FIXED ASSETS ARE ALWAYS SHOWN AT ITS COST LESS DEPRECIATION:

 FIXED ASSET:
 A fixed asset is an item with a useful life greater than one accounting period. A
fixed asset is not purchased with the intent of immediate resale, but rather
purchased by the management for productive use within the business
organisation.
 In the same way an inventory item cannot be considered a fixed asset, the reason
being it is purchased with the intent of either reselling it directly or using it to
manufacture a product that is then sold.
 The following are the examples of general categories of fixed assets: Buildings,
Computer equipment, Furniture and fixtures, Intangible assets, Land, Machinery,
Vehicles
 Fixed assets are initially recorded in the balance sheet of the company as assets,
and are then subject to the following general types of accounting transactions:
 Periodic depreciation is applied for the tangible assets or amortization for
intangible assets.
 Impairment write-downs occurs when the value of an asset declines below its
net book value. A company's asset that has a market price less than the value
disclosed in the company's balance sheet is called an impaired asset. Accounts
that are generally written down in this manner are the company's goodwill,
accounts receivable and long-term assets because the carrying value has a
longer span of time for impairment.
 Disposition entries once the assets are disposed of.
 A fixed asset appears at its net book value in the financial records, which is the
original cost minus the accumulated depreciation. Because of the ongoing
depreciation, the net book value of an asset always keeps on declining.
Nonetheless, it is possible to revalue a fixed asset by following the guidelines of
the financial reporting standards, so that its net book value can increase.
 A fixed asset does not actually have to be "fixed," that is there is no restriction in
the movement of the asset. Many fixed assets owned by the organisation are
portable enough to be routinely shifted within the company's premises, or entirely
off the premises. For e.g. laptop, vehicle, etc. could be considered a fixed asset as
long as its cost exceeds the capitalization limit.

