DEPRECIATION

1)ABSTRACT:
In the domains of engineering, social science, and management sciences, the phrase
"depreciation" is complicated, nuanced, and ambiguous. As a result, it has received excessive
use, stress, and labour from expert valuers and accountants. When an asset is employed by an
entity for production or service and has an economic useful life, as defined by International
Accounting Standard (IAS) 4, it qualifies for depreciation. In contrast, depreciation is defined
by Standard Statement of Accounting Practice (SSAP) 12 as the wearing out, consumption,
or other loss of value of a fixed asset, whether this loss results from usage, the passage of
time, or obsolescence due to changes in technology and the market. When it is considered as
a price decline, physical degradation, cost allocation, value decline, valuation approach, and
asset replacement, complexity may develop. When accountants use multiple ways to account
for depreciation on the same or similar assets with differing life spans, complexity and
confusion are unavoidable. These techniques may include straight line, lowering balance,
sum of the year's digits, revaluation, annuity, output, sinking fund, etc., and they could result
in a variety of values for the financial statement. The financial reports are ludicrous because
the resultant consequence is to either undervalue or overvalue the reported profit or
distributable profit in the hands of the stakeholders. Depreciation should be utilised carefully,
especially when the asset's expected economic useful life is limited due to new technology or
the passage of time, making it more challenging to recover or replace the asset's net book
value.

2)INTRODUCTION:
Depreciation is an accounting concept that helps companies determine how much their assets
are worth less over time. Depreciation is the accounting term for a decrease in asset value
over time as a result of usage or obsolescence. As a non-monetary transaction, it is not
considered to reflect actual cash flow. Following this introduction to depreciation, we'll
discuss depreciation presentation, depreciation procedures in India, and depreciation
accounting. These assets consist of the property, machinery, equipment, etc. that the company
bought during the relevant financial year. In essence, it's a non-cash transaction that takes
into account how quickly an asset's value depreciates. Businesses depreciate long-term assets
for accounting and taxation reasons. When a company creates its financial accounting
depreciation statements, depreciation is accounted for as a cost and a reduction from fixed
assets. This accomplishes the goal of spreading out the asset's initial cost across the asset's
useful life. An chance for a short-term investment may be worth more or less depending on
how a company handles depreciation. Although depreciation must be expensed in accordance
with a set of guidelines, management of the company has the ability to manipulate it to
deceive analysts and investors. Therefore, it is crucial to be aware of the many false
assumptions and techniques that firms employ to deal with the concept of depreciation while
assessing financial accounts.

3)DEFINATION OF DEPRECIATION:
Depreciation is a word used in accounting to describe the continual lowering of a fixed asset's
reported cost until the asset's value is zero or insignificant. Fixed assets include things like
buildings, furniture, office supplies, machinery, etc. As the value of land increases over time,
it is the single exception that cannot be depreciated. Depreciation enables a portion of a fixed
asset's cost to be applied to the income the fixed asset produces. According to the matching
principle, this is required since revenues and related costs are recorded in the accounting
period during which the asset is in use. Having a thorough view of the income generation
transaction is aided by this.
An example of depreciation: If a firm buys a delivery truck for Rs. 100,000 and expects to
use it for 5 years, the company may depreciate the asset as a depreciation charge of Rs.
20,000 each year for the five years.

4)DEPRECIATION METHODS:
The businesses compute depreciation in a variety of ways. These are listed below:

4.1 Straight line method

4.2 Diminishing balance method
4.3 sum of years digit method
4.4 double declining balance method
4.5 sinking fund method
4.6 Annuity method
4.7 Insurance policy method
4.8 Discounted cash flow method
4.9 Use based method
4.9.1 output method
4.9.2 working hours method
4.9.3 mileage method
4.10 other method
4.10.1 depletion method
4.10.2 revaluation method
4.10.3. group or composite method

1.STRAIGHT LINE METHOD:

The most popular approach for calculating depreciation is this one. It also goes by the
name "fixed instalment method." According to this system, each accounting period's
depreciation charge is identical for each fixed asset. Until the asset is reduced to zero
or its salvage value at the end of its expected useful life, this constant amount is
charged. So a graph of a straight line is where the name of this approach comes from.
After charting an equal amount of depreciation for each accounting period during the
asset's useful life, this graph is derived. Thus, to determine the amount of
depreciation, the difference between the fixed asset's initial cost or book value and its
salvage value is divided by the asset's useful life.

