Accounting policies and principles need to be consistently applied while recording the financial transactions. This is the Principle of Consistency. Any change in the method of depreciation implies a change in accounting estimate. Thus, there should be valid reasons for a change in method of depreciation.
Change in Method of Depreciation
At the end of each financial year, management should review the method of depreciation. When there is a significant change in the pattern of the future economic benefits from the asset then the method of depreciation should also be changed.
As per the Accounting Standard 1- Disclosure of Accounting Policies, the change in the method of depreciation is a change in the accounting estimate. Thus, it requires quantification and full disclosure in the footnotes. Also, the justification and financial effects of the change needs to be disclosed.
Thus, the method of depreciation can be changed without retrospective effect or with retrospective effect. Without retrospective effect means no adjustment will be made for past entries and only in the future depreciation shall be charged by the new method. While with retrospective effect implies that the amount of depreciation to be charged is adjusted from the date of purchase of the asset.
Browse more Topics under Concept And Accounting Of Depreciation
- Concept and Meaning of Depreciation
- Cost of Asset for Calculating Depreciation
- Straight Line Method
- Diminishing Balance Method
- Units of Production Method
- Annuity Method
- Sinking Fund Method
- Profit or Loss on Disposal of Asset
Solved Example For You
Q. On 1st April 2015, Zenith Ltd. purchased a building for ₹2000000. It was decided to charge depreciation @10% p.a. using the Written Down Value Method (WDV). However, on 31st March 2018, it was decided to change the method of depreciation to Straight-line Method. The remaining useful life of the building is estimated to be 5 years with a residual value of ₹100000. You are required to prepare Building A/c.
|1 Apr||To Bank A/c||2000000||31 Mar||By Depreciation A/c||200000|
|31 Mar||By Balance c/d||1800000|
|1 Apr||To Balance b/d||1800000||31 Mar||By Depreciation A/c||200000|
|31 Mar||By Balance c/d||1600000|
|1 Apr||To Balance b/d||1600000||31 Mar||By Depreciation A/c||300000|
|31 Mar||By Balance c/d||1300000|
|1 Apr||To Balance b/d||1300000|
Calculation of depreciation on 31st March 2018:
Depreciation = (Written-down value – Residual Value) / Remaining Useful Life
= (1600000 – 100000) / 5
Q. On 1st April 2015, Kaya Ltd. purchased machinery for ₹1000000. The estimated useful life of the machine is 5 years. The residual value will be ₹200000. The depreciation was charged using the Straight-line Method. However, on 1st April 2018, it was decided to change the method of depreciation to Written- down value Method with retrospective effect. The rate of depreciation is 20%. You are required to prepare Machinery A/c and show the workings.
|1 Apr||To Bank A/c||1000000||31 Mar||By Depreciation A/c||160000|
|31 Mar||By Balance c/d||840000|
|1 Apr||To Balance b/d||840000||31 Mar||By Depreciation A/c||160000|
|31 Mar||By Balance c/d||680000|
|1 Apr||To Balance b/d||840000||31 Mar||By Depreciation A/c||328000|
|31 Mar||By Balance c/d||512000|
|1 Apr||To Balance b/d||512000|
Calculation of depreciation using Straight-line Method:
Depreciation = (Original cost – Residual value) / Useful life = (1000000 – 200000) / 5 = 160000
Calculation of depreciation using written-down value method(WDV):
31st March 2016:
Depreciation = Book value x (Rate of depreciation / 100) = 1000000 x (20/100) = 200000
W.D.V. = 800000
31st March 2017:
Depreciation = 800000 x (20/100) = 160000
W.D.V. = 640000
31st March 2018:
Depreciation = 640000 x (20/100) = 128000
W.D.V. = 512000
Book value of the machinery on 1st April 2018 as per the Straight-line Method is ₹840000. But the same as per Written-down Value Method is ₹640000. Therefore, ₹200000 additional depreciation needs to be written off.