File Name: state and explain two methods of depreciation .zip
Cost of a fixed asset must be charged to the income statement in a manner that best reflects the pattern of economic use of assets. Straight Line Depreciation.
- Depreciation Methods
- What Is Depreciation?
- Depreciation Methods
- What are the Different Types of Depreciation Methods?
By Sathish AR. Depreciation is the accounting process of converting the original costs of fixed assets such as plant and machinery, equipment, etc into the expense.
It refers to the decline in the value of fixed assets due to their usage, passage of time or obsolescence. Furthermore, depreciation is a non — cash expense as it does not involve any outflow of cash. Hence, depreciation as an expense is different from all the other conventional expenses. However, there are different factors considered by a company in order to calculate depreciation. One such factor is the depreciation method.
Thus, companies use different depreciation methods in order to calculate depreciation. This is the most commonly used method to calculate depreciation. It is also known as fixed instalment method. Under this method, an equal amount is charged for depreciation of every fixed asset in each of the accounting periods. This uniform amount is charged until the asset gets reduced to nil or its salvage value at the end of its estimated useful life.
So, this method derives its name from a straight line graph. This graph is deduced after plotting an equal amount of depreciation for each accounting period over the useful life of the asset.
Thus, the amount of depreciation is calculated by simply dividing the difference of original cost or book value of the fixed asset and the salvage value by useful life of the asset. This method is also known as reducing balance method, written down value method or declining balance method.
A fixed percentage of depreciation is charged in each accounting period to the net balance of the fixed asset under this method. This net balance is nothing but the value of asset that remains after deducting accumulated depreciation. Thus, it means that depreciation rate is charged on the reducing balance of the asset. This asset is the one reflected in the books of accounts at the beginning of an accounting period. So, the book value of the asset is written down so as to to reduce it to its residual value.
Now, as the book value of the asset reduces every year so does the amount of depreciation. Accordingly, higher amount of depreciation is charged during the early years of the asset as compared to the later stages. Thus, the method is based on the assumption that more amount of depreciation should be charged in early years of the asset. This is on account of low repair cost being incurred in such years. As an asset forays into later stages of its useful life, the cost of repairs and maintenance of such an asset increase.
Hence, less amount of depreciation needs to be provided during such years. This method recognizes depreciation at an accelerated rate. Thus, the depreciable amount of an asset is charged to a fraction over different accounting periods under this method. Thus, this fraction indicates that the capital blocked or the benefit derived out of the asset is the highest in the first year. So, as an asset moves towards the end of its useful life, the benefit gained out of such an asset declines.
That is to say, highest amount of depreciation is allocated in the first year since no amount of capital has been recovered till then. Accordingly, least amount of depreciation should be charged in the last year as major portion of capital invested has been recovered. This method is a mix of straight line and diminishing balance method. Thus, depreciation is charged on the reduced value of the fixed asset in the beginning of the year under this method. This is just like the diminishing balance method.
However, a fixed rate of depreciation is applied just as in case of straight line method. This rate of depreciation is twice the rate charged under straight line method. Thus, this method leads to an over depreciated asset at the end of its useful life as compared to the anticipated salvage value. Therefore, companies adopt various approaches in order to overcome such a challenge. Firstly, the amount of depreciation charged for the last year is adjusted. This is done to make salvage value equal to the anticipated salvage value.
Secondly, many companies choose to use straight line depreciation method in the last year to adjust the over depreciated salvage value. This technological innovation causes the value of the old machinery to decline. Say, the profit before depreciation and tax for Kapoor Pvt. Ltd for the year ended December is Rs. And depreciation for the same accounting period is Rs.
Hence, depreciation for plant and machinery is shown as under:. Profit before depreciation and tax Rs. The cost of the asset is also known as the historical cost. It comprises of the purchase price of the fixed asset and the other costs incurred to put the asset into working condition. These costs include freight and transportation, installation cost, commission, insurance, etc.
Salvage value is also known as the net residual value or scrap value. It is the estimated net realizable value of an asset at the end of its useful life. This value is determined as a result of the difference between the sale price and the expenses necessary to dispose of an asset. The commercial or economic life of an asset is termed as the useful life of an asset.
Now, for estimating the useful life of an asset, its physical life is not taken into consideration. This is because an asset might be in good physical condition after a few years but it may not be used for production purposes. You need to determine a suitable way to allocate cost of the asset over the periods during which the asset is used.
Generally, the method of depreciation to be used depends upon the patterns of expected benefits obtainable from a given asset. This means different methods would apply to different types of assets in a company. However, in reality, companies do not think about the service benefit patterns when selecting a depreciation method. Types of GST Invoices.
