Various methods of depreciation are generally classified as follows:
1. Straight Line Method:
This method assumes that depreciation is a function of time rather than use. This method is based on the assumption that each accounting period receives same a benefits from using the assets. It allocates an equal amount of depreciation in each accounting periods of the service life of the assets. Therefore, it is called Straight Line Method.
The formula for calculating depreciation charge for each accounting period is:
(i) It is simple in use.
(ii) It realistically matches cost and revenue and determine income of each period easily.
(iii) There is no change either in the rate or the amount of depreciation over the useful life of the assets. Such a procedure provides for improved comparability.
(i) It ignores the cost of capital.
(ii) It is based on the wrong assumption of equal utility of the assets during the useful life.
(iii) It is also wrong to consider depreciation as a function of time rather than use.
(iv) The maintenance of asset is generally costly in the later years with the result that deductions from the revenue would be greater in later years than in the earlier years.
The journal entry for recording depreciation is
Depreciation A/c Dr.
To Asset A/c
ABC Ltd. acquires a machine on 1st July, 2007 at a cost of Rs. 2, 80,000 and spent Rs. 20,000 on its installation. The firm writes off depreciation at 10% of the original cost every year. The books are closed on 31st December every year. Prepare machinery A/c for 3 years.
Sale of Asset:
If the asset is disposed of in the middle of the year, the amount realized should be credited to the asset a/c for the time it has been in use. Any balance left in the account of asset will be profit or loss and should be transferred to P&L A/c.
On 1st Jan. 2009, a company purchased a machine costing Rs. 5, 00,000. Its estimated working life is 20 years at the end of which it will fetch Rs. 20,000. Additions are made on 1 January, 2010 and 1 July, 2011 to the value of Rs. 80,000 (scrap value Rs. 4000) and Rs. 40,000 (scrap value Rs. 2,000) respectively. The life of both the new machines is 20 years. Show machine a/c for first four years.
In case, no method of depreciation has been stated in an examination problem, it is appropriate to use straight line method.
Rubal Ltd. purchased a machine costing Rs. 3,00,000 on 1st April, 2000 and an additional machine on 1st Oct., 2000 costing Rs. 2,00,000 and on 1 July, 2001 costing Rs. 1,00,000.
On 1st Jan. 2002, one third of Machine purchased on 1st April, 2000 was sold at Rs. 30,000.
Prepare machine A/c for 3 years, it is given that depreciation is charged @ 10% p.a. on straight line method.
2. Diminishing Balance Method:
Under this method, a fixed percentage is applied to book value of the assets (cost of assets). In other words, the depreciation is calculated on the reducing balance (assets cost-depreciation) and not on the original cost. The procedure is that depreciation calculated is deducted from the cost of assets and balance known as the written down value. The written down value at the end of the estimated useful life of the assets should equal the estimated salvage or scrap value.
The formula for determining the rate of depreciation in diminishing balance method is as follows:
Rate of depreciation = 1 – n√s/c
1. It is easy to use.
2. There is same weight-age, in totality, on profit and loss A/c, of depreciation.
3. It facilitates replacement of fixed assets as it makes more funds available at an early stage.
4. This method is permissible under the Income Tax Act.
5. The higher depreciation is charged in the earlier years when the machine is most efficient compared to later years.
1. Under this method, value of asset can never be zero.
2. It is difficult to calculate proper rate of deprecation.
3. There is no provision of interest on capital invested in use of assets.
Y Ltd. Co. purchased a machine costing Rs. 3, 00,000 on 1st January, 2007. The depreciation is to be charged at 20% p.a. on Diminishing Balance method.
Write up Machinery A/c for first four years.
X Ltd. bought a machinery for Rs. 30,000 on 1st April, 2007. One more machine was purchased on Oct. 1st, 2007 costing Rs. 20,000. On July 1st, 2008, a new machinery for Rs. 10,000 was added to the existing machinery. On 1st January, 2009, one third of the machinery which was installed on April 1st, 2007 was sold for Rs. 3,000. Show the machinery A/c in the books of X Ltd. The rate of depreciation is 10% on reducing balance method.
A machine is purchased for Rs. 3, 00,000 and its estimated useful life is 3 years with scrap value Rs. 30,000. It is decided to depreciate the machine by diminishing balance method. Find out the rate of depreciation p.a.
