There are various methods of calculating depreciation on fixed assets. Once the method for charging depreciation is selected and adopted, then, it should be followed consistently every year.
Methods of Depreciation
The given below are the various methods for charging depreciation.
- Straight Line Method
- Written Down Value Method
- Depreciation Fund Method
- Replacement Method
- Annuity Method
- Insurance Policy Method
- Machine Hour Rate Method
- Sum of Years Digit Method
- Depletion Method
- Revaluation Method
Straight Line Method of Depreciation
It is one of the most popular and easy methods of charging depreciation on fixed assets. Under this method, depreciation is charged on the original cost of the asset every year, at a fixed rate of percentage. Therefore, in this case, the amount of depreciation remains the same for each of the years. This method of depreciation is also known as the Original Cost Method or Equal /Fixed Instalment Method.
Under this method, the amount to be written off each year as depreciation is calculated by dividing the cost of the asset by its estimated useful life. It should be noted that the scrap value of the asset is to be deducted from the original cost
before calculating depreciation. The given below is the formula for calculating depreciation under this method.
For example, the cost of machinery purchased is Rs 4,70,000, and the installation cost is Rs 30,000. The scrap value at the end of its estimated life of 10 years is expected to be Rs 50,000. In this case, the amount to be written off each year as depreciation is calculated as follows
Advantages of Straight Line Method
The given below are the various advantages of the Straight Line Method of depreciation.
- It is a simple and easy method of calculating depreciation.
- Under this method, assets can be completely written-off. That is, an asset can be depreciated to its net scrap value or zero value.
- As under this method, the same or equal amount of depreciation is charged from the Profit and Loss Account each year, so, the burden of depreciation on the net profit remains the same.
- It is suitable for those assets that have low repairs and maintenance costs and are used continuously in the business over a period of time.
Disadvantages of Straight Line Method
The disadvantages of the Straight Line Method of depreciation are given below.
- When the assets have been in use for a long time, it demands frequent repairs and maintenance. Thus, with the passage of time, the burden of depreciation on profit and loss accounts increases along with the repairs and maintenance costs of the asset.
- Under this method, the value of the asset becomes zero in the books even if the asset is still in usable condition by the business.
- The estimation of the scrap value of the asset after a long period of say, 10 or 15 years, is a difficult task.
- This method is not suitable for all kinds of fixed assets.
Written Down Value Method of Depreciation
This is another method of charging depreciation on fixed assets. Under this method, depreciation is not charged on the original cost of the asset. It is charged at a fixed rate on the diminished or reduced value of the asset, i.e. the cost after deducting previously charged depreciation. As a result of this, with the decline in the value of assets year after year, the amount of depreciation also decreases from one year to another. This method of charging depreciation is also known as Diminishing Balance Method or Reducing Instalment Method.
For example, the cost of machinery purchased is Rs 2,00,000, and the rate of depreciation is 10% p.a. In this case, depreciation for the first year would be Rs 20,000 (i.e. 2,00,000 × 10%).
For the second year, depreciation will be computed on the written down value of Rs 1,80,000 (i.e. 2,00,000 − 20,000). So, the amount of depreciation for the second year would be Rs 18,000 (i.e. 1,80,000 × 10%). In a similar manner, depreciation for the subsequent years can be computed by considering the written-down value of machinery.
Advantages of Written Down Value Method
The following are the advantages of the written down value method of depreciation.
- It is based on the logical assumption that asset is used more in the earlier years, so, more cost is charged in earlier years in the form of depreciation.
- It is suitable for those assets that have high repairs and maintenance costs.
- This method is accepted by the income tax authorities.
- As more depreciation is charged in the earlier years, so the loss of the asset due to obsolescence of technology is reduced.
Disadvantages of Written Down Value Method
Given below are the disadvantages of the written down value method of depreciation.
- It is difficult and a time-consuming process to calculate the rate of depreciation under this method.
- The value of an asset under this method cannot be zero, thus, the asset cannot be completely written-off in the books.
- Under this method, there arises a shortage of funds for the replacement of an asset. This happens due to the fact that the amount of depreciation is retained and used in the business. Consequently, at the end of the useful life of an old asset, a business finds it difficult to arrange funds for its replacement.
accounting information is often defined as data and facts produced or revealed by the financial statements of a business. This information is usually available within the sort of financial statements, financial reports, etc.
Petty Cash Book is a book that records a large number of small payments such as conveyance, cartage, postage, telegram, and other expenses.