Depreciation Accounting

Accounting for Fixed Assets

Advanced Financial Concepts (Part II)

Depreciation Accounting – Accounting Standard 6

Depreciation – is a measure of loss of value in an asset.

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Depreciation

Measure of the following:1. Wearing out• Consumption, or• Other reasons

Caused on account of 1. Use• Efflux of time• Or obsolescence due to

technology or market changes

Depreciation Process

Depreciation

Allocation of depreciable Amount

On Depreciable Asset

To Each Accounting Period

During the Useful life of the Asset

Depreciable Assets & Depreciable Amount

• Depreciation to be provided only for ‘Depreciable Assets’

1. Depreciable Assets ----2. Are expected to be used for more than one accounting period– Have limited useful life.– Are held by enterprise to be used in its basic & ordinary activities.

• Depreciable Amount ----o Cost – Estimated Residual Value.

Depreciation Accounting: …..cont

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• Measure of depreciation is based on :

1. Historical Cost or Substituted value.

2.Expected useful economic life.

• Expected Residual value.

Depreciation = Cost of the asset – Expected residual valueExpected useful economic life of the asset

Depreciation Accounting

• Cost of Depreciable Assets:1. Acquisition cost– Installation & commissioning cost– Other costs incurred to bring the assets to its

working condition.

• Scrap Value:Estimated value of the asset at the end of its useful life.

• Useful life:

Useful Life

The period over which as asset is expected to be used.

The number of units expected to be produced from the use of the asset.

Depreciation Accounting: …..cont

Depreciation Policy:

• Most commonly used methods SLM or WDV.

• Combination of two methods is also used at times.

• Small Value items are generally depreciated fully in the first year.

• Consistency ought to be maintained from year to year

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Depreciation Accounting: …..cont

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Change in Depreciable amount

Change in METHODOther Causes

Historical CostExpected residual Value

Estimated useful value

Retrospective effect

Prospective effect

Conditions for change in method of depreciation :

1. The change is necessitated by the Statue or a Standard.

1. The change should result in more appropriate preparation or presentation of the Financial Statement.

Example : When the method is changed from SLM to WDV or vice versa then,

i) The amount to be charged to revenue is to be recomputed on a Retrospective basis from the date the asset was put in use.

ii) Deficiency or surplus arising must be Adjusted in the year inwhich method is changed.

iii) Deficiency should be charged & surplus to be credited to P&L .

iv) Change in method of depreciation amounts to change inaccounting policy hence to be quantified & disclosed.

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Depreciation Accounting: …..cont

Depreciation Accounting: …..cont

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Depreciation Rates:

Accounting Standard – 6 does not specify any rate of depreciation. But it enables by implication , an entity to adopt the rates stipulated in Schedule XIV of the Companies Act.The rates provided in Schedule XIV of the Companied Act are bare minimum that requires to be provided. For the purpose of calculation of tax, depreciation has to be calculated according to the rates specified under the Income Tax Act.

Depreciation Accounting: …..cont

Straight line method Vs Written Down Value method

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Method Formula Effect on FS

Straight line (SLM) Cost (-) ERVUseful life

Charge equally spread over useful life.

Reducing balance (WDV) Net carrying amountof fixed assetsX% charge

Front end loading of cost on revenue (later years reduced)

Depreciation Accounting

• Question 1ABC Ltd charges depreciation on its assets on SLM basis. A machinery costing Rs.10 Lakhss has useful life of 5 years. After the end of 5 years, its scrap value would be Rs. 1 Lakh. Calculate the amount of depreciation to be charged I the books of the Company.

• Question 2• Cost of the Machinery purchased for mining – Rs 350000• Estimated tonnes of products that can be produced – 80 Lacs tonnes• Scrap Value – Rs20000• Total tonnes produced during first year – 6 Lacs tonnes• Calculate the depreciation to be charged in the first year.

• Question 3A machinery was purchased on 01-01-2009 which was delivered on 01-04-2009. The installation was completed on 30-09-2009 but was available for use on 01-10-2009. The actual utilization started from 01-12-2009. What is the effective period for calculation of its depreciation for the year 2009

Thank You

20 October 2009