A Company had bought machinery for Rs. 2, 00,000 including a boiler worth Rs. 20,000. The Machinery Account had been credited for depreciation on the reducing installment system for the past four years at the rate of 10 per cent. During the fifth year, the boiler became useless on account of damage to some of its vital parts. The damaged boiler is sold in the very beginning of the fifth year for Rs. 4,000. Write up the Machinery Account for all these five year.
On 1st April, 2000, a firm purchased a machinery for Rs. 2, 00,000. On 1st October, 2000, additional machinery costing Rs. 1, 00,000 was purchased. On 1st October, 2001, the machinery purchased on 1st April, 2000 was sold for Rs. 90,000. On 1st October, 2002, new machinery was purchased for Rs. 2, 50,000, while the machinery purchased on 1st October, 2000 was sold for Rs. 85,000 on the same day.
The firm provides depreciation on its machinery @10% per annum on original cost. It closes its books of accounts on 31st March every year. Show machinery account for three accounting years ending 31st March, 2003.
Mr. X purchased a second hand machinery on 1.2.2003 for Rs. 50,000; paid Rs. 11,000 for its over-hauling and Rs. 5,000 for its installation which was completed by 31.3.2003. The company provides depreciation on its machinery at 15% on diminishing balance method from the date it was put to use and closes its books on 31st December every year. On 1.10.2004, a repair work was carried out on the machine and Rs. 5,000 were paid for the same. The machine was sold on 31.10.2005, for a sum of Rs. 11,000 and an amount of Rs. 1,000 was paid as dismantling charges.
Prepare machinery account from 2003 to 2005.
i. Repair cost is not capitalized since it is a routine expense and it does not increase the capacity of the machine.
ii. Cost of dismantling has been deducted from the sale price for calculating loss on sale of machine.
ABC Ltd. purchased second hand machinery on 1st April, 2006 for Rs. 3, 70,000 and installed it at a cost of Rs. 30,000. On 1st October, 2007 it purchased another machinery for Rs. 1, 00,000 and on 1st October, 1998, it sold off the first machine purchased in 2006, for Rs. 2, 80,000. On the same date it purchased a machinery for Rs. 2, 50,000. On 1st October, 2009, the second machinery purchased for Rs. 1, 00,000 was sold off for Rs. 20,000.
In the beginning depreciation was provided on Machinery at rate of 10% p.a. on the original cost each year on 31st March. From the year 2007-2008, however, the company changed the method of providing depreciation and adopted the written down value method, the rate of Depreciation being 15%.
Give machinery A/c for the period 2006-2010.
On 1st January, 2000, Asha Ltd. purchased machinery for Rs. 12, 00,000 and on 30 June, 2001, one more machine of worth Rs. 2, 00,000. On 31 March, 2002, one of the original machinery which had cost Rs. 50,000 was found to have become obsolete and was sold as scrap for Rs. 7,000. It was replaced on that date by a new machine costing Rs. 80,000. Depreciation is to be provided @ 15% p.a. on W.D.V. method. Accounts are closed on 31 December every year. Show machinery A/c for 3 years.
Y Ltd. company purchased a second hand machinery on 1st January, 2009 for Rs. 3,70,000 and immediately spent Rs. 20,000 on its repairs and Rs. 10,000 for installation. On 1st July, 2010, it purchased another machine for Rs. 1, 00,000.
On 1st July, 2011, it sold off the first machine for Rs. 2, 50,000 and bought another for Rs. 3, 00,000 Depreciation was provided on the machine @ 10% on original cost annually on 31st December. With effect from 1st January, 2012, the company changed the method of providing Depreciation and adopted the W.D. V. method and rate of Depreciation was 15% p.a.
Prepare machinery A/c for 4 years.
M Ltd. which depreciates its machinery @ 10% p.a. according to D.B.M. (Diminishing Balance Method), had on 1st April, 2006 Rs. 4, 86,000 balance in its machinery A/c. During 2004 the year ended 31st March, 2007, the machinery purchased on 1st April, 2004 for Rs. 60,000 was sold for Rs. 40,000. On 1st October, 2006 and a new machinery costing Rs. 70,000 was purchased and installed on the same date, installation charges Rs. 5000.
The Company wants to change its method of depreciation from W.D.V to Straight line method w.e.f. 1st April, 2004 and adjust the difference before 31st March, 2007, the rate of Depreciation remaining the same as before.
