Depreciation

Definition

Depreciation is the gradual decrease in the efficiency of an asset expressed in monetary terms because of its usage
and wear and tear.

Depreciation may be defined as the permanent and continuous diminution in the quality, quantity or value of an
asset.

Causes of Depreciation

Internal depreciation
 Wear and tear
 Depletion

External depreciation
 Obsolescence
 Efflux of time
 Accident

Need for provision of depreciation

 Ascertainment of true profit or loss

 Ascertainment of true cost of production
 True valuation of assets
 Replacement of assets
 Legal restriction
Internal depreciation:
Depreciation which occurs for certain inherent normal causes is known as internal depreciation. Such as wear and
tear and depletion

External depreciation:
Depreciation caused by some external reasons is called external depreciation. Such as obsolescence, efflux of time
and accident

Wear and tear:

The change in the shape of an asset due to use in business is known as wear and tear.

Depletion:
Decrease in the value of wasting assets is called depletion for example mines, oil wells, forests etc.

Obsolescence:
The decrease in the value of an asset due to new inventions, change in habit and taste of people, improvements is
known as obsolescence.

Efflux of time:
Some assets diminish in value on account of sheer passage of time even though they are not used. For example
copy right and patent right etc.

Accident:
Assets may be destroyed by abnormal reasons such as fire, earthquake and flood etc.

Fluctuation:
The decrease or increase in the market value of an asset not due to use in business is known as fluctuation.

Cost price of an asset:

It includes all expenses involved in carrying and installing the asset to the site.

Working life of an asset:

The period during which an asset will help earning income of business

Scrap value of an asset:

The price at which an asset will be sold at the end of its working life. It is also known residual value or breakup
value.

Market price of an asset:

The price at which an asset can be sold in the market is called market price.

Amortization:
The decrease in the value of intangible assets such as patents, copy right, goodwill etc.

Fixed Assets:
Assets which have long life and which are bought for use for a long period of time are called fixed assets. e.g. land,
building, machinery etc.

Tangible Assets:
Assets which have physical existence and which can be seen touched and felt are called tangible assets. For
example building, machinery etc

Intangible Assets:
Assets which have no physical existence and which cannot be seen, touched but can be felt are called intangible
assets for example goodwill, patents right and trade mark etc.

Fixed installment method of depreciation:

Under this method depreciation of an asset will be equal in each accounting year.
Reducing balance method
Under this method depreciation is calculated on the book value of an asset.
Method of Depreciation

1. Fixed installment method/ Straight line method/ Original cost method/ Equal installment method

2. Reducing balance method/ Diminishing balance method/Book value method/ Written down value method

Fixed installment method

Asset Cost (1/1/2001) 100000
Depreciation (31/12/2001) 10% 10000 (100000*10%)
Balance (1/1/2002) 90000
Depreciation (31/12/2002) 10% 10000 (100000*10%)
Balance (1/1/2003) 80000
Depreciation (31/12/2003) 10% 10000 (100000*10%)
Balance (1/1/2004) 70000

Reducing balance method

Asset Cost (1/1/2001) 100000

Depreciation (31/12/2001) 10% 10000 (100000*10%)
Balance (1/1/2002) 90000
Depreciation (31/12/2002) 10% 9000 (90000*10%)
Balance (1/1/2003) 81000
Depreciation (31/12/2003) 10% 8100 (81000*10%)
Balance (1/1/2004) 72900

Entries
When we buy an asset
Asset (Debit)
Cash/ Bank (Credit)
When depreciate the asset
Depreciation (Debit)
Asset (Credit)
When we sale the asset
Cash/ Bank (Debit)
Asset (Credit)

Requirement

Asset Account
Date References Amount(Rs) Date References Amount(Rs)

Practice questions
Question 1
X & Co. purchased a machinery for Rs. 70,000 on 1 st july, 2002. They spent Rs. 8,000 on its installation. Prepare
the machinery account for the first four years under straight line method of depreciation. Depreciation is written off
at10 % per annum. Assume the accounts are closed every year on 31st December.

1-7-2002 Machinery 70000+8000= 78000

Method: Straight line method

Dep rate: 10% p.a.

