UNIT – 4

CHAPTER 1-
DEPRECIATION
 DEPRECIATION
Depreciation Account is used in accounting to record the depreciation of fixed assets over time.
Depreciation refers to the gradual reduction in the value of an asset due to factors like wear and
tear, obsolescence, or usage.

Carter
"Depreciation is the gradual and permanent decrease in the value of an asset due to
wear and tear, obsolescence, or use."
3. Institute of Chartered Accountants of India (ICAI)
"Depreciation is a systematic allocation of the depreciable amount of an asset over its
useful life."
 IMPORTANCE
1. Accurate Financial Reporting
- Helps allocate the cost of an asset systematically over its useful life, reflecting a
true and fair view of financial performance.
- Ensures profits are not overstated by accounting for the asset's wear and tear.

2. Tax Deduction
- Depreciation is treated as an expense and reduces taxable income, offering a
legitimate way to lower tax liability.

3. Asset Valuation
- Reflects the net book value of assets in the balance sheet by accounting for
accumulated depreciation.
- Provides a realistic picture of an asset's worth.

4. Decision-Making
- Helps in making informed decisions regarding asset replacement, repair, or
disposal based on the remaining useful life and value.
5. Matching Principle in Accounting
- Ensures that the expense of an asset is matched with the revenue it generates, adhering to the
accrual basis of accounting.
6. Fund Provision for Replacement
- By charging depreciation, companies can set aside funds to replace assets at the end of their
useful life, ensuring smooth operations.
7. Prevents Overstatement of Assets
- Avoids overstatement of asset value in financial statements, presenting a more accurate financial
position of the company.
8. Compliance with Accounting Standards
- Mandatory under various accounting frameworks like IFRS, GAAP, or ICAI guidelines,
ensuring adherence to financial regulations.
 Depreciation
•Accurate Profit Measurement: To allocate the cost of assets over their useful life and ensure
the correct determination of profits.
•AssetValuation: To reflect the true value of assets in the financial statements by accounting for
wear and tear.
•Tax Savings: To avail legitimate tax benefits as depreciation is treated as an expense.
•Fund Accumulation: To create a reserve for replacing assets at the end of their useful life.
•Compliance with Accounting Standards: To adhere to legal and regulatory requirements for
financial reporting.
 Depreciation
•Wear and Tear: Assets lose their efficiency due to continuous usage over time.
•Obsolescence: Technology advancements or market changes render assets outdated.
•Accrual Concept: Depreciation ensures the matching of revenue with the expenses incurred to
generate it.
•Asset Replacement: To create funds for replacing assets at the end of their useful life.
•Legal Compliance: Regulatory frameworks mandate the systematic allocation of asset costs.
 Features of Depreciation
•Gradual Process: Depreciation occurs over the useful life of the asset.
•Non-Cash Expense: It does not involve any cash outflow but reduces taxable profits.
•Causes a Decline in Value: Reflects the decrease in the book value of tangible assets.
•Charged on Fixed Assets: Applicable to tangible, long-term assets like machinery and
buildings.
•Systematic Allocation: Allocated as per defined methods like Straight Line or Reducing
Balance.
 Basis Straight Line Method Written Down Value Method

Under this method of charging depreciation, the

Under this method of charging depreciation, the
amount charged as depreciation for any asset is
Meaning amount charged as depreciation for any asset is fixed
charged at a fixed rate, but on the reducing value of
and equal for every year.
the asset every year.

Depreciation is calculated on the original cost of the Depreciation is calculated on the written-down
Depreciation Charged
asset. value of the asset.

The amount of depreciation charged is different for

Amount of The amount of depreciation charged is same for
every year. It is higher in the initial year and
Depreciation every year.
gradually decreases.

The value of an asset under this method is The value of an asset under this method is not
Value of Asset
completely written off. completely written off.

Under this method, the cost of maintenance

Under this method, the cost of maintenance
increases year by year, but depreciation decreases in
increases year by year adding to the increased
Burden later years. Because of this, the burden on the
burden on the company as depreciation is also fixed
company is more or less the same throughout the
for every year.
year.

This method is not recognised by the Income Tax This method is recognised by the Income
Tax Purpose Department, and therefore, it is not applicable for Tax Department, and therefore, it is applicable for
Income Tax purposes. Income Tax purposes.