Depreciation
Subject: Other
Overview
Depreciation is a permanent, continuous and gradual decline in the value of fixed assets due to wear and tear or passage of time. This note has information about depreciation, its causes and importance.Depreciation
Depreciation is a permanent, continuous and gradual decline in the value of fixed assets due to wear and tear or passage of time. It is treated as an expense or loss. It is a non-cash revenue expense and charged in profit and loss account. It is quality, quantity or value deterioration of fixed assets because of their constant use.
“Depreciation is the permanent and continuing diminution in the quality, quantity or value of an asset.” – William Pickles
“The allocation of the original cost of plant, property and equipment to the particular periods or products that benefit from the utilization of assets.” – C.T. Horngren
From the above definition, it is apparent that depreciation is the constant reduction in the value of fixed assets possessed by the business due to their constant use.
Causes
Depreciation is the fall or decrease in the value of fixed assets. The following are the main causes of depreciation:
- Wear and tear
Wear and tear refer to the decline in the efficiency of an asset due to its constant use. When an asset loses its efficiency, its value falls down thus depreciation arises. - Elapse of time
There are certain fixed assets such as intangible assets such as patent right, copyright, etc. whose value decline due to the passage of their time, even if they are not put in use. The decline in the value of such assets due to elapse of time is called ‘amortization’. - Exhaustion
A fixed asset such as mine may lose its value as minerals are exploited from there. Thus, the decline in the value of such fixed assets is called ‘depletion’. - Obsolescence
Some fixed assets become obsolete because of change in technology, fashion and consumers’ tastes and preferences. As a result, they are discarded as they lose their values. - Other causes
Besides, there may be other causes of depreciation of fixed assets such as accident and fall in their market value.
Need for providing depreciation
The need for providing depreciation arises due to the following reasons:
- Ascertaining true profits
When fixed assets like machines are used for the production of goods and services, they are gradually worn out and consequently their values go down. The fall in the value of fixed assets due to their constant use is an operating expense for a business. - Reporting true financial position
The value of fixed assets decrease over time due to some reasons. In order to report the true financial position of the business, it is essential to provide depreciation fixed assets to show their true values in the balance sheet. - Replacement of assets
Fixed assets have fixed operating lives. After their lives are over, they are fully out of use. Therefore, it is essential to replace fully worn out assets, as business is a going concern. Depreciation provided on fixed assets is set aside and used as a source of fund when they need replacement. - Paying fair taxes
The profit ascertained without the provision for depreciation on fixed assets is not true and taxes paid to the government on such profit is not fair. Therefore, it is essential to provide depreciation on fixed assets to pay fair amount of tax to the government.
Things to remember
- Depreciation is a permanent, continuous and gradual decline in the value of fixed assets due to wear and tear or passage of time.
- The value of fixed assets decrease over time due to some reasons.
- Wear and tear refers to the decline in the efficiency of an asset due to its constant use.
- It is essential to provide depreciation on fixed assets to pay fair amount of tax to the government.
- It includes every relationship which established among the people.
- There can be more than one community in a society. Community smaller than society.
- It is a network of social relationships which cannot see or touched.
- common interests and common objectives are not necessary for society.
Videos for Depreciation
Depreciation
Depreciation - Straight line method
What Is Depreciation - How It Affects Profit And Cash Flow
Questions and Answers
V/S Auto Piston Ltd. Purchased a plant on 1st Jan, 1995 at a cost on Rs.8,000 and spent 2,000 for its erection. The firm writes off depreciation on 31st December of each year at 20% p.a. on the original cost method. The plant was sold for Rs.5,500 on 30th June, 1997.
Required: Plant account
Solution:
| Dr. | Machinery a/c | Cr. |
| Date | Particulars | Amount | Date | Particulars | Amount |
| 1995-1-1 | To bank a/c | 10,000 | 1995-12-31 | By depreciation a/c | 2,000 |
| By balance c/d | 8,000 | ||||
| 10,000 | 10,000 | ||||
| 1996-1-1 | To balance b/d | 8,000 | 1996-12-31 | By depreciation a/c | 2,000 |
| By balance c/d | 6,000 | ||||
| 8,000 | 8,000 | ||||
| 1997-1-1 | To balance b/d | 6,000 | 1997-12-31 | By depreciation a/c | 1,000 |
| To gain on sales | 500 | By bank a/c | 5,500 | ||
| 6,500 | 6,500 | ||||
Consider the following information:
|
Date |
Transactions |
|
2009-01-01 |
Purchased machinery for Rs.50,000 |
|
2011-07-01 |
Sold the machinery for Rs.40,000 which was purchased on 2009 |
|
2011-12-31 |
Purchased new machinery for Rs.50,000 |
Assuming the rate of depreciation is @ 10% on straight line method and accounts are closed on 31st December of each year.
Required: Machinery account for the first three years.
