Concept And Accounting of Depreciation

Diminishing Balance Method

The various methods of depreciation are based on a formula. This formula is derived from the study of the behavior of the assets over a period of time. One such method of depreciation is the Diminishing Balance Method. Let us learn more about this method.

Diminishing Balance Method

According to the Diminishing Balance Method, depreciation is charged at a fixed percentage on the book value of the asset. As the book value reduces every year, it is also known as the Reducing Balance Method or Written-down Value Method.

Since the book value reduces every year, hence the amount of depreciation also reduces every year. Under this method, the value of the asset never reduces to zero.

When the amount of depreciation charged under this method and the corresponding period are plotted on a graph it results in a line moving downwards.

This method is based on the assumption that in the earlier years the cost of repairs to the assets is low and hence more amount of depreciation should be charged. Also, in the later years, the cost of repairs will increase and therefore less amount of depreciation shall be provided. Hence, this method results in an equal burden on the profit every year during the life of the asset.

However, under this method, if the rate of depreciation applied is not appropriate it may happen that at the end of the useful life of the asset full depreciation is not provided.

Also, while applying this method, the period of use of the asset should be considered. If an asset is used only for 2 months in a year then depreciation will be charged only for 2 months.

Diminishing Balance Method

However, for the Income Tax purposes, if an asset is used for more than 180 days full years’ depreciation will be charged. Income Tax Rules also allow depreciation charged on Diminishing Balance Method.

Formulae are as follows:

$$ \text{Amount of depreciation} = \frac{ \text{Book Value} \times \text{Rate of Depreciation} }{100} $$

Browse more Topics under Concept And Accounting Of Depreciation

Journal entry for Diminishing Balance Method of Depreciation

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

Solved Example on Diminishing Balance method

Q. M/s. Bharat and sons purchased a machine on 1 Apr 2015 for ₹400000 from ABC & Co. and paid ₹100000 on its installation. The useful life of the machine is 3 years and its estimated residual value is ₹40000. On 31st March 2018, M/s. Bharat and sons sell the machinery for 250000.

Charge depreciation as per the W.D.V. method @10 % p. a. Prepare the necessary ledger accounts in the books of Anil for the year ending 31st December every year.

Ans: In the books of M/s. Bharat and sons

Machinery A/c

Date Particulars Amount   Date Particulars Amount
2015 2015
1 Apr To ABC & Co. A/c 400000 31 Dec By Depreciation A/c 37500
To Cash A/c (installation exp.) 100000 31 Dec By balance c/d 462500
   
500000 500000
2016 2016
1 Jan To balance b/d 462500 31 Dec By Depreciation A/c 46250
31 Dec By balance c/d 416250
462500 462500
2017 2017
1 Jan To balance b/d 416250 31 Dec By Depreciation A/c 41625
31 Dec By balance c/d 374625
416250 416250
2018 2018
1 Jan To balance b/d 374625 31Mar By Depreciation A/c 9366
31 Mar By Cash A/c 250000
By Profit & Loss A/c       ( loss on sale) 115259
401625 401625

Depreciation A/c

Date Particulars Amount   Date Particulars Amount
2015 2015
31 Dec To Machinery A/c 37500 31 Dec By Profit & Loss A/c 37500
   
2016 2016
31 Dec To Machinery A/c 46250 31 Dec By Profit & Loss A/c 46250
   
2017 2017
31 Dec To Machinery A/c 41625 31 Dec By Profit & Loss A/c 41625
   
2018 2018
31 Mar To Machinery A/c 9366 31 Dec By Profit & Loss A/c 9366

Working Notes:

Calculation of amount of depreciation

$$ \text{Amount of depreciation} = \frac{ \text{Book Value} \times \text{Rate of Depreciation} }{100} $$

  • 2015: Depreciation =  500000 x 10/100  x 9/12 =  37500
  • 2016: Depreciation =  462500 x 10/100 = 46250
  • 2017: Depreciation =  416250 x 10/100 = 41625
  • 2018: Depreciation =   374625 x 10/100 x 3/12 =  9366

Calculation of loss on sale of machinery

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

=  374625 – 9366- 250000 = 115259

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