HYPOTHETICAL EXAMPLE OF STRAIGHT LINE METHOD:

Depreciation = cost of asset- salvage value

useful life of asset

Depreciation rate = annual depreciation

cost of asset- salvage value

Q. Company purchased a machine for 50000 with an estimated scrap value of 5000 and
useful life is 3 years. find depreciation and depreciation rate by straight line method.
cost= 50000
scrap value = 5000
estimatesd life = 3 years

annual depreciation = 50000- 5000 = 45000 = 15000

3 3

depreciation = 15000

depreciation rate = 15000 * 100 = 33.3%

45000

2. DIMINISHING BALANCE METHOD:

The written-down value method, decreasing balance method, and diminishing balance
method are other names for this technique. Under this technique, a fixed percentage of
depreciation is charged to the net balance of the fixed asset each accounting period. The
asset's value that is left over after subtracting cumulative depreciation is what makes up
this net balance. Depreciation is therefore assessed based on the asset's declining
balance. This asset is the one that is recorded at the start of an accounting period in the
books of accounts. Thus, the asset's book value is reduced to its residual value by
writing off some of its worth. Depreciation now decreases annually in proportion to the
asset's declining book value. As a result, more depreciation is charged in the asset's
early years than it is in its later years. Depreciation should thus be charged at a higher
rate throughout the asset's early years, according to the technique. This is due to the
cheap cost of repairs throughout those years. The price of repairs and maintenance rises
as an item enters the latter phases of its useful life. Therefore, during such years, less
depreciation is require

HYPOTHETICAL EXAMPLE OF DIMINISHING BALANCE METHOD:

Depreciation amount = book value * rate of depreciation

100

A boiler was purchased from abroad for ₹ 10,000. Shipping and forwarding charges ₹ 2,000,
Import duty ₹ 7,000 and expenses of installation amounted to ₹ 1,000.
Calculate the Depreciation for the first three years (separately for each year) @ 10% p.a. on
Diminishing Balance Method.

Boiler Account
Dr. Cr.
Amount Amount
Date Particulars J.F. Date Particulars J.F.
(₹ ) (₹ )
I year I year
Jan.01 Bank (10,000 + 20,000 Dec.31 Depreciation 2,000
2,000 + 7,000 +
 1,000)
Balance c/d 18,000
20,000 20,000
II year II year
Jan.01 Balance b/d 18,000 Dec.31 Depreciation 1,800
Dec.31 Balance c/d 16,200
18,000 18,000
III III year
year
Jan.01 Balance b/d 16,200 Dec.31 Depreciation 1,620
Dec.31 Balance c/d 14,580
16,200 16,200

3. SUM OF YEARS DIGIT METHOD:

The Sum of Years' Digits Method is another technique for accelerated depreciation. With this
approach, depreciation is recognised more quickly. Accordingly, using this approach, the
depreciable value of an asset is charged to a fraction across several accounting periods. This
fraction represents the relationship between an asset's remaining usable life in a certain time
and the digitised total of the years. The capital blocked or profit obtained from the asset is
therefore biggest in the first year, according to this proportion. As a result, the benefit
received from an asset decreases as it nears the end of its useful life. In other words, the first
year gets the biggest allocation of depreciation because no capital has been recovered yet. As
a result, because the majority of the capital invested has been recovered, the least amount of
depreciation should have been charged in the previous year.

FORMULA:

Depreciation Expense = Depreciable Cost x Remaining useful life of

the asset
Sum of Years’ Digits

Where depreciable cost = Cost of asset – Salvage Value

Sum of years’ digits = (n(n +1))/2 (where n = useful life of an asset)

4) DOUBLE DECLINING METHOD:

This approach combines the straight-line and diminishing-balance approaches. Accordingly,
under this system, depreciation is billed at the start of the year on the fixed asset's lower
value. Similar to the declining balance approach, this is. However, just like with the straight
line technique, a predetermined rate of depreciation is used. This depreciation rate is twice as
high as the rate assessed using the straight-line technique. Therefore, compared to the
expected salvage value, this procedure results in an asset that has been over-depreciated at the
end of its useful life. As a result, businesses use a variety of strategies to meet this difficulty.
First, the depreciation charged for the previous year is modified. To bring salvage value into
line with expected salvage value, this is done. Second, to correct the over-depreciated salvage
value in the previous year, many businesses opted to employ the straight line depreciation
technique.

