Methods of depreciation

Methods of depreciation

The method by which a fixed amount of a fixed asset is charged as deprecation or the amount of depreciation is calculated at a fixed rate on an original coat of fixed assets at the end of each accounting period, i.e. known as the Straight Line Method or Fixed Installment Method. 

Under this method, the deprecation is calculated with the help of the following formula.

= V+I-S/ N

Here: V= value of the fixed assets.

I= Installation charge of the fixed assets.

 S= Scrap Value of the fixed assets.

N= number of years of expected life.

D= Depreciation of the fixed assets.

Depreciation may be expressed as a rate and this rate on cost can be calculated as under: 

R= D/V × 100

R= Rate of the depreciation.

D= Amount of depreciation.

V= Value of fixed asset.

Now we shall discuss which assets the Straight-Line Method or Fixed Instalment Method is applied properly.

This method is applicable to those assets which have equal usefulness in each accounting period, e.g. copyright, trademark, pattern, leasehold property, etc.

It is must be important to note that before charging the depreciation with the help of the following formula

1. The amount of depreciation is the same every year.

2. If the rate of the depreciation is given, depreciation is computed on the original cost.

3. If the asset is purchased in between the year, depreciation is charged for the part of the year, the asset is used.

Advantages or Merits of the straight-Line Method:

1. It is easy to apply and simple to calculate.

2. In this method, assets can be depreciation up to the estimated scrap value or zero value.

3. Every year the profit or loss is debited by the same amount of depreciation.

4. Amount of depreciation is easily found under this method.

Disadvantages or Demerits of the straight-Line Method:

1. There is no arrangement of interest on capital invested in assets in this method.

2. The amount of depreciation is not calculated on the basis of the uses of assets under this method.

3. The calculation process is not so easy.

4. Sometimes the book value of the assets becomes nil. Still, the assets are used in the business.

 

Example: A firm purchased machinery for ₹200000 on 1st April 2015 and ₹20000 is spent on its installation. Its life was estimated to be of 5 years. Its estimated scrap value at the end of the period was ₹10000. Find out the amount of annual depreciation and rate of depreciation.

Solution:   Depreciation = Value of Asset + Installation charge - Scrap value                                                 / Estimated Life of the Asset                       = (180000 + 20000) – 10000/ 5                      = 200000-10000/5                      = 190000/5                      = 38000 Methods of depreciation Reducing Installment Method or Diminishing Balance Method: The method of depreciation by which the amount of depreciation is to be calculated on the cost price of the assets after deduction of depreciation of previous accounting periods, is called Diminishing Balance Method, it’s also known as WDV (Written Down Value Method).    Under this method the amount of depreciation is gradually decreased in the passage of time and is to be calculated after ascertaining the scrap value of assets under the following formulas: The Cost of assets, residual value, and useful life of assets is given, and the rate may be calculated by the following formula: The cost price of an asset is Rs. 25,00,000 residual value is Rs. 95000, and the estimated life of the assets is 4 years then find out the rate of depreciation with the help of the above formula.   Solution:   Rate of Depreciation = (1-s/c)1/n                                                               = 1- (95000/2500000)1/4                                                               = 1- 1/26                                                               = 26-1/26                                                               = 25/26                                                               = 0.9615384 x 100                                                               = 96%    Advantages of Diminishing Balance Method:   (I) Under this method, the amount of depreciation is charged on the basis of the usefulness of the assets in the passage of time i.e. the amount of depreciation is gradually decreased when the usefulness of assets is gradually diminished.   (II) The calculation of the amount of depreciation is very easy.   (III) Under this method, the depreciation is charged on the assets on the basis of their effectiveness. When an asset is more effective, then more depreciation is to be charged or vice versa.   (IV) The value of assets cannot be eliminated from the books of accounts by charging depreciation under this method.     (V) The total expenditure relating to assets is almost the same under this method. Because the number of repair charges is gradually increased with the passage of time.    Disadvantages of Diminishing Balance Method:   (I) Under this method, the rate of depreciation is higher than any other method. But the scrap value of an asset may not be ascertained correctly at the end of the life of assets.   (II) The method cannot be used where the value of assets is necessary to be reduced to 'Zero' Because the value of assets never is shown 'Zero' under this method.    (III) Under this method, the depreciation is charged on the historical cost of assets. But the historical cost is not effective at the time of replacement of assets. Rate of Depreciation as per Assessment Year 2022-23 Capital Goods/ Assets Rate of Depreciation as per IT Act. Residential Building 5% Other than Residential Building 10% Furniture and fittings/electrical fittings 10% Plant & Machinery 15% Aero planes 40% Commercial vehicle 40% Buses, Lorries, Taxis, Car and Bike 30% Rubber and plastic goods 30% Pollution control equipment 40% Conclusion : Both methods are very useful to calculate depreciation, but many people used the diminishing balance method in their business according to Income Tax Rate. If any businessmen charged depreciation according to their own rate then the assessing officer does not approve the rate of depreciation. So, if any person wants to claim the loss of depreciation in their business they must be followed the actual rate of depreciation as per the Income Tax (IT) Act, 1961. But it does not mean the Fixed Installment method is not applicable, this method is applicable to the  Land & Building, Office Building Capital Goods, etc.