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Depreciation Accounting

Uniform Charge Method

Depreciation refers to the decrease in the value of the fixed assets due to normal wear and tear, efflux of time or obsolescence due to technology. Thus, it becomes important to measure this decrease in value of an asset and also account for it. There are various methods of providing depreciation through depreciation formula. However, we can broadly classify these methods into Uniform Charge Methods, Declining Charge Methods, and Other Methods.

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Concepts of Depreciation I
Concepts of Depreciation II
Straight Line Method
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Uniform Charge Method

Under the Uniform Charge Methods, we charge depreciation on the fixed assets which are uniformly productive on a uniform basis every year. Thus, the amount of depreciation remains the same every year.

Depreciation Formula

$$\text{Amount of Depreciation} = \frac{\text{Cost of Asset} – \text{Net Residual Value}}{\text{Useful life}}$$

$$\text{Rate of Depreciation} = \frac{\text{Annual Depreciation}}{\text{Cost of Asset}} \times 100$$

The following methods fall under this category:

  1. Fixed installment method
  2. Annuity method
  3. Depreciation fund method
  4. Insurance policy method

Fixed Installment Method

According to this method, we write off the cost of the asset uniformly during its useful life. Therefore, we charge an equal amount of depreciation every year throughout the useful life of an asset.

At the end of the useful life of the asset, its value becomes zero or equal to its residual value. Thus, we also know this method as Straight line method or Fixed percentage on original cost method.

While applying this method, we need to consider the period of use of the asset. If an asset is in use only for 9 months in a year then we charge depreciation only for 9 months. However, as per the Income Tax provisions, if an asset is in use for more than 180 days we have to charge full years’ depreciation.

 Note:

  1. The cost of the asset includes installation expenses and also any other expenses which an entity incurs order to bring the asset into the working condition.
  2. We need to depreciate any addition in the asset during the year only for the period it is in use. In a case where there is no mention of the purchase date of the new asset, we charge depreciation for 6 months or half year.
  3. Also, on the sale of an asset we charge depreciation from the beginning of the year till the date of sale.

Advantages of fixed installation method:

  1. It is an easy and simple method to calculate and charge the depreciation.
  2. Under this method, the organization writes off the cost of the asset completely.
  3. This method is more suitable in case of leases and also where we can calculate the useful life and the residual value of the asset accurately.
  4. The value of the asset appearing in the Balance Sheet each year is fair.

Disadvantages of fixed installation method:

  1. It assumes that the asset is in use uniformly throughout the year.
  2. Where the repairs are low in the initial years and increase in subsequent years, this method will increase the charge on the profit.

Journal entry for Straight line 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 asset)
3. Transfer Depreciation Profit & Loss A/c Dr.
To Depreciation on Asset A/c
(Being depreciation transferred to profit and loss account)

 

depreciation formula

Annuity Method:

Annuity method of depreciation considers the cost of the asset and also the amount of interest lost on the capital expenditure.

This method is based on the assumption that if the amount that is spent on the purchase of the asset was invested elsewhere, it would have earned a certain amount of interest.

Therefore, we need to allocate not only the cost of the asset but also the amount of interest on it over its useful life.

Journal Entries for Annuity Method:

         Date                           Particulars Amount (Dr.) Amount (Cr.)
1. Charging  interest on the asset Asset A/c Dr.
To Interest A/c
(Being interest charged on asset)
2. Charging depreciation on asset Depreciation A/c Dr.
To Asset / Provision for Depreciation A/c
(Being depreciation charged on asset)
3. Transfer of depreciation to Profit & Loss A/c Profit &Loss A/c Dr.
To Depreciation A/c
(Being depreciation transferred to Profit & Loss A/c)
4. Transfer of interest to Profit & Loss A/c Interest A/c Dr.
To Profit &Loss A/c
(Being interest on capital expenditure on purchase of asset transferred to Profit & Loss A/c)

 

Solved Example for you:

A Ltd. purchased a 5 years lease on 1 April 2013 for ₹600000. The company decides to write off depreciation on lease using the Annuity Method. Assume the rate of interest to be 6% p.a. The annuity for ₹1 for 5 years at 6% interest is 0.237396. Prepare the Lease A/c for 5 years.

Ans.

Amount of depreciation to be written off every year = 0.237396 x 600000

= ₹118698

Lease A/c

Date Particulars Amount   Date Particulars Amount
2013-14 2013-14
1 Apr To Bank A/c 600000 31 Mar By Depreciation A/c 142438
To Interest  A/c

(6% on 600000)

36000 31 Mar By balance c/d 493562
   
636000 636000
2014-15 2014-15
1 Apr To Balance b/d 493562 31 Mar By Depreciation A/c 142438
To Interest  A/c

(6% on 493562)

 29614 31 Mar By balance c/d 380738
   
523176 523176
2015-16 2015-16
1 Apr To Balance b/d 380738 31 Mar By Depreciation A/c 142438
To Interest  A/c

(6% on 380738)

22844 31 Mar By balance c/d 261144
   
403582 403582
2016-17 2016-17
1 Apr To Balance b/d 261144 31 Mar By Depreciation A/c 142438
To Interest  A/c

(6% on 261144)

15669 31 Mar By balance c/d 134375
   
276813 276813
2017-18 2017-18
1 Apr To Balance b/d 134375 31 Mar By Depreciation A/c 142438
To Interest  A/c

(6% on 134375)

8063
   
142438 142438

 

 

 

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