Depreciation Accounting

Declining Charge Method

Depreciation is the decrease in the value of fixed assets due to normal wear and tear, efflux of time or obsolescence due to technology. Thus, depreciation is an expense and we charge it to Profit and Loss A/c at the end of the year. One of such methods of charging depreciation is Declining Charge Method.

This formula is derived from the study of the behaviour of the assets over a period of time.

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Charging Depreciation – Declining Charge Method

Under these methods, the depreciation amount decreases for every subsequent year. Usually, we apply these methods when the receipts from the assets decline and it becomes essential to charge the depreciation as per the asset’s expected earnings.

The methods of charging depreciation that fall under this category are:

  1. Diminishing Balance Method
  2. Sum of Years’ Digit Method
  3. Double Declining Method

Diminishing Balance Method

According to the Diminishing Balance Method, we charge depreciation at a fixed percentage on the book value of the asset appearing in the Balance Sheet.

As the book value of the depreciable asset reduces every year, it is also known as Reducing Balance Method or Written-down Value Method.

As the book value of the asset reduces every year applying this method, hence the amount of depreciation expense also reduces every year. Thus, under this method, the value of the asset never reduces to zero or becomes nil.

The assumption underlying is that in the earlier years the cost of repairs to the assets are low and hence there is a requirement to charge more amount of depreciation.

Also, in the later years, the cost of repairs will increase and therefore the charge of depreciation will be less. Hence, as a result, there is an equal burden on the profit every year during the useful life of the asset.

This method also considers the period of use of the asset. When an asset is in use only for 4 months in a year then we charge depreciation only for 4 months.

However, the Income Tax Act states that if an asset is in use for more than 180 days, we need to charge full years’ depreciation. Income Tax Rules allow depreciation charged on Reducing Balance Method.

Formula:

  1. Rate of Depreciation = [1 – \(\sqrt[n]{s/c}\)] x 100

Where, n = useful life

s = scrap value

c = cost of asset

  1. Amount of depreciation = Book Value x \(\frac{ Rate of Depreciation}{100}\)

Journal entry for Diminishing Balance method of Depreciation:

Date                                            Particulars Amount

(Dr.)

Amount

(Cr.)

1. Purchase of asset Asset A/c Dr.
To Cash/ Bank/ Creditor’s A/c
(Being asset purchased)
2. Charge Depreciation Depreciation on Asset A/c Dr.
To Asset A/c
(Being depreciation charged on the book value of the asset)
3. Transfer Depreciation Profit & Loss A/c Dr.
To Depreciation on Asset A/c
(Being transfer of depreciation on the asset to profit and loss account)

charging depreciation

Advantages of Diminishing Balance Method:

  1. This method lays an equal burden on the profit of every year as depreciation decreases every year and repair expenses increase every year.
  2. It is permissible to charge depreciation using this method as per the Income Tax Act.
  3. As the major part of depreciation is charged in the earlier years the problem of obsolescence is given due care. Thus, it is easy to replace the asset.

Disadvantages of Diminishing Balance Method:

  1. Under this method, it is difficult to calculate the appropriate rate of charging depreciation. Thus, it may happen that at the end of the useful life of the asset full depreciation is not provided.
  2. The cost of the asset never becomes nil.
  3. This method does not distribute the depreciation uniformly throughout the useful life of the asset.

Solved Example For You:

M/s. Bhanu and sons purchase a machine on 1 Apr 2015 for ₹750000 from AB & Co. and paid ₹50000 on its installation. The estimated useful life of the machine is 3 years. The estimated residual value of the machine is ₹40000. On 31st March 2018, the machine was sold for 250000. Depreciation is charged as per the W.D.V. method @10 % p. a. Prepare the necessary ledger accounts for the year ending 31st December every year for charging depreciation.

Ans.

In the books of M/s. Bharat and sons

Machinery A/c

Date Particulars Amount   Date Particulars Amount
2015 2015
1 Apr To AB & Co. A/c 750000 31 Dec By Depreciation A/c 60000
To Cash A/c (installation exp.) 50000 31 Dec By balance c/d 740000
   
800000 800000
2016 2016
1 Jan To balance b/d 740000 31 Dec By Depreciation A/c 74000
31 Dec By balance c/d 666000
740000 740000
2017 2017
1 Jan To balance b/d 666000 31 Dec By Depreciation A/c 66600
31 Dec By balance c/d 599400
666000 666000
2018 2018
1 Jan To balance b/d 599400 31Mar By Depreciation A/c 14985
31 Mar By Cash A/c 250000
By Profit & Loss A/c       ( loss on sale of machinery) 334415
401625 401625

 

Depreciation A/c

Date Particulars Amount   Date Particulars Amount
2015 2015
31 Dec To Machinery A/c 60000 31 Dec By Profit & Loss A/c 60000
   
2016 2016
31 Dec To Machinery A/c 74000 31 Dec By Profit & Loss A/c 74000
   
2017 2017
31 Dec To Machinery A/c 66600 31 Dec By Profit & Loss A/c 66600
   
2018 2018
31 Mar To Machinery A/c 14985 31 Dec By Profit & Loss A/c 14985

 

 

Working Notes:

  1. Calculation of amount of depreciation

Depreciation = Book Value x \(\frac{Rate of depreciation}{100}\)

2015

Depreciation = 800000 x \(\frac{10}{100}\)  x \(\frac{9}{12}\)

= 60000

2016

Depreciation = 740000 x \(\frac{10}{100}\) = 74000

2017

Depreciation = 666000 x \(\frac{10}{100}\) = 66600

2018

Depreciation = 599400 x \(\frac{10}{100}\)  x \(\frac{3}{12}\) =  14985

  1. Calculation of loss on sale of machinery

Loss = Book Value on 1st Jan 2018 – depreciation for 3 months – cash received on the sale

= 599400 – 14985- 250000 = 334415

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