Year End: 31st December

Date Particulars Amount Date Particulars Amount

1-7-02 Cash A/C 78000 31-12-02 Dep (78000*10/100*6/12) 3900

31-12-02 Balance c/d 74100

Total 78000 Total 78000

1-1-03 Balance b/d 74100 31-12-03 Dep (78000*10/100) 7800

31-12-03 Balance c/d 66300

Total 74100 Total 74100

 66300 7800

58500

66300 66300

58500 7800
1-1-04 Balance b/d 31-12-04 Dep
50700
31-12-04 Balance c/d
58500 58500
Total Total
50700
1-1-05 Balance b/d 31-12-05 Dep
Question 2
A firm purchased a machine for Rs. 210,000 on 1st July, 2002 and spent Rs. 24,000 as wages and installation
charges. Prepare the machine account for the first four years under diminishing balance method of depreciation
assuming that the accounting year of the firm ends on 31 st December every year. Rate of depreciation is 10 % per
annum.

Question 3
On 1st January, 2001 a firm purchased machinery worth Rs. 50,000. On 1 st July, 2003 it buys additional machinery
worth Rs. 10,000 and spends Rs. 1,000 on its erection. The accounts are closed each year on 31 st December.
Assuming the normal depreciation to be 10% p.a. Show the machinery account for four years under fixed
installment method and reducing installment method.

Question 4
A firm purchased a machinery for Rs. 50,000 on 1st January 2006. Depreciation is to provided annually according
to fixed installment method. The useful life of the asset is 10 years and residual value is Rs. 10,000.
Show the machinery account for first four years and find out annual depreciation.
Question 5
A firm purchased a second hand truck for Rs. 50,000 on 1 st January, 2002 and spent Rs. 20,000 on its overhauling.
Depreciation is written off 10% p.a. on the reducing balance. On 30 June, 2005 the truck was sold for Rs. 30,000
being unsuitable. Prepare the truck account from 2002 to 2005 assuming that accounts are closed on 31 st December
every year.

1-1-2002 Cost of Truck: 50000+20000 = 70000

Depreciation rate: 10% p.a.
30-6-2005 Truck sold: 30000
Method: Reducing balance method
2002-2005
Year Ends on 31st Dec
Date Particulars Amount Date Particulars Amount

1-1-02 Cash A/C 70000 31-12-02 Dep (70000*10/100) 7000

31-12-02 Balance c/d 63000

Total 70000 Total 70000

1-1-03 Balance b/d 63000 31-12-03 Dep (63000*10/100) 6300

31-12-03 Balance c/d 56700

Total 63000 Total 63000

1-1-04 Balance b/d 56700 31-12-04 Dep (56700*10/100) 5670
31-12-04 Balance c/d 51030
Total 56700 Total 56700
1-1-05 Balance b/d 51030 30-06-05 Dep (51030*10/100*6/12) 2551.5
30-6-05 Cash A/C 30000
30-6-05 Profit & Loss A/C 18478.5
Total 51030 Total 51030
Book value of truck at the time of sale: 51030-2551.5 = 48478.5

Truck sold: 30000

Loss on sale of truck: 18478.5

Cash A/C 30000

Profit & Loss A/C 18478.5

To Truck A/C 48478.5

Question 5.1
A firm purchased a second hand truck for Rs. 50,000 on 1 st January, 2002 and spent Rs. 20,000 on its overhauling.
Depreciation is written off 10% p.a. on the reducing balance. On 30 June, 2005 the truck was sold for Rs. 60,000
being unsuitable. Prepare the truck account from 2002 to 2005 assuming that accounts are closed on 31 st December
every year.

