
Less : Depreciation @ 10% on ` 3,93,660 (39,366)
W.D.V. on 31-12-2014 3,54,294
Less : Depreciation @ 10% on ` 3,54,294 for 5 months (14,762)
3,39,532
Less : Sale proceeds on 1-6-2015 (75,000)
Loss 2,64,532
(ii) Calculation of loss on scrapped machine
`
Cost on 1-1-2014 4,37,000
Less : Depreciation @ 10% on ` 4,37,000 (43,700)
W.D.V. on 1-1-2015 3,93,300
Less : Depreciation @ 10% on ` 3,93,300 for 5 months (16,388)
Loss 3,76,912
(iii) Depreciation
Balance of machinery account on 1-1-2015 19,00,000
Less : W.D.Vof machinery sold 3,54,294
W.D.V. of machinery scrapped 3,93,300 (7,47,594)
W.D.V. of other machinery on 1-1-2015 11,52,406
Depreciation @ 10% on ` 11,52,406 for 12 months 1,15,240
Depreciation @ 10% on ` 2,88,920 for 7 months 16,854
1,32,094

Answer 3
Machinery A/c

Date Particulars Amount Date Particulars Amount

2014 2014
Jul-01 To Bank A/c 6,40,000 Dec-31 By Depreciation A/c for ½ yr. 78,000
Jul-01 To Bank A/c 80,000 Dec-31 By balance c/d 7,02,000
Jul-01 To Bank A/c 60,000
7,80,000 7,80,000
2015 2015
Jan-01 To balance b/d 7,02,000 Dec-31 By Depreciation A/c 1,56,000
Jan-01 To Bank A/c 1,00,000 Dec-31 By balance c/d 6,46,000
8,02,000 8,02,000

© The Institute of Chartered Accountants of India

 CONCEPT AND ACCOUNTING OF DEPRECIATION 5.35

Date Particulars Amount Date Particulars Amount

2016 2016
Jan-01 To balance b/d 6,46,000 Jul-01 By Bank A/c 1,34,800
To Bank A/c 50,000 Jul-01 By Depreciation A/c 26,000
(On machinery sold)
Jul-01 By Profit & Loss A/c 21,200
(Loss on sale of machinery)
Dec-31 By Depreciation A/c 1,24,000
Dec-31 By balance c/d 3,90,000

6,96,000 6,96,000

Working Note:

1. In the absence of information about depreciation method to be used, Straight line method of
depreciation has been used. Alternatively, written down value method of depreciation may be assumed.
2. The method of machinery sold as on 1.7.2016 may be obtained as follow:

`
Cost of machinery sold as on 1.7.2014 2,60,000
Less: Depreciation for 2014 (for ½ year) (26,000)
2,34,000
Less: Depreciation for 2015 (52,000)
1,82,000
Less: Depreciation for 2016 (for ½ year) (26,000)
1,56,600
Less: Amount received (1,34,800)
21,200

Answer 4

Date Particulars Amount Date Particulars Amount

2016 2016
Jan-01 To balance b/d 2,92,50,000 Oct-01 By bank A/c 27,00,000
To Profit & Loss A/c
Oct-01 (Profit on settlement 4,50,000 Oct-01 By Depreciation 6,75,000
of Truck) on lost assets

© The Institute of Chartered Accountants of India

5.36 PRINCIPLES AND PRACTICE OF ACCOUNTING

Oct-01 To Bank A/c 50,00,000 Oct-01 By Depreciation A/c 83,50,000

Dec-31 By balance c/d 2,29,75,000

3,47,00,000 3,47,00,000

2017 2017
Jan-01 To balance b/d 2,29,75,000 Dec-31 By Depreciation A/c 91,00,000
Dec-31 By balance c/d 1,38,75,000

2,29,75,000 2,29,75,000

Working Note:

1. To find out loss on Profit on settlement of truck

`
Original cost as on 1.4.2014 45,00,000
Less: Depreciation for 2014 (6,75,000)
38,25,000
Less: Depreciation for 2015 (9,00,000)
29,25,000
Less: Depreciation for 2016 (9 months) (6,75,000)
22,50,000
Less: Amount received from Insurance company (27,00,000)
4,50,000

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