Question

Describe merits and demerits of any two methods of charging depreciation.​

Answer 1

Answer:

A) Straight Line (Or) Fixed Instalment Method

This is the oldest and simplest method of charging depreciation. The life of the asset is estimated and depreciation is written off equally over the life of an asset. The amount of depreciation is such that the book value of the asset is reduced to zero at the end of life of the asset. The amount of depreciation is calculated as follows:

Amount of Depreciation (Rs.) = Original cost – Residual or Scrap value / Estimated Useful life of the Asset

Rate of Depreciation (%) = [ Amount of Depreciation / Original Cost ] X 100

• ADVANTAGES

1. Simple to Understand: This method of calculating depreciation is very simple to understand.
2. Easy to Calculate: It is easy to calculate the amount and rate of depreciation.
3. Accuracy: In this method, the book value of the asset, i.e., cost price of the asset less depreciation, becomes zero or equal to its scrap value of the expiry of its useful life.

• DISADVANTAGES

1. Difficulty in Calculating Depreciation: Calculation of depreciation is easy only when life of the original asset and its additions are similar. When both have varied life calculation becomes difficult and complicated.
2. No Provision for Replacement of Asset: This method does not provide any provision for replacement of asset on the expiry of its useful life.
3. This method increases the charge to the Profit and Loss Account over the years because the repairs to an old asset increases.
4. This method increases the cost of the asset over the years as the amount of depreciation is fixed over the years.

B) Diminishing or Written Down Value Method

In this method depreciation is charged at a fixed percentage on the reducing balance of the asset every year over the useful life of the asset. The amount of depreciation goes on decreasing every year. This method is very useful for plant and machinery where additions and extensions take place very often.  

• ADVANTAGES

1. It is a simple method of providing depreciation as fixed rate is applied on book value or written down value of assets.
2. This method is quite popular.
3. It provides uniform charge for services of the assets throughout the life.

• DISADVANTAGES

1. The method is slightly complicated.
2. If the asset has no residual value it is very difficult to calculate the rate.
3. SUITABILITY : This method of charging depreciation is suitable when – (a) the possibility of obsolescence are more, and (b) the amount of repairs and renewals increases as the asset grows older.

C) ANNUITY METHOD

Annuity method considers both the value of asset and the amount of interest on the investment made in the fixed asset. Besides, interest, a fixed amount of depreciation is calculated on the basis of depreciation from Annuity Table and is charged to Profit and Loss Account every year. The method is precise and exact from the point of view of calculations, so it is called a scientific method.

• ADVANTAGES

1. This method takes interest on capital invested in the asset into account.
2. It is regarded as most exact and precise from the point of view of calculations and is therefore most scientific.

• DISADVANTAGES

1. The system is complicated and difficult to understand.
2. The ultimate consequences being that the net burden on profit and loss account grows heavier each year.

Answer 2

Depreciation is the normal wear and tear in the value of fixed asset.

Fixed assets depreciates due to constant use or obsolence ot by time.

There are two methods of charging depreciation.

1. Straight Line Method

In this ,ethod depreciation is charged at a fixed rate amd on the original cost always.

Merits -

• This  method is easy to follow and to apply as amount of depreciation remaims same every year.

• Total asset value can be zero under this method.

Demerits-

• Asset is not utilised effectively as same amount of depreciation is charged every year.

• Efficiency of any asset is more in recent years as it is new purchase so depreciation should be charged more in early years and less in layer years.

2. Diminshing Balance Method

Under this method depreciation is charged on book value of fixed asset and depreciation amount change evry year.

Merits -

• This method is simple and value can be calculated easily.
• Under this method value of asset can never be zero.

Demerits-

• Book value of asset can never be zero , even if it is not working.
• original cost of the asset is not shown in the balance sheet.