Solution:
| Dr. | Machinery a/c | Cr. |
| Date | Particulars | Amount | Date | Particulars | Amount |
| 2009-01-01 | To Bank a/c | 50,000 | 2009-12-31 | By depreciation | 5,000 |
| By balance c/d | 45,000 | ||||
| 50,000 | 50,000 | ||||
| 2010-01-01 | To balance b/d | 45,000 | 2010-12-31 | By depreciation | 5,000 |
| By balance c/d | 40,000 | ||||
| 45,000 | 45,000 | ||||
| 2011-01-01 | To balance b/d | 40,000 | 2011-12-31 | By bank a/c | 40,000 |
| To bank a/c | 50,000 | By depreciation of sold machine | 2,500 | ||
| To profit on sales | 2,500 | By balance c/d | 50,000 | ||
| 92,500 | 92,500 | ||||
| 2012-01-01 | To balance b/d | 50,000 |
EP12
Consider the following information:
|
Date |
Transactions |
|
2009-01-01 |
Purchased first machinery for Rs.80,000 |
|
2010-07-01 |
Purchased second machinery for Rs.60,000 |
|
2011-10-01 |
Purchased third machinery for Rs.1,20,000 |
Assume the rate of depreciation is @ 105 on diminishing balance method and are closed on 31st December of each year.
Required: Machinery account for the first 3 years.
Solution:
| Dr. | Machinery a/c | Cr. |
| Date | Particulars | Amount | Date | Particulars | Amount |
| 2009-01-01 | To bank a/c | 80,000 | 2009-12-31 | By depreciation a/c | 8,000 |
| By balance c/d | 72,000 | ||||
| 80,000 | 80,000 | ||||
| 2010-01-01 | To balance b/d | 72,000 | 2010-12-31 | By depreciation a/c | 10,200 |
| To bank a/c | 60,000 | By balance c/d | 1,21,800 | ||
| 1,32,000 | 1,32,000 | ||||
| 2011-01-01 | To balance b/d | 1,21,800 | 2011-12-31 | By depreciation a/c | 12,180 |
| To bank a/c | 1,20,000 | By balance c/d | 2,26,620 | ||
| 2,41,800 | 2,41,800 | ||||
| 2012-01-01 | To balance b/d | 2,26,620 |
Pramesh purchased machinery on 1st July, 2003 at a cost of Rs.78,000 and spent rs.2,000 on its installation. The firm writes off depreciation on 31st December each year at 20% per annum on the written down value method. The machinery was sold for Rs.32,000 on 1st October,2006. Prepare the machinery account from 2003 to 2006.
Solution:
| Dr. | Machinery a/c | Cr. |
| Date | Particulars | Amount | Date | Particulars | Amount |
| 2003-07-01 | By bank a/c | 80,000 | 2003-12-31 | By depreciation a/c | 8,000 |
| By balance c/d | 72,000 | ||||
| 80,000 | 80,000 | ||||
| 2004-07-01 | To balance b/d | 72,000 | 2004-12-31 | By depreciation a/c | 14,400 |
| By balance c/d | 57,600 | ||||
| 72,000 | 72,000 | ||||
| 2005-07-01 | To balance b/d | 57,600 | 2005-12-31 | By depreciation a/c | 11,520 |
| By balance c/d | 46,080 | ||||
| 57,600 | 57,600 | ||||
| 2006-07-01 | To balance b/d | 46,080 | 2006-12-31 | By depreciation a/c | 6,912 |
| By bank a/c | 32,000 | ||||
| By balance c/d | 7,168 | ||||
| 46080 | 46080 | ||||
Consider the following information:
|
Date |
Transactions |
|
2008-01-01 |
Purchased machinery for Rs.50,000 |
|
2010-07-01 |
Sold the machinery for Rs.50,000 |
|
2010-12-31 |
Purchased new machinery for Rs.50,000 |
Assuming the rate of depreciation is @ 10% on written down value method and accounts are closed on 31st December of each year.
Required: Machinery account for the first three years.
Solution:
| Dr. | Machinery a/c | Cr. |
| Date | Particulars | Amount | Date | Particulars | Amount |
| 1995-01-01 | To bank a/c | 45,000 | 1995-12-31 | By depreciation a/c | 4,500 |
| By balance c/d | 40,500 | ||||
| 45,000 | 45,000 | ||||
| 1996-01-01 | To balance b/d | 40,500 | 1996-12-31 | By depreciation a/c | 10,050 |
| By balance c/d | 90,450 | ||||
| 1,00,500 | 1,00,500 | ||||
| 1997-01-01 | To balance b/d | 90,450 | 1997-12-31 | By bank a/c | 22,000 |
| By depreciation a/c | 9,045 | ||||
| By profit and loss a/c | 10,085 | ||||
| By balance c/d | 48,600 | ||||
| 90,450 | 90,450 | ||||
| 1998-01-01 | To balance b/d | 48,600 |
Quiz
© 2019-20 Kullabs. All Rights Reserved.