What is depreciation ?
*the fall in value of the fixed Assets(Vehicle , Machines) .
*It is the allocation of the cost of an asset over its useful life.
Why does a business need to open a depreciation account?
*Because the whole cost of the fixed assets should be spread out over its useful life and it is not just treated as an expense in the year of purchase.- by GOING CONCERN CONCEPT (business operation is assumed to be indefinitely)
Causes of depreciation?
*1)Physical Deterioration (Wear & Tear) -Due to the exposed of asset to the elements of nature. eg Furniture & Fittings
*2) Obsolescence- Outdated eg, Computers
*3) Depletion of assets as time passes - disappear eg , mining land
*4) Passage of time - Shorten life of assets eg , rent on land , patent rights
Calculation of Depreciation
Straight-line method
formula:
Original cost$ - Estimated Scrap Value$ / No. of useful Life(Years)
OR
Rate of Depreciation% / year X Original cost$
Adv(+) VS Disadv(-)
+Easy to calculate and understand
-In real life, its not accurate amount of wear and tear may vary every year.
Reducing balance method
formula:
Rate of Depreciation% / year X Net Book Value$ (Remaining value aft every accounting year)
Adv(+) VS Disadv(-)
+Most Efficient in giving asset a more truthful allocation of depreciation
- takes a long time to write off the books
-Rate of depreciation is high as compared to straight-line method
Revaluation method( not in O lvl, A lvl syllabus )
formula:
Value of purchase $ + Any New Purchases $ - Value of asset at the end $
Adv(+)Vs Disadv(-)
+More realistic financial position to be expressed
- In practical takes up a lot of time and effort ,thus increase cost of labour.
