Depreciation complete concept and methods
- 1. Prepared By: Muhammad Awais Sarmad Ali Kamran Zaheer
- 2. Depreciation Depreciation Methods 1. Straight Line / 2. Declining Balance / 3. Sum-of-the-year’s-digits / 4. Unit of Production It is a process of allocating Costs Cost to be allocated = Acquisition Cost (Purchase Price) – Scrap Value Gradually decrease in the value of assets is Known as Depeciation.
- 3. • To calculate proper profits. • To show the asset at its reasonable value. • To provide of replacement of an asset. • Depreciation is permitted to be deducted from profits for tax purposes.
- 4. • Wear and Tear • Disuse • Maintenance • Change in production • Restriction of production • Reduced demand
- 5. 1. Straight Line Depreciation Method Illustration Question: On Jan, 2011, a Company purchased an equipment at a cost of Rs 140,000, having a life span of 5 years. At the end of the 5th year the scrap value will be Rs 20,000. Calculate the depreciation for 2011 & 2012 using straight line depreciation method. Depreciation = (Cost – Residual/Scrap Value) Useful Life Depreciate at equal rate throughout the life
- 6. Answer Cost = 140,000 Salvage Value = 20,000 Life = 5 Depreciation = (Cost – Residual/ Scrap Value) Useful Life Depreciation for 2011 = (140,000 – 20,000) 5 = 12,0000 = Rs 24,000 5 Depreciation for 2012 = (140,000 – 20,000) 5 = 120,000 = SR 24,000 5
- 7. 2. Reducing Balance Method Depreciation = Book Value x Depreciation Rate Book Value = Cost – Accumulated Depreciation
- 8. Illustration Question: On January, 2011, a Company purchased an equipment at a cost of Rs 140,000, having a useful life of 5 years. The depreciation rate is 20%. a) Calculate the depreciation from 2011 to 2015 using Reducing Balance Depreciation method. Also calculate the scrap value of the equipment at the end of the year 2015.
- 9. Answer Year Book Value (SAR) in the beginning Depreciation 2011 140,000 (140,000) (20/100) = 28,000 2012 140,000 – 28,000 = 112,000 (112,000) (20/100) = 22,400 2013 112,000 – 22,400 = 89,600 (89,600) (20/100) = 17,920 2014 89,600 – 17,920 = 71,680 (71680) (20/100) = 14,336 2015 71,680 – 14,336 = 57,344 (57,344) (20/100) = 11,469 At the end of the year 2015, the Scrap Value = 57,344 – 11,469 = Rs 45,875 Depreciation = Book Value x Depreciation Rate Book Value = Cost – Accumulated Depreciation
- 10. 3. Sum-of-the-year’s-digits method This method is popular in the USA but not common in the UK. It provides for higher depreciation to be charged early in the life of an asset with lower depreciation in the last year. Illustration Question: Given an asset costing Rs 3000 which will be in use for 5 years, the calculations will be: From purchase the asset will last for 5 years From the second year the asset will last for 4 years From the Third year the asset will last for 3 years From the fourth year the asset will last for 2 years From the fifth year the asset will last for 1 years Sum of these digits 15
- 11. Answer Rs 1st year 5/15 of Rs 3000 is charged= 1000 2nd year 4/15 of Rs 3000 is charged= 800 3rd year 3/15 of Rs 3000 is charged= 600 4th year 2/15 of Rs 3000 is charged= 400 5th year 1/15 of Rs 3000 is charged= 200 3,000
- 12. All natural resources like mines, fuel oil, gas and woods are ending by using them. We calculate the depreciation with depletion method for such perishing assets. Under this method, first, we estimate the total value of assets. After this, we calculate the rate of depreciation per unit by dividing the estimated life in the term of production of units. 4.Depletion Unit Method Formula Depreciation Rate under Depletion Method = Original Cost - Scrap Value / Estimated life in terms of production units
- 13. 5.Units of Output Method ' A depreciation procedure used for property that is not in continuous use. The unit of production method is useful when the property's value is more closely related to the number of units it produces than the number of years it is in use. Formula: Depreciation = Number of units produced × ( Cost – Scrap Value) Life in Number of Units
- 14. 6.Machine hour Method As per machine hour rate method of depreciation, we calculate the total life of any fixed asset on the basis of its working hours life. After this, we divide actual cost of fixed assets with life of fixed assets in hours. After dividing, we will obtain the depreciation rate per hour. This method will apply mostly on the machines. So, in following formula, we have used the word machine instead of fixed asset. Hourly depreciation Rate= Original Cost of Machine – scrap Value Estimated Life of Machine in Hours