Method of Depreciation

In the previous post I wrote about some basic info about depreciation and I suggest to read the post before you proceed. In this post I am going to discus about the method of depreciation.

Although there are a few method of depreciation, but out of them two main method of depreciation are "Straight line" method (also known as "fixed installment" method) and "Diminishing" method" (also known as "Reducing" method).

Straight line method: It is the easiest method of depreciation. In this method, assets will depreciates in equal annual value for each year. For example, value of a motor vehicle depreciating Rs. 3000/- for each year, which was purchased at Rs. 2,00,000/-. Here, at the end of first year, the book value of asset will be Rs. 1,97,000/- (2,00,000-3000). At the end of second year, it will be Rs. 1,94,000/- (1,97,000-3000). At the end of third year, the value will be Rs. 1,91,000/- (1,94,000-3000) and so on...
To find out the amount of depreciation and written down value, the formula will be as follow:

and

Where,
WDV= Written down value or simply the value of depreciation
D = Depreciation of the asset
x = The cost price of the asset.
s = Scrap value of the asset, what will be left at the disposal. Scrap value is the value of junk, hence can not be depreciated any more.
t = estimated life span of the asset (generally in year).
Y= Completed year.

Diminishing method: Unlike straight line method it is more complex and scientific method of depreciation. In this method the value of asset will decrease gradually year after year. For example,
value of a motor vehicle depreciating @10% P.A., which was purchased at Rs. 2,00,000/-. Here, at the end of first year, the book value of asset will be Rs. 1,80,000/- (2,00,000*90%). At the end of second year, it will be Rs. 1,62,000/- (1,80,000*90%). At the end of third year, the value will be Rs. 1,45,800/- (1,62,000*90%) and so on...
To find out the amount of depreciation and written down value, the formula will be as follow:

and

Where,
WDV= Written down value or simply the value of depreciation
D = Depreciation of the asset
x = The cost price of the asset after deducting scrap value (if any).
r= Rate of depreciation (%)
t = Number of Completed year.

Depreciation of asset

What is Depreciation?
As we know nothing is stay forever, but why? because everything contains it's own life span, likewise every fixed assets loose it's value as time elapsed, that's bring the concept of depreciation. In simple words depreciation is the loss of value of fixed assets.

Why assets depreciates?
Assets are depreciates for some "internal" and "external" reasons. Assets loose their value internally due to some inherent reasons like "regular wear and tear", "depletion" or "exhaustion".
Where some another facts like "obsolescence of technologies" , "Efflux of time" or "Accidental loss" make assets to be depreciated.

What makes the depreciation necessary?
Depreciation need to be accounted due to three main reasons as mentioned below
• To ascertain correct financial picture: It is important to report the remaining  asset value after deducting the depreciation to the financial statement like balance sheet to ensure that the balance sheet reflects the correct value of asset to the accounting users.
• To figure out the cost of  production: Depreciation is also the part of production cost, like purchase, wages, carriage inwards etc., hence depreciation is need to be added with the cost of production, to make the prising decision accurately.
• To ensure fund for replacement: Depreciation is also necessary to make enough provision so assets can be replaced at the disposal without any additional capital requirement. Without depreciation the profit will be overstated and can be distributed as dividend or added to the share holders' fund, in both cases​, a deficit in the available fund may realised while replacing the assets.
[Method of depreciation to be continued in the next post]