1-1-2002 Cost of Truck: 50000+20000 = 70000

Depreciation rate: 10% p.a.
30-6-2005 Truck sold: 60000
Method: Reducing balance method
2002-2005
Year Ends on 31st Dec
Date Particulars Amount Date Particulars Amount

1-1-02 Cash A/C 70000 31-12-02 Dep (70000*10/100) 7000

31-12-02 Balance c/d 63000

Total 70000 Total 70000

1-1-03 Balance b/d 63000 31-12-03 Dep (63000*10/100) 6300

31-12-03 Balance c/d 56700

Total 63000 Total 63000

1-1-04 Balance b/d 56700 31-12-04 Dep (56700*10/100) 5670
31-12-04 Balance c/d 51030
Total 56700 Total 56700
1-1-05 Balance b/d 51030 30-06-05 Dep (51030*10/100*6/12) 2551.5
30-6-05 Profit & Loss A/C 11521.5 30-6-05 Cash A/C 60000
Total 62551.5 Total 62551.5
Book value of truck at the time of sale: 51030-2551.5 = 48478.5

Truck sold: 60000

Profit on sale of truck: 11521.1

Cash A/C 60000

To Truck A/C 48478.5

Profit & Loss A/C 11521.5

Question 6
A & Co purchased a machinery for Rs. 160,000 on 1 st July 2001. The books are closed on 31st December every
year. On 30th June 2004, it was sold for Rs. 70,000 and new machinery was purchased for Rs. 180,000 on the same
date. Depreciation is charged at the rate of 15% P.a. on original cost method.
Prepare the machinery account up to 2004 in the books of company.

1-7-2001 Cost of Machinery: 160000

Depreciation rate: 15% p.a.
30-6-2004 Old Machinery sold: 70000
30-6-2004 New Machinery Purchased: 180000
Method: Straight line method
2001-2004
Year Ends on 31st Dec

Machinery Account

Date Particulars Amount Date Particulars Amount

1-7-01 Cash A/C 160000 31-12-01 Dep (160000*15/100*6/12) 12000

31-12-01 Balance c/d 148000

Total 160000 Total 160000

 148000 24000

124000

148000 148000

124000 24000

100000

124000 124000

100000 12000
1-1-02 Balance b/d 31-12-02 Dep (160000*15/100)
180000 70000
31-12-02 Balance c/d
18000
Total Total
13500
1-1-03 Balance b/d 31-12-03 Dep
166500
31-12-03 Balance c/d
280000 280000
Total Total
166500
1-1-04 Balance b/d 30-06-04 Dep (160000*15/100*6/12)
30-6-2004

Book value of machinery at the time of sale: 100000-12000 = 88000

Old Machine was sold: 70000

Loss on sale of machinery: 18000

Cash A/C 70000

Profit & Loss A/C 18000

To Truck A/C 88000

Machinery A/C 180000

To Cash A/C 180000

Question 7
On 1st July 2002, Basharat purchased machinery for Rs. 60,000. Depreciation is to be provided for at 10% on
straight line method each year. On 31st October, 2004 machinery was sold for Rs. 24,000 as they become useless.
On the same date he purchased a new machinery for Rs. 20,000. Prepare machinery account from 2002 to 2005.
Accounts are closed on 31st December every year.

1-7-2002 Cost of Machinery: 60000

Depreciation rate: 10% p.a.
31-10-2004 Old Machinery sold: 24000
31-10-2004 New Machinery: 20000
Method: Straight line method
2002-2005
Year Ends on 31st Dec

Date Particulars Amount Date Particulars Amount

1-7-02 Cash A/C 60000 31-12-02 Dep (60000*10/100*6/12) 3000

31-12-02 Balance c/d 57000

Total 60000 Total 60000

1-1-03 Balance b/d 57000 31-12-03 Dep (60000*10/100) 6000

31-12-03 Balance c/d 51000

Total 57000 Total 57000

1-1-04 Balance b/d 51000 31-10-04 Dep (60000*10/100*10/12) 5000
 20000 24000

22000

333.33

19666.67

71000 71000
31-10-04 Cash A/C 31-10-04 CashA/C
19666.67 2000
31-10-04 Profit & Loss A/C
17666.67
31-12-04 Dep (20000*10/100*2/12)
19666.67 19666.67
31-12-04 Balance c/d
17666.67
Total Total
31-10-2004

Book value of machinery at the time of sale: 51000-5000 = 46000

Old Machine was sold: 24000

Loss on sale of machinery: 22000

Cash A/C 24000

Profit & Loss A/C 22000

 To Machinery A/C 46000

Machinery A/C 20000

To Cash A/C 20000