Depreciation Accounting
Meaning:
Depreciation means fall in the value of the asset. AS 1-29 govern accounting method followed in the
preparation of balance sheet in India. Pickles defined depreciation as “The permanent and
continuing diminution in the quality, quantity or value of an asset.”
It is important to note that depreciation is charged on almost all fixed assets except forests,
plantations and similar regenerative natural resources. In other words if land has a limited useful life
for the enterprise then it can be depreciated.
Characteristics
• Measure of wearing out
• Reduces the book value of the asset but not
its market value
• Takes place gradually unless there is a quick
physical deterioration or obsolescence due to
technological developments
• Process of allocation of cost of the asset to the
useful life of the asset.
Related concepts
• Depletion- It is used in relation to extraction of
natural rsources like quarries, mines that reduces
the availability of quantity of the material or
asset
• Obsolescence- refers to the decrease in
usefulness caused on account of the asset
becoming out of date, old fashioned.
• Amortization- refers to writing off proportionate
value of the intangibles such as goodwill,
copyrights, patents etc.
Case
• Mr. A starts a small manufacturing business and buys
machinery worth Rs. 2 lakh
• He does not depreciate machinery every year and
therefore uses up all the profits which his business
generates.
• By the end of 5 years he has earned a total income of 4
lakh without considering depreciation.
• The machinery bought by A is useless at the end of 5th
year. It is clear that net income to Mr. A is not Rs. 4 lakh
but only Rs. 2 lakh , because out of 4 lakh he must
deduct the cost of machinery worth Rs. 2 lakh. Would it
not have been better if he had dducted every year a
due proportion of his expenditure on the machinery
before ascertaining his profit.
Objectives of charging depreciation
•To ascertain the profit or loss properly
•To show the asset at its proper value
•BASIS OF PROVIDING DEPRECIATION
•Original cost of the asset
•Estimated residual or scrap value at the end of its life
•Estimated useful or commercial life or the legal life whichever is shorter.
•METHODS FOR PROVIDING DEPRECIATION
•Uniform charge methods
•A) Fixed Installment Method
•B) Depletion method
•C) Machine hour rate method
• Declining charge or accelerated depreciation methods
•A) Diminishing balance method
•B) Sum of year’s digits method
•Revaluation method
•Sinking Fund method
A firm bought machiney for Rs. 86000 on 1st April 2005 and its life was estimated
To be 8 Years> Its estimated scrap value at the end of the period was Rs. 6000.
Calculate the amount of depreciation.
Depreciation= Cost- Estimated Scrap value
Number of years of expected useful life
=10000 per year.
A machine having a scrap value of 2000 os purchased for 20000 and it has an
effective life of 10 years. If it is used for 1000 hours each year then, the amopunt of
depreciation per hour will be computed as follows
Depreciation= Original cost-Scrap value
Life of the asset in hours
A firm purchases plant and machinery on 1st jan for 10000. It charges depreciation
of diminshing balance method. The amount of depreciation in the third year will be
Depreciation rate is calculated as =1-n√Net Residual value
Acquisition cost
Cost of an asset is Rs. 20000 and it has an effective life of 5 years. The amount of
depreciation is as
• Remainning life of the asset
Sum of all the digits of the life of the asset
Yr. 1- 6667
Yr. 2= 5333
A plant having a scrap value of Rs. 1000 and a life of 5 years was purchased in
January 2008. Calculate the amount of depreciation according to double
declining rate.
40%
Disposal of Assets
• When the assets wear out and are no longer
usable, then they are sold or scrapped. On the
disposal of an asset it may happen that the
realizable value by the sale of the asset is
equal to its book value or may be higher or
lower than the book value.
Gain and loss under Income tax Law
• For taxation purposes gain and loss on assets
are calculated on block of asset. Under the
income tax rules depreciation is charged on
block of assets. Block of asset is defined as all
assets on which same rate of depreciation
applies. As long as the cash realized on sale of
asset is less than the depreciable amount of
the block to which the asset belongs, there is
no need to recognise any gain for tax
purposes.
Disposal of Assets
• When the assets wear out and are no longer
usable, then they are sold or scrapped. On the
disposal of an asset it may happen that the
realizable value by the sale of the asset is equal
to its book value or may be higher or lower
than the book value.
Gain and Loss under Income Tax Law
• For taxation purposes gain or loss is calculated on
block of assets. Block of assets is defined as all
assets on which the same depreciation rate
applies. As long as the cash realized on sale of
assets is less than the depreciable amount of the
block to which the assets belong, there is no
need to recognise any gain for tax purposes. A
gain will be realized only when the book value of
the block at the time of disposal of an asset turns
into a credit balance after the disposal value is
credited and vice versa.
Revaluation of fixed assets
• All assets in the books of account are to be recorded at
their historical cost. But because of inflationor deflation it
may happen that there is a significant difference in the
book value of the asset and its real worth in the market.
Since the objective of the balance sheet is to convey the
true picture to the user, this historical concept of valuation
prevents the company from reflecting the true worth.
Revaluation is particularly required in the case of land and
building since property value appreciates significantly. So
the concept of revaluation has caught the attention of
many accountants. Sometimes, the upward valuation of
fixed assets is misused where a company revalues its fixed
asset to present a healthier balance sheet.
Case Law
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40. The accessories and peripherals of computers provide input processing, storage and various
output devices. The output devices such as printer, scanner etc. are computer peripherals and form
essential parts of PC. These output devices cannot work in isolation and also working on computer
system without an output device such as printer would be futile. In view of the above, the claim of
depreciation at 60% on printer, scanner and other computer peripherals is completely justified. The
claim of depreciation of 60% further gets justified in view of the fact that even computer software
which is installed on computer system supports the computer hardware and is eligible for
depreciation at 60%.
41. As held by the Calcutta High Court decision in Jokai India Ltd. 251 ITR 39. in view of decision of
Kolkata, ITAT in the case of ITO Vs. Sa Majumdar-2804TR~ 74, we hold that printers, scanners and
other peripherals were part and parcel of computer and depreciation against such asset are
allowable @ 60%. This ground is to be decided in favour of the assessee and against the revenue in
view of the decision of the Kolkata Bench `B’ of the Tribunal in the case of ITO vs. Samiran
Majumdar (2006) 98 ITD 119 (Kol) wherein the Tribunal allowed the claim by observing as under :
“Therefore, the printer and scanner were integral part of the computer system and were to be
treated as computer for the purposes of allowing higher rate of depreciation, i.e., 60 per cent and
accordingly, no interference was required in the order passed by the Commissioner (Appeals) on
that account.” Therefore, the effective ground remains with regard to deduction under section 80IA
in respect of inland ports.
42. We accordingly uphold the order of the CIT(A) in allowing depreciation @ 60% on computer
peripherals and accessories by treating them as computers