Fixed Assets and Depreciation

Mahesh Joshi

FIXED ASSETS
tangible resources used in the operation of a business not intended for sale to customers

FIXED ASSETS
FIXED assets are subdivided into various classes: 1. Land 2. Land improvements 3. Buildings 4. Equipment 5. Furniture 6. Goodwill, patents, copy rights 7. Leaseholds, mines
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FIXED ASSETS

Land Improvements

Buildings

(any permanent structure)

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Equipment

FACTORS IN COMPUTING DEPRECIATION

Cost (Historical cost, Original cost ) : All costs viz Acquisition, installation ( wages), transportation, legal expenses for registration of sale/ lease agreement, improvement, additions etc which are incurred before the asset is brought into use. May include Training cost. Useful life estimate of the expected life based on need for repair, service life, and vulnerability to obsolescence viz. lease period, level of use, degree of maintenance and technological development. USEFUL LIFE IS SHORTER THAN PHYSICAL LIFE (true even for human beings) Salvage / residual value : estimate of the assets realizable value at the end of its useful life/ commercial use. Other relevant factors : a) replacement cost b) provision of Companies Act , Income Tax Act

Recurring Costs
Recurring costs such as licenses and insurance for an asset are NOT included with the asset instead, they are charged as EXPENDITURE.

DEPRECIATION
Assets slowly lose value.

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DEPRECIATION
Assets slowly lose value.
That decrease of the assets value becomes an expense

Expense Expense Expense

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Depreciation recognizes that a plant asset is worth less and less over its useful life.

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Causes of Depreciation Usefulness may decline because of ( Internal factors) Wear and tear : P&M Depletion eg. in wasting assets mines

External :
Obsolescence : Better substitutes Inadequacy : Due to increase in scale of production

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Causes of Depreciation Time element : Lease, patents, copyrights lose their value or effectiveness. Amortization is a better word for the gradual fall in their values Abnormal events: Accident, fire, natural calamity may reduce effectiveness.

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Land is not depreciated.

No wear and tear No obsolescence

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Depreciation Methods
I. Fixed / Equal Instalment OR Straight Line Method (i) A fixed portion of the cost of a fixed asset is allocated and charged as periodic depreciation. (ii) Such depreciation becomes an equal amount in each period. Depreciation = (V-S)/n , Where, V= Cost of the Asset S= Residual value or the expected scrap value n= estimated life of the asset.

Straight-Line Method Example

(Cost Salvage value) years of useful life (30,000 500) 5 = Depreciation per year = Rs.5,900

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STRAIGHT-LINE DEPRECIATION METHOD

Depreciation amount is the same for each year of the assets useful life. Using this method, depreciation is measured only by time.

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Depreciation Methods
Reducing / Diminishing Balance Method OR Written Down Value Method (i) Depreciation is calculated at a fixed percentage on the original cost in the first year. But in subsequent years it is calculated at the same percentage on the written down values gradually reducing during the expected working life of the asset. (ii) The rate of allocation is constant (usually a fixed percentage) but the amount allocated for every year gradually decreases.

Depreciation Methods Sum of Years Digit Method (i) It is a revised form of Reducing Balance Method. (ii) Here also the working life of an asset has to be preestimated and Total Depreciation is considered as Cost of the Asset () Residual or Scrap Value. (iii) The amount of annual depreciation goes on decreasing with the use. For calculating depreciation, the denominator becomes the sum of the digits representing the life of the asset. Thus if an asset has a life of 5 years, the denominator should be 1+ 2 + 3 + 4 + 5 or 15.
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Depreciation Methods Sum of Years Digit Method --- continued

Depreciation = (Remaining Life of the Asset x Depreciable Amount) Sum of the Years Digit

Where, Depreciable Amount = Cost of the Asset Estimated Scrap Value Sum of the Years Digit = n(n+1)/2 n = estimated life of the asset
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Sum of Years Digit Method

Example: If an asset costs Rs. 50,000, it has a residual value of Rs. 5,000 and working life of 5 years the depreciation will be 1st year 5/15 of (50,000 5,000) or Rs. 15,000; 2nd year 4/15 of (50,000 5,000) or Rs. 12,000; 3rd year 3/15 of (50,000 5,000) or Rs. 9,000; 4th year 2/15 of (50,000 5,000) or Rs. 6,000; 5th year 1/15 of (50,000 5,000) or Rs. 3,000.

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Double Declining Balance Method :

(i) Depreciation is charged at a fixed rate and it is calculated on the written down value of an asset brought forward on the opening date of an accounting year. (ii) The Rate of Depreciation becomes the double of the rate under fixed installment method. It may be illustrated as follows: Rs. Original Cost of an Asset 2,20,000, Scrap Value (Estimated) 20,000 ,Working Life (Estimated) 5 years Total Depreciation Rs. 2,20,000 Rs. 20,000 =Rs. 2,00,000 Annual Depreciation = Rs. 2,00,000 /5 =Rs. 40,000 Rate of Depreciation under Straight Line Method = Rs. 40,000 100 Rs 2,00,000, = 20%

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Double Declining balance Method

Rs.