Show Machinery A/c for the year ended 31st March, 2007.
Manoj Ltd. purchased a Computer Costing Rs. 80,000 on January 2000. The expected life is 5 years and scrap value Rs. 5000. Find the annual depreciation for 5 years by sum-of- years-digit methods.
A bus was purchased by a Transport Company for Rs. 10, 00,000 on 1st January, 2000. The scrap value is estimated at the end of 5 years Rs. 1, 00,000. The rate of depreciation is 20% p.a. Calculate the annual Depreciation by Double Declining method.
The rate of Depreciation = 20 x 2 = 40% p.a.
4. Unit of Production Method:
Under this method depreciation expense is allocated in proportion to the degree of asset used for production because estimation of useful life is done in terms of units of output or services hour and not a calendar time period. A machine can produce a limited number of quantity or run for a limited hour. As a result of this limitation, the depreciation is related to usage and not to time.
Under this method, the following is calculated:
Depreciation Per annum = Dep. expense Per unit x No. of units produced during the year
Dep. expense per hour x No. of hours used during the year
Dep. per unit = Cost – Scrap value/Total estimated unit of output or service hrs.
X Ltd., bought a machine for Rs. 4, 00,000 expected to run 72,000 hrs. Its salvage value is estimated at Rs. 40,000. Calculate depreciation for an accounting year in which it was used for 20,000 hrs.
Dep. per hour = 4, 00,000 – 40,000/72,000
= 3, 60,000/72,000 = Rs. 5
Dep. Amount for Accounting period
= 2, 0000 x 5 = Rs. 1, 00,000
5. Annuity Method:
The main disadvantages of the different methods are that they do not consider the interest on the capital invested on fixed assets. Annuity method deals with the effect of cost of capital in depreciation calculation. It makes treatment more explicit by showing the interest payment in the P&L A/c.
Under this system the capital sum is assumed to earn a certain rate of interest. The assets are, therefore, charged with interest along with actual payment; interest is calculated on the debit balance of the assets on the commencement of the year.
The following journal entry is made:
Assets A/c Dr.
To Interest A/c
At the same time, fixed amount is charged as a depreciation expense so that it eliminates the asset or brings down its salvage value, as the case may be. The important point to be noted is that the amount of depreciation to be charged every year must be calculated as to reduce the assets together with interest accumulated thereon to its salvage value at the end of the useful life of the assets.
X Ltd. acquires a lease costing Rs. 2, 00,000 on April 1st, 1997 for a term of 4 years. You find from annuity tables that in order to write off lease on the annuity method at 6% p.a. interest, the amount to be written off annually works out to be Rs. 2,88,591 for every rupee. Prepare lease A/c for 4 years. Books are closed on 31st March every year.
Depreciation = Rs. 2, 00,000 x .288591
= Rs. 57,718.2
7. Sinking Fund Method:
Under this method, the amount of depreciation goes on accumulating till the asset is completely worn out. This method provides necessary cash to replace the asset at end of its useful life. The amount of depreciation is fixed and remains same for every year and is charged to P&L A/c.
The amount of depreciation is invested outside the business every year. The process of investing amount of depreciation and interest goes on till the time of replacement of asset. At the time of replacement all the investments are sold out and cash received, and the new asset purchased.
(a) At the end of first year.
(i) For setting aside amount of Depreciation
Depreciation A/c Dr.
To Sinking Fund A/c
(ii) For transfer of Depreciation A/c to P&L A/c
P&L A/c Dr.
To Depreciation A/c
(iii) For Investment of Amount
Sinking Fund Investment A/c Dr.
To Bank A/c
(b) Subsequent Year
(i) For receiving interest
Bank A/c Dr.
To sinking fund A/c
(ii) For setting aside amount of Depreciation
(iii) Depreciation A/c Dr.
To Sinking fund A/c
(iv) For transferring Depreciation A/c to P&L A/c
P&L A/c Dr.
To Depreciation A/c
(v) For investing amount of depreciation + interest received
Sinking fund investment A/c Dr.
To Bank A/c
(c) Last Year
(i), (ii) & (iii) entry remain same as in (b), but amount is not invested.
(iv) On sale of investment
Bank A/c Dr.
Sinking Fund A/c (if loss) Dr.
To Sinking Fund Investment A/c
To Sinking fund (in profit)
(v) On Sale of Asset
Bank A/c Dr.
