UNIT III - DEPRECIATION

Meaning and Definition of Depreciation:

The word depreciation is derived from the Latin word ‘Depretium’ which means
reduction. Every business concern acquires some fixed assets which are used in the business
for its trading activity. These assets are purchased for business with an intention of
permanent use and not for resale. Working life of all fixed assets, except Land, decreases
with the passage of time. The value of these assets decreases every year. So, reduction in
the value of fixed assets due to its Wear and Tear or actual use is called as ‘Depreciation’.
“Depreciation is defined as shrinkage in the value of an asset due to wear and
tear, passage of time or obsolescence.”
Unless depreciation is charged to the revenues, the true income of the business cannot
be ascertained properly, and we cannot make provision for their replacement. Purchase of
an asset is a capital expenditure and not a recurring expenditure.
Factors to be considered while charging depreciation:
While deciding the amount of depreciation to be charged every year, the following
basic factors should be taken into consideration.
1. Cost of Asset:
The cost of asset is an important factor while computation of depreciation. Historical
cost of the assets represents the money spent in connection with its acquisition, installation
or improvement thereof. In short Original Cost of the Assets = Purchasing Price of Assets
+ its Installation or Incidental charges i.e., cost of transportation, transit insurance, custom
duty, unloading charges, brokerage, wages for fixation, amount spent for repairs on second
hand assets or reconditioning, etc.
2. Useful or Estimated Economic Life of Assets:
The useful life of an asset is generally taken to be in terms of years or working life of
the assets expected utility to the business concern. In other words, it means the business
should use the assets till the business gets useful services from the asset and earns Profit
from its use.
3. Estimated Terminal or Scrap or Residual Value:
 Scrap Value is the Realisable (net) value of the asset at the end of its economic life.
This value should be calculated after deducting the disposal and removal costs from the sale
value of the asset.
Methods of Depreciation:
There are different methods of charging depreciation according to the nature of asset,
use of asset and necessity. Following are the various methods for providing depreciation.
1. Fixed Instalment or Straight Line or Original Cost Method.
2. Diminishing or Reducing Balance or Written Down Value Method.
3. Sum of year digit method
4. Production unit method
5. Change in Method
6. Annuity Method.
7. Sinking Fund Method.
8. Machine Hour Rate Method, etc.
Fixed Instalment or Straight Line or Original Cost Method:
Under this method depreciation is charged at a specific percentage on the Original
Cost of the asset every year, so as to reduce the asset account to nil or to its Scrap value at
the end of the estimated life of the asset. To ascertain the annual charge under this method,
all that is necessary is to divide the original value of the asset (minus its residual value, if
any) by the number of years of its estimated life.
Depreciation is calculated by following formula:
Cost of Asset + Installation Charges − Scrap Value
Estimated Life of Asset
Depreciation is also charged when the rate of depreciation is given. It is calculated by using
following formula
Cost of Asset + Rate of Depreciation
100
For example –
The Original cost of an asset is Rs. 80,000, and the depreciation is charged @ 10%
p.a. at Fixed Instalment Method
Note: At the time of calculation of depreciation amount, the period for which the asset is
used in the business during the current accounting year should be considered.
Diminishing or Reducing Balance or Written Down Value Method:
Under this method, depreciation is calculated at a certain percentage each year on the
balance of the asset which is brought forward from the previous year. In other words, under
this method depreciation is calculated at a specific percentage on the value of that asset
which stands in the books of accounts on the opening date of each year.
The amount of depreciation charged per year is not fixed but it goes on decreasing
gradually as the opening balance of the asset will decrease in each year. The charges
depreciation in initial periods are higher than those in the later periods.
For example –
The Original Cost of an asset is Rs. 80,000, and the depreciation is charged @ 10%
p.a. under Written Down Value Method.

Problems:
Q.1 On 1st April 2016 M/s Punawala & Co. Latur. Purchased Equipments of Rs. 50,000
against cheque. They decided to follow Fixed Instalment Method of depreciation. The life
of the Equipment’s is estimated as 8 years and scrap-value of the Equipments at the end of
its life is estimated as Rs. 2,000. On 1st Jan 2019 entire Equipment is sold for ` 35,000. The
firm closes its Books of Accounts on 31st March, each year
Prepare Equipments A/c, Depreciation A/c and also calculate depreciation.

Q.2 Prabhune and Sons Kolhapur, made Furniture for their own office on 1st October 2015.
For this they had spent Rs. 72,000 on Materials and Rs. 32,000 on Wages. The estimated
life of the Furniture is to be for 10 years and its expected scrap value at the end of it would
be Rs. 24,000. They sold the entire Furniture for ` 80,000 on 1st October 2018. They close
the books of accounts on 31st March every year.
Show the Furniture A/c and Depreciation A/c for first four years.

