Prepared By: Muhammad AwaisSarmad AliKamran Zaheer

Depreciation

Depreciation Methods

1. Straight Line / 2. Declining Balance / 3. Sum-of-the-year’s-digits / 4. Unit of Production

It is a process of allocating Costs

Cost to be allocated = Acquisition Cost (Purchase Price) – Scrap Value

Gradually decrease in the value of assets is Known as Depeciation.

• To calculate proper profits.• To show the asset at its reasonable value.• To provide of replacement of an asset.• Depreciation is permitted to be deducted

from profits for tax purposes.

• Wear and Tear• Disuse• Maintenance• Change in production• Restriction of production• Reduced demand

1. Straight Line Depreciation Method

Illustration Question:

On Jan, 2011, a Company purchased an equipment at a cost of Rs 140,000, having a life span of 5 years. At the end of the 5th year the scrap value will be

Rs 20,000. Calculate the depreciation for 2011 & 2012 using straight line depreciation method.

Depreciation = (Cost – Residual/Scrap Value)

Useful Life

Depreciate at equal rate throughout the life

Answer

Cost = 140,000

Salvage Value = 20,000

Life = 5

Depreciation = (Cost – Residual/ Scrap Value)

Useful Life

Depreciation for 2011 = (140,000 – 20,000)

5

= 12,0000 = Rs 24,000

5

Depreciation for 2012 = (140,000 – 20,000)

5

= 120,000 = SR 24,000

5

2. Reducing Balance Method

Depreciation = Book Value x Depreciation Rate

Book Value = Cost – Accumulated Depreciation

Illustration Question:

On January, 2011, a Company purchased an equipment at a cost of Rs 140,000, having a useful life of 5 years. The depreciation rate is 20%.

a) Calculate the depreciation from 2011 to 2015 using Reducing Balance Depreciation method. Also calculate the scrap value of the equipment at the end of the year 2015.

Answer

Year Book Value (SAR) in the beginning

Depreciation

2011 140,000 (140,000) (20/100) = 28,000

2012 140,000 – 28,000 = 112,000 (112,000) (20/100) = 22,400

2013 112,000 – 22,400 = 89,600 (89,600) (20/100) = 17,920

2014 89,600 – 17,920 = 71,680 (71680) (20/100) = 14,336

2015 71,680 – 14,336 = 57,344 (57,344) (20/100) = 11,469

At the end of the year 2015, the Scrap Value = 57,344 – 11,469 = Rs 45,875

Depreciation = Book Value x Depreciation Rate

Book Value = Cost – Accumulated Depreciation

3. Sum-of-the-year’s-digits method

This method is popular in the USA but not common in the UK. It provides for higher depreciation to be charged early in the life of an asset with lower depreciation in the last year.

Illustration Question:

Given an asset costing Rs 3000 which will be in use for 5 years, the calculations will be:

From purchase the asset will last for 5 yearsFrom the second year the asset will last for 4 yearsFrom the Third year the asset will last for 3 yearsFrom the fourth year the asset will last for 2 yearsFrom the fifth year the asset will last for 1 years

Sum of these digits 15

Answer

Rs1st year 5/15 of Rs 3000 is charged= 10002nd year 4/15 of Rs 3000 is charged= 8003rd year 3/15 of Rs 3000 is charged= 6004th year 2/15 of Rs 3000 is charged= 4005th year 1/15 of Rs 3000 is charged= 200

3,000

All natural resources like mines, fuel oil, gas and woods are ending by using them. We calculate the depreciation with depletion method for such perishing assets. Under this method, first, we estimate the total value of assets. After this, we calculate the rate of depreciation per unit by dividing the estimated life in the term of production of units.

4.Depletion Unit Method

Formula

Depreciation Rate under Depletion Method

= Original Cost - Scrap Value / Estimated life in terms of production units

5.Units of Output Method

' A depreciation procedure used for property that is not in continuous use. The unit of production method is useful when the property's value is more closely related to the number of units it produces than the number of years it is in use.

Formula:

Depreciation = Number of units produced × ( Cost – Scrap Value)Life in Number of Units

6.Machine hour Method

As per machine hour rate method of depreciation, we calculate the total life of any fixed asset on the basis of its working hours life. After this, we divide actual cost of fixed assets with life of fixed assets in hours. After dividing, we will obtain the depreciation rate per hour. This method will apply mostly on the machines. So, in following formula, we have used the word machine instead of fixed asset.

Hourly depreciation Rate= Original Cost of Machine – scrap Value Estimated Life of Machine in Hours