1st Yr Less 2nd yr Less 3rd Less 4th Less 5th yr Less 40% 40% 40% 40% 40%

Opening cost Dep Opening bal Dep Opening bal Dep Opening bal Dep Opening (-) Dep Scrap Value

220000 88000 132000 52800 79200 31680 47520 19008 28512 8512 20000
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Mileage Method/ Working Hrs Method/ Service Hrs Method Cost Salvage Value = Cost per Unit Total Units of Activity

Rs 30,000 - 500 100,000 miles

= Rs. 0.295 per mile

Depreciation if truck driven 15,000 in 2010 Expense = (Cost per mile) x (# miles) = 0.295 x 15,000 = Rs. 4,425 depreciation

Sinking Fund Method

Annual depreciation is considered as a source of providing the replacement cost of an asset. It becomes a means of maintaining capital. D=CXi . (1+i)n - 1 D= Depreciation C= Cost of the asset i= Rate of Depreciation n= Life of the asset

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Journal Entries under the Sinking Fund method :

At the end of First Year : 1. (a) Profit & Loss A/c Dr To Depreciation A/c (annual contribution) ; Depreciation A/c Dr. To Sinking Fund A/c OR P/L A/c Dr To Sinking Fund A/c (b) 2. Sinking Fund Investment A/c Dr. To Bank A/c (invested amount)
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Journal Entries under the Sinking Fund method : : At the end of second/subsequent years : 1. Profit & Loss A/c ... Dr. To Sinking Fund A/c (annual contribution) 2. Bank A/c Dr. To Interest on Investment A/c (annual interest)

3. Interest on Investment A/c Dr. To Sinking Fund A/c (interest transferred) 4. Sinking Fund Investment A/c Dr. To Bank A/c [amt. invested usually = annual contribution + annual interest]
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Journal Entries under the Sinking Fund method :

When the working life of the asset ends (1), (2) & (3) same as above; (4) not made in the last year 5. Bank A/c Dr. To Sinking Fund Investment A/c (Investments sold out) 6. Sinking Fund Investment A/c Dr. To Sinking Fund A/c (Profit on Sale) OR Sinking Fund A/cDr. To Sinking Fund Investment A/c (Loss on Sale) 7. Sinking Fund A/c Dr. 6. Sinking Fund Investment A/c Dr. To Asset A/c 29 [Asset A/c closed]

Sinking Fund method :

Notes: (i) No investment is made in the last year as the investments are to be sold out. (ii) Sinking Fund Account may be called Depreciation Fund Account also. It is to be shown on the liability side of Balance Sheet. (iii) Sinking Fund Investments Account may be called Depreciation Fund Investments Account also. It is to be shown on the Asset side of the Balance Sheet. (iv) Annual Contribution (charged in lieu of annual depreciation) = Original Cost x Present Value of Re. 1 at given interest rate.

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Sinking Fund method :

Illustration: Cost of an Asset Rs.40,000 Life:4 years. Depreciation 10% p.a. Under Sinking Fund Method: Annual Depreciation = C x i . (1+i) n -1 = Rs 8619 This amount shall be invested at the end of years 1,2 and 3. The amount of investment shall fetch 10% interest p.a. which will lead to accumulation of Rs.40,000 at the end of the 4th year. The amount of Rs.8,619 shall not be invested at the end of the 4th year.
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Annuity method :

Cost of an asset is considered to be an investment. such investment would earn interest if invested outside the business. D = C i (1+i)n (1+i)n -1 = 40000X 10%X1.4641 = 12,619 1.4641-1 D= Depreciation C= Cost of the asset i= Rate of Depreciation n= Life of the asset
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Annuity method : Journal entries

Depreciation A/c Dr. To Asset A/c (Calculated from annuity table) 2. Asset A/c Dr. To Interest A/c (Calculated on diminishing values) 3. Profit & Loss A/c Dr. . To Depreciation A/c 4. Interest A/c Dr. To Profit & Loss A/c
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Annuity method : Creation of Internal reserve

In case of Annuity Method, the amount of Rs.12,619 shall not be invested outside the business. It shall have to be taken as an yearly appropriation. The total amount to be appropriated over a period of 4 years = Rs.12,619 x 4 = Rs.50,476. Cost of Capital = Total Appropriation - Actual Cost of the Asset = Rs.50,476 -40,000 = Rs.10,476.

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HAPPY WEEKEND HAPPY VOTING NO STUDIES ALL PLAY ENJOYM THANKS MAHESH JOSHI

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