Q.3 On 1st Jan 2015 ‘SCON’ Transports’, Pune, purchased four Trucks for Rs. 25,000 each.
Depreciation has been provided @10%p.a. using Straight Line Method. On 1st Jan 2016
one Truck was sold for Rs. 20,000. On 1st July 2016 another Truck (purchased for Rs.
25,000 in 1st Jan 2015) was sold for Rs. 22,000. A new Truck costing Rs. 40,000 was
purchased on 1st Jan 2017.
You are required to prepare Trucks A/c and Depreciation A/c for First three years
assuming that books of accounts are closed on 31st March each year.

Q.4 M/s Rubina Traders, Sindhudurg, bought Furniture worth Rs. 30,000 on 1st April 2016
and additional Furniture on 1st October 2016 worth Rs. 20,000. They charged depreciation
at 15% p.a. on Fixed Instalment Basis. On 1st October 2018 they sold one Cupboard for Rs.
5,000 Original cost of which on 1st April 2016 was Rs. 10,000. On the same date, a new
Cupboard was purchased for Rs. 15,000.
Show the Furniture A/c and Depreciation A/c for the years 2016-17, 2017-18 and
2018-19 assuming that the financial year closes on 31st March every year.

Q.5 M/s Amir Agency Solapur showed a debit balance of Rs. 56,000 to Machinery A/c on
1st Oct. 2015. The Original Cost of the Machinery was Rs.80,000. On 1st April 2016 M/s
Amir Agency bought an additional Machinery of Rs. 45,000 and spent Rs. 5,000 for its
installation. On 1st Oct 2017 a part of the Machinery purchased on 1st April 2016 was sold
for Rs. 15,000 the Original Cost of which was Rs. 20,000. M/s Amir Agency charged 10%
depreciation on Fixed Instalment Basis and its financial year closes on 31st March every
year.
Show Machinery A/c for the years 2015-16, 2016-2017 and 2017-18 and pass Journal
Entries for Third year only.

Q.6 Saurabh bought a Machine costing Rs. 1,15,000 on 1st April 2016 and paid Rs. 5,000
towards its installation. He writes off depreciation @10% p.a. on Written Down Value
Method every year. His books are closed on 31st March every year. On 1st Oct 2018 he
disposed off the Machine for Rs. 80,000.
Prepare Machinery Account & Depreciation Account for the year 2016 – 17, 2017 –
18, 2018 – 19.
Q.7 Sangam Trading Co. Buldhana purchased Vehicle on 1st April 2016 costing Rs. 85,000
and spent Rs. 5,000 on its registration. On 30th Sept 2016 additional Vehicle is purchased
for Rs. 10,000. On 31st March 2018, a Vehicle was sold for Rs. 12,000 the Original Cost of
which was Rs. 20,000. On 1st April 2016.
Prepare Vehicle A/c for the years 2016-17, 2017-18 and 2018-19 and pass the Journal
Entries for the year 2017-18 assuming that Vehicle is depreciated at 10% p.a. on
Diminishing Balance Method on 31st March each year.

Q.8 Sharmila Automobiles Ltd Thane. Purchased a Machine for Rs. 80,000 on1st July,2015.
On 1st Oct, 2016. Company purchased an additional Machine costing Rs. 30,000. On 31st
March 2018 the Machine purchased on 1st July 2015 became obsolete and was sold for Rs.
65,000. Depreciation was provided annually on 31st March the rate of 10% per annum on
the Reducing Balance Method.
Prepare Machinery A/c and Depreciation A/c for the period from 2015-16, 2016-
17and 2017-18.

Q.9 Kanchan Trading Centre. Dadar, purchased a computer on 1st April 2015 for Rs.
50,000. In the same year on 1st Oct additional Computer was purchased for Rs. 20,000. On
1st Oct 2016 the computer purchased on 1st April 2015 was sold for Rs. 40,000 and on the
same date new Computer was purchased for Rs. 24,000. Their charge depreciation at 8%
p.a. on Reducing Balance Method.
Prepare Computers A/c and Depreciation A/c for the first three (3) years Assuming
that the accounting year closes on 31st March every year.

Q.10 M/s Janki Traders, Ratnagiri acquired a Building on 1stApril 2015 for Rs. 12,00,000.
On 1st April 2016 an extension was made to the above Building by spending Rs. 8,00,000.
On 1st October,2016 they sold half part of the building through broker for Rs. 9,50,000.
Brokerage was paid at 3% on selling price. On 31st March every year, they charged
depreciation @10% under Diminishing Balance Method
Prepare Building A/c and Depreciation A/c for three (3) years i.e2015-16, 2016-17
and 2017-18.