 DEPRECIATION:
 Depreciation can be described as a permanent, continuing and gradual decline in
the book value of fixed assets. It is based on the cost of assets consumed in a
business and not on the fluctuations and decline in its market value.
 The depreciation is the decrease in the intrinsic value of the asset due to useage
and/or lapse of time. It is a non-cash expense that is it does not involve any cash
outflow. It is the process of writing-off the capital expenditure that is already been
incurred.
 The Institute of Chartered Accountants of India (ICAI) defines depreciation as a
measure of the wearing out, consumption or other loss of value of depreciable
asset arising from use, effluxion of time or obsolescence through technology and
market-change. Depreciation is allocated so as to charge fair proportion of
depreciable amount in each accounting period during the expected useful life of
the asset. Depreciation includes amortisation of assets whose useful life is pre-
determined.
 Depreciation is charged in each and every accounting period with reference to the
extent of the depreciable amount. It should be noted that the subject matter or
the base of depreciation, are ‘depreciable’ assets which:
 Are expected to be used by the organisation during more than one accounting
period;
 Have a useful life that is limited; and
 Are held by an organisation for production or supply of goods and services, for
earning remuneration by leasing or renting to others, or for any other
administrative purposes and not for the purpose of sale in the ordinary course
of business.
 There are other terms like ‘depletion’ and ‘amortisation’, which are closely related
with depreciation. This has been due to the similar treatment given to them and
on the basis of similarity of their outcome in accounting, as they represent the
expiry of the usefulness of different assets.
 In accounting the term depletion is used in relation with the extraction of natural
resources like mines, quarries, etc. this reduces the availability of the quantity of
the material or asset.
 For example, if a business enterprise that is dealing into the mining business and
purchases a coalmine for ₹ 10,00,000. Then the value of coalmine keeps on
declining with the extraction of coal out of the mine. This decline in the value of
the coalmine property is termed as depletion.
 One of the major differences between depletion and depreciation is that depletion
is concerned with the exhaustion of the economic resources and on the other side
depreciation relates to the reduction in the value of the asset from the usage of
the asset. The final outcome is the erosion in the volume of natural resources and
expiry of the service potential of the asset. Therefore, depletion and depreciation
have a similar accounting treatment.
 Amortisation means the writing-off of the cost of intangible assets like patents,
copyrights, trademarks, franchises, goodwill that have a utility for the business
enterprise for a specified period of time.
 The organisation follows the procedure for the periodic write-off that is the
amortisation of a portion of the cost for the intangible assets is mostly the same
as that for the depreciation of the tangible fixed assets. For example, if a business
firm buys a patent for ₹ 20,00,000 and estimates that its useful life to be 10 years
then the business firm must write-off this cost of ₹ 20,00,000 over the period of
10 years. The amount so written- off is technically referred as the amortisation.
 The depreciation amount to be charged by the organisation during an accounting
year depends upon depreciable amount and the method of allocation used by the
business enterprise. For this, there are two methods the straight line method and
written down value method that are mandated by law and enforced by accounting
professionals practicing in India.
 Straight line method:
 It is also called the fixed instalment method because the amount of the
depreciation charged and recorded in the books of accounts remains constant
from year to year over the useful life of the asset. This is due to the assumption
that this method is based on that is the assumption of equal usage of the asset
over its entire useful life.
 According to this method, a fixed amount of depreciation is charged by the
organisation to the income statement as expense and deducted from the cost
of the fixed asset in every accounting period during the lifetime of the asset.
The amount annually charged by the organisation as depreciation reduces the
original cost of the asset to its scrap value at the end of its useful life.
 This method is also known as the fixed percentage on original cost method
because the same percentage of original depreciable cost is written off as
depreciation from year to year from the cost value of fixed asset.
 This method of depreciation is considered appropriate for those assets for
which the useful life of the asset can be estimated accurately and the use of
the asset remains consistent from year to year, for example the leasehold
buildings.
 Written Down Value Method:
 In this method, instead of charging the depreciation on the acquirement cost
of the fixed asset the depreciation is charged on the book value of the asset.
Since the book value keeps on reducing by the amount of the annual charge of
depreciation, hence it is also known as the ‘reducing balance method’. This
method is based on the assumption that the benefit accruing to business from
assets keeps on diminishing as the time passes asset becomes old.
 This method involves the application of a pre-determined
proportion/percentage of the book value of the asset at the beginning of every
accounting period, to calculate the amount of depreciation. The amount of
depreciation reduces year after year. This method is more realistic based on a
more logical assumption hence Income Tax Act accept this method for tax
purposes.
 This method is suitable for fixed assets which require increased repair and
maintenance expenses with passage of time and which last for longer period
of time. This method of depreciation can also be used where the obsolescence
rate is high.
 CONCEPT OF USEFUL LIFE OF THE ASSET:
 The estimated economic or commercial life of the asset is called the useful life of
an asset. Physical life of the asset holds not much significance for the purpose of
the organisation because an asset may still exist physically but may lack the
efficiency and the capability of commercial viability of production.
 For example, a machine purchased by an business organisation is estimated to be
used in production process for 5 years. After the completion of 5 years the
machine may still be in a really good physical condition but it can’t be used for
production profitably, that is if it is still used by the organisation the cost of
production may be very high in comparison with other organisations that have a
more updated and relevant technology. And hence the organisation considers the
useful life of the machine to be 5 years irrespective of its physical life because the
machine I now being considered obsolete.
 The estimation of the useful life of an asset is considered to be difficult as it is
dependent upon several factors such as usage level of asset, maintenance of the
asset, technological changes, market changes, etc. As per the guidelines of the
ICAI’s Accounting Standard 6, the useful life of an asset is normally the “period
over which it is expected to be used by the enterprise”.
 It has been observed that the useful life is usually shorter than the physical life of
the asset. The useful life of an asset is usually expressed in number of years but it
can also be expressed in other units of measurement, e.g., number of units of
output as in case of coalmines or number the of working hours.
 Useful life of an asset depends upon the following factors :
 Pre-determined by legal or contractual limits, for e.g. in case of leasehold asset
the useful life of the asset is considered to be the period of lease.
 The number shifts for which asset is to be used.
 Repairing and maintenance policy followed by the business organisation.
 Technological obsolescence.
 Innovation/improvement in production method.
 Legal or other restrictions.

 METHOD OF RECORDING DEPRECIATION:

 There are two methods followed by the business organisation in the books of
account for recording depreciation on the fixed assets:
 Charging depreciation to the asset account or,
 Creating Provision for depreciation/Accumulated depreciation account.

 CHARGING DEPRECIATION TO ASSET ACCOUNT:

 According to this method, the amount of depreciation is deducted from the
depreciable acquisition cost or the book value of the asset that is it is credited to
the asset account and debited to profit and loss account.
  Journal entries passed under this recording method are as follows:
 For recording purchase of asset:
Asset A/c (Increase on the Asset side)
To Bank/Vendor A/c (Decrease in the Asset/Increase in the Liability)
(With the cost of asset including installation, freight, etc.)
 For deducting depreciation amount from the cost of the asset at the end of
every year.
Depreciation A/c (Increase on the expenditure side)
To Asset A/c (Decrease on the Asset side)
(With the amount of depreciation)
 This amount of depreciation is then transferred to the income statement of
the business organisation.
 Balance Sheet treatment when this method is used is, the fixed asset appears
at its net book value (i.e. cost less depreciation charged till date) and not at its
original cost (also known as the historical cost) on the asset side of the balance
sheet.