FORMULA:

Annual Depreciation Expense = 2 x (Cost of an asset – Salvage Value)

Useful life of an asset

Or

Depreciation Expense = 2 x Cost of the asset x depreciation rate

5) SINKING FUND METHOD:

When a company wishes to lay aside enough money to pay for a replacement asset once the
present asset has reached the end of its useful life, they employ the sinking fund technique of
depreciation. A corresponding amount of cash is invested for every unit of depreciation, and
the interest earned is put into a fund for asset replacement. This fund also invests the interest
that is contributed. The money required to complete the acquisition will have accrued in the
corresponding fund by the time a replacement asset is required.

FORMULA:

Annual depreciation (A) = [ (FC -V) (i) ]

[ (1 + i)^(n) -1 ]

Total depreciation after x years = A [(1 + i)^x - 1]

i

Book Value = FC -Total depreciation

6) ANNUITY METHOD :
The annuity method of depreciation is a technique used to determine the rate of
depreciation on an asset, precisely as if it were an investment. It is frequently used to assets
with high initial costs, lengthy useful lives, and fixed (or at least consistent) rates of return.
The internal rate of return (IRR) on the cash inflows and outflows of the asset must be
calculated for this annuity method of depreciation. To determine the real amount of
depreciation that may be taken, the IRR is multiplied by the asset's original book value, and
the product is then removed from the period's cash flow.

FORMULA:

Annuity= i×TDA×(1+i)n
(1+i)−1
 Depreciation=annuity−(i×BVSY)

where:
i=Interest rate percentage/100
TDA=Total depreciation on amount
n=Annuity number of years
BVSY=Book value start of year

7)INSURANCE POLICY METHOD:

The insurance policy approach is a minor alteration of the sinking fund or depreciation fund
methods. This strategy involves paying an insurance firm a premium out of the amount
represented by the depreciation fund rather than investing it in securities. The insurance
provider offers a policy committing to replace the asset at the conclusion of its useful life
with a lump sum payment. The benefit of using an insurance policy is that you may eliminate
the danger of losing money when you sell your investment and the hassle and price of
purchasing one, but the drawback is that the return you get for paying the premiums is
comparably quite low.

8) DISCOUNTED CASH FLOW METHOD:

The term "discounted cash flow" (DCF) refers to a method of valuation that calculates an
investment's value based on its anticipated future cash flows. Using estimates of how much
money an investment will make in the future, DCF analysis seeks to evaluate the value of an
investment now. It can aid individuals who are trying to decide whether to purchase stocks or
a firm. Business owners and managers may use discounted cash flow analysis to help them
make choices about operational and capital budgets.

5)CONCUSION:
For tax and accounting purposes, many depreciation techniques are utilised, and they each
have a distinct effect on the company's net profit. For tax purposes, the business often
employs the accelerated depreciation technique to lower taxable revenue in the first year of
the asset's life. The difference between the straight-line technique used by the firm for
accounting and the accelerated method used by the company for tax reasons is recorded as a
deferred tax obligation on the balance sheet of the company and will ultimately be paid. The
timing of depreciation expenditure varies with different depreciation techniques, even if the
overall depreciation expense during the asset's life is the same for all of them. A corporation
may choose to apply various depreciation techniques over time, and this shift is seen as an
alteration to the accounting estimate. There are no necessary retrospective modifications in
this situation. The accounting estimate change is reflected in both the present and the future.

6) REFRENCES:

Accounting Standards Committee (various dates). 'Exposure Drafts' (EDs), 'Statements of

Standard Accounting Practice' (SSAPs), London.

Derbes, M. J. (1982). 'Is the cost approach obsolete', The Appraisal Journal, October.
Griffiths, I. (1986). Creative Accounting, Wyvern Business Library, Ely. Hartmann, D. J. F.
and Shapiro, M. B. (1983). 'Depreciation: incurable

functional obsolescence', The Appraisal Journal, July. Leach, S. and Stamp, E. (1981).
British Accounting Standards,

Woodhead-Faulkner, Cambridge.