To Asset A/c
(vi) Sinking Fund A/c balance is transferred to asset a/c and any balance left in the asset a/c is transferred to P&L A/c.
X Ltd. Bought a, machinery for Rs. 2, 00,000 on 1st January, 2000. The useful life was estimated at 3 years with a scrap value of Rs. 20,000. The Company uses Sinking Fund Investment Method, investment to carry 5% p.a. Interest. The sinking Fund Table shows that 31720 at 5% p.a. will in 3 years accumulate to Re. 1. Prepare Machinery A/c, Sinking Fund A/c & S.F. Investment.
(Insurance Policy Method) Y Ltd. purchased a Machinery for Rs. 4, 00,000 on 1st January, 2007 to be replaced after 4 years. An Insurance Policy is taken to ensure availability of funds at the time of replacement, the annual premium being Rs. 90,000.
Prepare Machinery A/c, Dep. Fund A/c, Dep. Fund Policy A/c.
General Manufacturers had a debit of balance of Rs. 8, 00,000 in their machinery account on 1.1.2000. The concern was charging depreciation @ 15% p.a. on diminishing balance. On 31.3.2000, a part of the machinery purchased on 1.1.1997 at a cost of Rs. 70,000 was sold for Rs. 45,000. New machinery was purchased for Rs. 80,000 on 1.7.2000 and Rs. 6,700 was spent for installation. On 31.12.2000 the concern decided to change the depreciation method from diminishing balance method to straight-line method. It was also decided to charge depreciation @ 10% p.a. under the new method. Prepare machinery account for the year 2000.
A limited company purchased on 1st January, 1998 a second-hand plant for Rs. 12,000 and immediately spent Rs. 8,000 on its overhauling. On 1st July in the same year additional plant costing Rs. 10,000 is purchased. On 1st July, 2000 the plant purchased on 1st January, 1998 having become obsolete is sold for Rs. 4,000 and on the same date fresh plant is purchased at a cost of Rs. 24,000.
Depreciation is provided @ 10% per annum on original cost on 31st December every year. In 2001, however, the company changes the method of providing depreciation and adopts the method of writing off 15% per annum on the diminishing balance method.
Show the Plant Account from 1998 to 2001.
On January 1, 2001 X Ltd. purchased a machine for Rs. 58,000 and spent Rs. 2,000 on its erection. On July 1, 2001, an additional machine costing Rs. 20,000 was purchased. On July 1, 2003 the machine purchased on 1.1.2001 was sold for Rs. 28,600 and on the same date a new machine was purchased at a cost of Rs. 40,000.
Depreciation was provided for annually on December 31, at the rate of 10% p.a. on written down value of the machinery. In 2004 the company decided to change the method of depreciation from Written down Value Method to Straight Line Method @ 5% p.a. with effect from 1st January, 2001. Prepare the Machinery Account from the first calendar years.
Excess Depreciation provided
= Depreciation under Old Method – Depreciation under New Method
= Rs. 6,610 – Rs. 3,500 = Rs. 3,110.
The Plant and Machinery Account of a company had a debit balance of Rs. 1, 47,390 on April 1st, 2006. The company was incorporated in April, 2003 and has been following the practice of charging full year’s depreciation every year on Diminishing Balance System @ 15%.
In 2006 it was, however, decided to change the method from Diminishing Balance to Straight Line with retrospective effect from April, 2003 and to give effect to the change while preparing the final accounts for the year ending 31st March, 2007, the rate of depreciation remaining same as before.
In 2006-07, new machinery was purchased at a cost of Rs. 50,000. All the other machines were acquired in 2003-04.
Show the Plant and Machinery Account from 2003-04 to 2006-07.
M/s Hot and Cold commenced business on 1st April, 2002 when they purchased a new machinery costing Rs. 8, 00,000. On 1st October, 2003, they purchased another machinery for Rs. 6, 00,000 and again on 1st July, 2006, machinery costing Rs. 15, 00,000 was purchased. They adopted a policy of charging @ 20% p.a. on diminishing balance basis.
On April 1st, 2006, they, however, changed the method of providing depreciation and adopted the method of writing-off the machinery account at 15% p.a. under straight line method with retrospective effect from 1st April, 2002, the adjustment being made in the accounts for the year ended 31st March, 2007.
Show the Machinery Account for the year ending 31st March, 2007.