 CREATING PROVISION FOR DEPRECIATION ACCOUNT/ACCUMULATED DEPRECIATION

ACCOUNT:
 This method is designed to accumulate the depreciation that is provided on the
asset in a separate account called ‘Provision for Depreciation’ or ‘Accumulated
Depreciation’ account.
 By such accumulation of depreciation, the asset account is not going to be
disturbed in any way and it is to be shown at its original cost over the successive
years of the useful life of the asset.
 There are some basic characteristics of this method of recording depreciation that
are given below:
 The asset account continues to appear at its original cost or accusation
year after year over the useful life of the asset;
 Depreciation is accumulated on a separate account instead of being adjusted
in the asset account at the end of each accounting period.
 The following journal entries are recorded under this method:
 For recording purchase of asset only in the year of purchase
Asset A/c (Increase in Asset side)
Bank/Vendor A/c (Decrease in Asset/ Increase in liability)
(with the cost of asset including installation, expenses etc.)
 For crediting depreciation amount to provision for depreciation account
Depreciation A/c (Increase on Expenditure Side)
Provision for depreciation A/c (Decrease on Asset Side)
(with the amount of depreciation)
 The fixed asset continues to appear at its original cost on the asset side in the
balance sheet. The depreciation charged up to that date appears in the
provision for depreciation account, which is either shown on the “liabilities
 side” of the balance sheet OR by the way of deduction from the original cost
of the asset concerned on the asset side of the balance sheet.

 REASON FOR PASSING ADJUSTMENT ENTRIES FOR DEPRECIATION:

The need for providing depreciation in the accounting records of the company comes
from the conceptual, legal, and practical taken into consideration by the professionals
of accounting. These aspects have provided depreciation a particular significance as a
business expense.
 Wear and Tear of the Asset:
 Every machinery or tool is bound to wear out and age with the passage of time.
As time passes the parts of the asset may need to be repaired or in some cases
even replaced for the proper working of the asset. Usually, the assets have a
fixed span of life, after which, they have to be scrapped. Thus the wear and
tear of the asset must be accounted for in financial terms by providing
depreciation and reducing the cost of the asset in the balance sheet.
 Perishability of Asset:
 Items such as raw material and inventory, usually undergo deterioration over
a quick span of time, but this process is seen to be faster in relation to a fixed
asset, which normally lasts for a few years at least. Hence accounting the
perishability of the assets is dealt with providing depreciation and reducing the
cost value of the asset.
 Abnormal Factors:
 Sometimes abnormal factors such as accidents due to fire, earthquake, floods,
etc. may result in the decline in the usefulness of the asset. Such accidental
losses are permanent but not continuing or gradual. For example, a car
repaired after an accident will not fetch the same price in the market even if
the business organisation has not put it much to use.
 Usage Right Expiration:
 Software, licenses and leasehold properties are assets that have a typical span
of life over which it can be used. As soon as the time span for the rights for
using the asset ends, the owner has to give up the asset. The depreciation of
this asset must be done over the time which the organisation owned the rights
to use the asset because it is not appropriate to it write off on the day of
expiration of rights.
 Obsolescence:
 Another reason for providing the depreciation is the obsolete nature of certain
assets. Over a period the assets loses their value. A new alternative is needed
to be developed for replacing the asset and its functions.
 Need to Comply with Accounting Standards:
 As per the guidelines set by ICAI in the standard of accounting, a firm needs to
follow the basic concept of matching concept while recording accounts. The
funds for replacing the asset need to be set aside at regular intervals. Also, the
 expense related to each period needs to be charged to that period to reach to
the correct amount of profit and representing the accounts perfectly.
 The purpose of the acquisition of fixed assets by the organisation is to put them
to use for generating revenue. Every asset is bound to undergo some wear
and tear and age with passage of time, and hence the tend to lose their value,
once it is put to use in business. Therefore depreciation need to be considered
important as any other expense incurred in the normal course of business like
salary, carriage, postage and stationary, etc. Hence according to the ‘Generally
Accepted Accounting Principles’ it is a charge against the revenue of the
corresponding accounting period that must be deducted for arriving at the
accurate net profit.
 It is mandatory to provide depreciation as per AS 6 and the Companies Act,
2013. Not providing depreciation during a year is the violation of the
accounting standard and the provisions stated under it. Moreover, providing
for the depreciation of assets ensure that the accounts of the business
organisation present a true and fair view of the financial status of the firm.
 If depreciation on assets is not provided for, then the assets will be over valued
and the balance sheet will not show the correct financial position of the
business. This is permitted neither by the accounting practices nor by the
specific provisions of law.
 Compliance with Law:
 Depreciation is a deductible cost under the guidelines of taxation. However,
the tax rules for the calculation of depreciation amount may differ from the
practices followed by business organisations.
 Apart from the tax regulations, there are certain specific legislations that
indirectly compel the business organisations to provide depreciation on fixed
assets.