Depreciation

PRESENTED BY:
MAYANK AGRAWAL
 Depreciation
As per Accounting Standard 6, depreciation is defined as the reduction in the value of a product arising from the
passage of time due to use or abuse, wear and tear. Depreciation is not a method of valuation but of cost
allocation. This cost allocation can be based on a number of factors, but it is always related to the estimated period of
time the product can generate revenues for the company (economic life). Depreciation expense is the amount of cost
allocation within an accounting period. Only items that lose useful value over time can be depreciated. That said,
land can't be depreciated because it can always be used for a purpose.

Cost : Cost of acquisition is a term used across business and accounting to describe the total costs incurred when
signing a new client, purchasing and installing a new asset or acquiring a new item for the business.

Residual value: The residual value is the estimated value of a fixed asset at the end of its lease or at the end of its
useful life. The lessor uses residual value as one of its primary methods for determining how much the lessee pays in
lease payments. As a general rule, the longer the useful life or lease period of an asset, the lower its residual value.

Useful life: The useful life of an asset is an accounting estimate of the number of years it is likely to remain in
service for the purpose of cost-effective revenue generation. The Internal Revenue Service (IRS)employs useful life
estimates to determine the amount of time during which an asset can be depreciated. There are a variety of factors
that can affect useful life estimates, including usage patterns, the age of the asset at the time of purchase and
technological advances.
 Types of depreciation.
1. Straight-line Method(SLM):
Straight line depreciation is the default method used to gradually reduce the carrying amount of a fixed asset over its useful
life. The method is designed to reflect the consumption pattern of the underlying asset, and is used when there is no particular
pattern to the manner in which the asset is to be used over time. Use of the straight-line method is highly recommended, since
it is the easiest depreciation method to calculate, and so results in few calculation errors.

• Under the straight-line method of depreciation, recognize depreciation expense evenly over the estimated useful life of an
asset. The straight-line calculation steps are:
• Determine the initial cost of the asset that has been recognized as a fixed asset.
• Subtract the estimated salvage value of the asset from the amount at which it is recorded on the books.
• Determine the estimated useful life of the asset. It is easiest to use a standard useful life for each class of assets.
• Divide the estimated useful life (in years) into 1 to arrive at the straight-line depreciation rate.
• Multiply the depreciation rate by the asset cost (less salvage value).

𝐶𝑜𝑠𝑡 − 𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒

𝑈𝑠𝑒𝑓𝑢𝑙 𝑙𝑖𝑓𝑒
 Types of depreciation.
2. Written-down value Method:
• Depreciation is calculated on written down value of the asset.
• Amount of depreciation keeps on reducing every year.
• Book value never gets reduced to zero.
• Applicable for income tax purposes.
• The total charge remains almost the same as in the initial years repairs are less and
depreciation is high while in later years, repairs increase and depreciation decreases.
• This method is suitable for assets which gives higher utility in the initial years like
Machinery etc..

𝑛 𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒
Depreciation Rate = 1 − , n is useful life in years.
𝑐𝑜𝑠𝑡
 What is depreciation?
• Non cash expense.

• Reduces value of tangible asset.

• Limited useful life.

• Result of -
• Wear and tear
• Age
• Outdated / obsolete
 Why use Depreciation ?
• Determining P & L.
• Showing true and fair value of asset.
• Provision of funds for replacement.
 Who uses depreciation ?
• Organizations under Companies Act 2013

• Required by AS/IT

• Small companies use it for loan requirement.

 Variables on which Depreciation depend ?
• Original cost

• Scrap value

• Useful life

• Depreciation percentage
 Methods of Calculating Depreciation.

Straight line method(SLM) Written-down-value(WDV)

• Same amount every year • Amount reduces every year.
• Depreciation Expense • Depreciation Rate

𝑛 𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒
=1− , n is useful
𝐶𝑜𝑠𝑡−𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒 𝑐𝑜𝑠𝑡
= life in years.
𝑈𝑠𝑒𝑓𝑢𝑙 𝑙𝑖𝑓𝑒
 Why switch between SLM & WDV?

• Required by Law / ICAI

• Better presentation of financial statement.

• Change accounting policy.

 Example
(SLM)

Q. ABC Ltd purchased a furniture in the beginning of the year at

Rs.1,00,00,000. It has a useful life of 10 years and had a re-sale value of
Rs.1,00,000. Find depreciation using SLM method.

𝑆𝑜𝑙 𝑛
𝐶𝑜𝑠𝑡−𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒
Depreciation expense=
𝑈𝑠𝑒𝑓𝑢𝑙 𝑙𝑖𝑓𝑒
1,00,00,000−1,00,00
=
10
=₨. 9,90,000
 Example
(WDV)
Q. ABC Ltd purchased a furniture in the beginning of the year at Rs.2,00,000.
It has a useful life of 6 years and had a re-sale value of 2,00,000. Find
depreciation using WDV method.

𝑆𝑜𝑙 𝑛
𝑛 𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒
Depreciation % = 1 −
𝑐𝑜𝑠𝑡
6 20,000
=1-
2,00,000
= 31.87 %
Depreciation = 2,00,000*0.3187 = Rs. 63740