Depreciation

Depreciation Accounting Standard 6

Learning Objectives ► Understand

the concept of depreciation ► Identify the causes of depreciation ► Compute depreciation as per various methods of providing depreciation ► Appreciate the role of a proper depreciation policy ► Understand salient feature of AS 6

Concept of Depreciation ► The

concept of depreciation is closely linked with the concept of business income. ► In revenue generation process long term assets is used. ► At some point of time these assets becomes useless and are disposed of and possibly replaced. ► The assets get economically exhausted

►The

economic potential so consumed represents the expired cost of these assets and must be recovered from the revenue of the business in order to determine the income earned by the business.

Definition ► Depreciation

is defined as that portion of the cost of the assets that is deducted from the revenue for assets services used in the operation of a business. ► The Institute of Chartered Accountant of England and Wales defines depreciation as “that part of the cost of a fixed asset to its owner which is not recoverable when the asset is finally put out of use. Provision

► Against

this loss of capital is an integral cost of conducting the business during the effective commercial life of the asset and is not dependent upon the amount of profit earned”.

Factors determining Depreciation to be charged ► Cost

of the Assets

► Estimated

Scrap Value

► Estimated

Useful Life of Asset

Method of Depreciation Accounting ► When

Depreciation Provision is not maintained For charging depreciation entry is made Depreciation A/c Dr To Assets A/c For transfer to P/L account Profit & Loss A/c Dr To Depreciation

When provision for Depreciation is maintained ► For

providing depreciation Depreciation A/c Dr. To Provision for Depreciation ► For transferring the depreciation to P/L acc. Profit & Loss A/c Dr. To Depreciation A/c

► On

sale of Asset A} Provision for Depreciation A/c Dr. To Asset A/c B} If profit: Asset Account Dr To P/L Account If Loss: P/L Account Dr Asset Account

Change in depreciation method ► Change

in depreciation method may be desired from the current year onwards. In such a case, depreciation will be charged according to the new method from the current year ► Change in depreciation method may be desired from back date. In such a case depreciation as per old method is calculated

► First

from the date of change and then depreciation as per new method is calculated from the required date of change. Then the difference between dep. Under two methods is adjusted to the asset account.

Depreciation Policy The objectives are ► Recovery of original investment, i.e. the acquisition cost of the asset, before the expiry of the economic life of the asset. ► Ensuring a uniform rate of return on investment. ► Generating sufficient funds for the replacement of the asset after the expiry of the economic life of the asset.

► ►

Deriving maximum tax benefit Ascertainment of correct profit or loss.

The above objectives are achieved if 1. Proper dep method is selected 2. Periodic review of dep provision 3. Evaluation and disclosure of depreciation policy