What is depreciation? Explain the various methods of charging the depreciation?
Answers
Answer:
Depreciation is the reduction in value of a tangible fixed asset due to normal usage, wear and tear, new technology or unfavourable market conditions .
The three most commonly used depreciation methods are: straight-line, double-declining balance, and sum-of-the-years-digits. By far the most common is the straight-line method.
hope it helps..
Answer:
What is depreciation?
The monetary value of an asset decreases over time due to use, wear and tear or obsolescence. This decrease is measured as depreciation.
The various methods of charging the depreciation are as follow:-
1. Fixed installment method:
This is the oldest and simplest method of charging depreciation. The life of the asset is estimated and it is written off equally in all the years. The amount of depreciation is such that the book value of the asset is reduced to zero at the end of purposeful life of the asset. The amount is calculated by dividing the cost of the asset less estimated scrap value by the number of years the asset will be used.
formula :-
Depreciation = Cost of the asset – Scrap value at the end/Life of the asset (number of years)
2. Diminishing Balance Method:
The depreciation is charged as a fixed percentage on the diminishing balance of the asset given charging depreciation, hence the name diminishing balance. The amount of depreciation goes on decreasing every year. The amount of depreciation and repairs charged to profit and loss account remains almost the same because depreciation decreases every year and expenditure on repairs increases with the passage of time.
The method does not reduce the asset to zero as in the fixed installments system. Some balance, though insignificant, remains in the asset account at the end of asset life.
This method is very useful for plant and machinery where additions and extensions take place very often. This method will not be used for those assets whose value is to be reduced to zero, i.e., patents, etc.
3. Annuity Method:
In both the methods discussed earlier, depreciation is provided only on the amount of asset and no attention is given to the amount of interest which might have been earned, had this amount been used elsewhere. Annuity method considers both the value of asset and the amount of interest. The interest is taken on debit balance of the asset.
The interest is debited to asset account and is credited to profit and loss account. A fixed amount is charged as depreciation every year. The amount of depreciation is calculated with the help of Depreciation Annuity Tables. The method is precise and exact from the point of view of calculations, so it is called a scientific method. This is the only method which takes into consideration interest on capital sunk in the asset.
4. Depreciation Fund Method:
The sinking fund method is a technique for depreciating an asset while generating enough money to replace it at the end of its useful life. As depreciation charges are incurred to reflect the asset's falling value, a matching amount of cash is invested. These funds sit in a sinking fund account and generate interest.
5.Insurance Policy Method:
This method is almost similar to Depreciation Fund Method. In depreciation fund method if investments are sold at a loss then the aim of replacement will be adversely affected. Insurance policy method overcomes this drawback. In this method an insurance policy is purchased for the value of the asset. This policy is taken up for the life of the asset and it matures at a time when the asset is to be replaced.
The amount provided for depreciation is paid towards insurance premium. The amount of premium remains the same in all the years. No entries for interest and reinvestments are required as in depreciation fund method. On maturity of the policy, insurance company will pay the amount and the amount will be used for replacing the asset.
6. Revaluation Method:
Under this method the fixed assets are valued at the end of each accounting period. The difference between the value at the beginning of the period and the value at the end of the period represents the depreciation value which is charged against the profit and loss account. This method is used in case of assets like loose tools, packages, Farmers’ livestock etc.
formula:-
Depreciation = Value of asset at the end – Value of asset at the beginning + Any new purchases
Explain renewal method to calculate depreciation.
7. Depletion Method:
This method is specially used for those assets which deplete with use. The cost of the assets is divided by total workable deposits. If a mine has 2 lakh tons of coal and the value of mine is Rs. 5 lakhs, each ton of coal will cost Rs. 2½. The quantity of coal taken out of the mine in a period will be multiplied by the rate per ton, i.e., Rs. 2½ and the resultant figure will be the amount of depreciation.