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COMPUTER ORIENTED ACCOUNTING SYSTEM DEPRECIATION
DEPRECIATION
1. Introduction and Meaning
Fixed assets like machinery, buildings, furniture, vehicles, and computers are purchased for long‑term use in the business. These assets gradually lose their value over time due to wear and tear, passage of time, or obsolescence. This gradual reduction in the value of a fixed asset is called Depreciation.
In accounting, depreciation is the systematic allocation of the cost of a tangible fixed asset over its useful life. It represents the portion of the asset’s cost that has been consumed or expired during an accounting period.
[!NOTE]
Definition (ICAI): “Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes.”
2. Definitions from Experts
| Expert | Definition |
|---|---|
| R.N. Carter | “Depreciation is the gradual and permanent decrease in the value of an asset from any cause.” |
| William Pickles | “Depreciation represents that part of the cost of a fixed asset which is written off during an accounting period.” |
| Spicer & Pegler | “Depreciation is the measure of the exhaustion of the effective life of an asset from any cause during a given period.” |
| AS‑6 | “Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes.” |
3. Features / Characteristics of Depreciation
- Only for Tangible Fixed Assets: Charged on machinery, building, furniture, etc. Not on land (unlimited life) or current assets.
- Gradual Reduction: The decrease is continuous over the asset's life.
- Non‑cash Expense: No actual cash outflow occurs when recording depreciation.
- Systematic Allocation: The cost is spread rationally over useful life.
- Necessary for True Profit/Loss: Prevents overstatement of profits.
- Based on Estimated Useful Life: Typically expressed in years, units, or hours.
4. Causes of Depreciation
Depreciation is caused by both internal and external factors.
A. Internal Causes
- Wear and Tear: Physical deterioration from regular use.
- Depletion: Exhaustion of natural resources (mines, oil wells).
- Accidents: Permanent damage from fire, flood, or mishaps.
B. External Causes
- Obsolescence: Becoming outdated due to new technology or market shifts.
- Passage of Time: Assets like leaseholds or patents lose value simply by aging.
- Legal Limits: Expiry of legal rights (e.g., a 10-year lease).
5. Objectives of Providing Depreciation
- True Profit/Loss: Matches costs against revenues.
- True Financial Position: Shows assets at their realistic "book value".
- Replacement Fund: Accumulates internal funds to replace the asset later.
- Tax Benefits: Since it's an expense, it reduces taxable income.
- Capital Maintenance: Prevents capital erosion by ensuring replacement funds exist.
6. Factors Affecting Depreciation
Three main factors determine the depreciation amount:
- Cost of the Asset: Purchase price + installation + freight.
- Estimated Useful Life: How long the business expects to use it.
- Residual (Scrap) Value: Estimated value at the end of its life.
Formula:
Depreciable Amount = Cost of Asset – Residual Value
7. Methods of Charging Depreciation
7.1 Straight Line Method (SLM)
Equal depreciation is charged every year.
Formula:
Annual Depreciation = (Cost – Residual Value) / Useful Life
- Pros: Simple, easy to calculate, asset can reach zero value.
- Cons: Ignores increasing repair costs in later years.
7.2 Written Down Value Method (WDV)
Depreciation is a fixed % of the reducing balance.
- Pros: Realistic (assets lose value faster early on), matches rising repairs with falling depreciation.
- Cons: Complex calculation, book value never reaches absolute zero.
8. Accounting Treatment
Depreciation is recorded via journal entries and then transferred to the P&L Account.
Key Journal Entry:
Depreciation A/c ... Dr.
To Asset A/c
(Being depreciation charged)
9. Illustrative Problems
Problem 1: SLM Method
Scenario: Machine bought for ₹2,00,000 on April 1, 2022. Life = 10 yrs, Scrap = ₹20,000.
Solution:
Annual Dep. = (2,00,000 - 20,000) / 10 = ₹18,000.
Problem 2: WDV Method
Scenario: Machine bought for ₹1,00,000 on April 1, 2023. Dep. @ 15% WDV.
Solution:
- Year 1: 15% of 1,00,000 = ₹15,000 (BV = ₹85,000)
- Year 2: 15% of 85,000 = ₹12,750 (BV = ₹72,250)
10. Summary
- Depreciation: Non-cash expense allocated over asset life.
- SLM: Equal amount every year.
- WDV: Fixed % on reducing balance (Tax-preferred).
- Land: Does not depreciate.