Advantages of GST. GST Audit Checklist. Depreciation Methods. GST Exemption List. Partnership Firm Registration. What are the Different Types of Depreciation Methods? Various methods are used by the companies to calculate depreciation. These are as follows:. Various Depreciation Methods. Straight Line Depreciation Method. Straight Line Depreciation Formula.
Diminishing Balance Method. Diminishing Balance Method Formula. Double Declining Balance Method. Double Declining Balance Formula. Factors for Estimating Depreciation. Cost of the Asset.
Estimated Useful Life. Method of Depreciation. Starting a Business. Cash Flow. Expenses Manage. GST Center. QuickBooks Blogs. Social Media. Customer Service. Information may be abridged and therefore incomplete. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation. Popular Articles. Related Articles.
What Is Depreciation?
Depreciation is defined as the expensing of the cost of an asset involved in producing revenues throughout its useful life. Depreciation is defined as the expensing of an asset involved in producing revenues throughout its useful life. Depreciation for accounting purposes refers the allocation of the cost of assets to periods in which the assets are used depreciation with the matching of revenues to expenses principle. Depreciation expense affects the values of businesses and entities because the accumulated depreciation disclosed for each asset will reduce its book value on the balance sheet. Depreciation expense also affects net income. Generally the cost is allocated as depreciation expense among the periods in which the asset is expected to be used.
Image: Methods of providing depreciation. Under this method, a fixed percentage of original cost is written off the asset every year. Thus, if an asset costs Rs. The amount to be written off every year is arrived at as under:. The period for which the asset is used in a particular year should also be taken into account. This method is simple in calculation and also in such a case, the charge to the Profit and Loss Account is uniform every year.
GAAP is a set of rules that includes the details, complexities, and legalities of business and corporate accounting. GAAP guidelines highlight several separate allowable methods of depreciation that accounting professionals may use. There are four methods for depreciation: straight line, declining balance, sum-of-the-years' digits, and units of production. The difference is the value that is lost over time during the asset's productive use. That difference is also the total amount of depreciation that must be expensed.
This chapter deals with the different methods of depreciation with their merits and demerits so that keep the asset in its usable state^ are also to be capitalised. The useful life expert's opinion, consulting asset's manual, statistical tools for forecasting etc. Salvage value The name of this method is derived from the fact if.
Depreciation is used to gradually charge the book value of a fixed asset to expense. There are several methods of depreciation, which can result in differing charges to expense in any given reporting period. The following are the general methods of depreciation available for use:. Straight line.
A business wants to deduct expenses against revenues in the most effective fashion possible. But being effective doesn't mean that you always deduct an expense immediately. Depreciation allocates the cost and expense of tangible and real assets over the assets' useful life. Depending on the type of asset, a business might depreciate an asset over a period of up to 30 years. These methods of depreciation are recognized as appropriate accounting principals by the Internal Revenue Service IRS.
In accountancy , depreciation refers to two aspects of the same concept: first, the actual decrease of fair value of an asset , such as the decrease in value of factory equipment each year as it is used and wears, and second, the allocation in accounting statements of the original cost of the assets to periods in which the assets are used depreciation with the matching principle. Depreciation is thus the decrease in the value of assets and the method used to reallocate, or "write down" the cost of a tangible asset such as equipment over its useful life span. Businesses depreciate long-term assets for both accounting and tax purposes. The decrease in value of the asset affects the balance sheet of a business or entity, and the method of depreciating the asset, accounting-wise, affects the net income, and thus the income statement that they report.
In accounting terms, depreciation is defined as the reduction of recorded cost of a fixed asset in a systematic manner until the value of the asset becomes zero or negligible.
What are the Different Types of Depreciation Methods?
A depreciation method is the systematic manner in which the cost of a tangible asset is expensed out to income statement. Popular depreciation methods include straight-line method, declining balance method, units of production method, sum of year digits method. Amount spent on acquisition of an asset is initially recorded as an asset on balance sheet and charged to income statement over the useful life of the asset. The purpose of depreciation is to match revenues with expenses, hence the depreciation method must replicate the manner in which a particular asset is expected to generate revenues or cost savings. Depreciation methods can be broadly classified into two types: the time-factor methods and the usage-factor-methods.
By Sathish AR. Depreciation is the accounting process of converting the original costs of fixed assets such as plant and machinery, equipment, etc into the expense. It refers to the decline in the value of fixed assets due to their usage, passage of time or obsolescence. Furthermore, depreciation is a non — cash expense as it does not involve any outflow of cash. Hence, depreciation as an expense is different from all the other conventional expenses. However, there are different factors considered by a company in order to calculate depreciation.
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