Depreciable Assets
The assets that are purchased
for long-term use and are not likely to be converted quickly into cash, such as
land, buildings, furniture
& fixtures and equipment.
In the accounting world, these are
also called as "Fixed Assets" or "Property Plants
& Equipment (PPE)
Classification of
Assets:
The Assets can be classified into Tangible or Intangible assets.
Tangible Assets:
Tangible assets are
those assets which we can
touch, see and feel. For example, Building, Furniture, Machinery
etc.
Intangible Assets:
Intangible assets
cannot be seen, felt or touched
physically by us, but they are also valuable. For example, Intellectual
Property, Copyrights, Brands, Trademarks etc.
Depreciation:
A
reduction in the value of
an asset over time, due to use, wear and tear or obsolescence. As we use the
assets, obviously the capacity
and quality will deteriorate, the measurement of the same is called as
depreciation. Calculating the right
depreciation gives us correct value of the Asset which is shown in the Balance
Sheet.
What does depreciation refer to in
accounting?
3
Depreciation involves loss of value of assets due to the passage of time and
obsolescence.
Methods of Depreciation:
There are various methods of depreciation. However, the straight line method (SLM) and the written down value (WDV) method are the most popular. SLM means equal depreciation every year.
SLM Method
Let us understand through an example, Suppose you bought a car for Rs.10 lakhs and if we assume that the useful life of the car is 5 years. Then the depreciation per year will be 2 lakhs. (Amount / Life in Years). This is called as Straight line method. The Rate of depreciation per year in this case is 20% p.a. Thus, depreciation of 2 Lacs p.a. is 20% of the original cost of Rs.10 lacs.
Formula for calculating Depreciation by SLM
Hence, to compute
depreciation, we
need 3 things i.e. Cost of the Asset, estimated life of Asset and residual value of the asset.
Assuming, this car
can be sold after
5 year for Rs. 1Lac (residual value), then instead of dividing the actual cost, we will compute
depreciation per
year by Rs.9 Lakhs / 5 Years. Hence Depreciation per year shall be Rs.1.8 Lakhs per year.
Now, since there are
assumptions
involved on the useful life of the asset and the future expected residual value, it may create a lot
of confusion,
if everyone starts using their own assumptions. To solve this, there are rules as per law under
different Acts, on
the method and process of computation. Like in India, Depreciation as per Income Tax is different
from Depreciation
as per the Companies Act. Hence, any entity which is not a company, follows the Income Tax method
and for companies,
both IT Act and Companies Act needs to be followed.
Assuming the life of asset is 10 years, what is rate of
depreciation
assuming SLM method ?
1
Since the life is 10 years, the rate of depreciation (SLM) will be 1/10 = 10%
WDV Method
WDV means written down value
method, which is Cost
reduced by depreciation. The depreciation rate is applied on the WDV.
Let us understand the WDV method with a simple example:
Asset Original Cost - Rs.100
Rate of Depreciation - 10%
Method - WDV
1st year:
Depreciation = Cost (Rs.100) x Rate
(10%) = Rs.10
WDV at the end of the year = Original Cost
(Rs.100) -
Depreciation (Rs.10) = 90
2nd Year:
Opening WDV = Rs.90 (brought forward from last
year)
Depreciation =
WDV
(Rs.90) x 10% = Rs.9
WDV at the end of the
year =
Opening WDV (90) - Depreciation (9) = 81
Thus, it may be now
clear that,
depreciation is calculated on the written down value of the asset.
Which depreciation method allocates an equal amount of
depreciation expense
each year?
3
Straight-line method allocates an equal amount of depreciation expense each year
In the reducing balance method of depreciation, the depreciation
expense
each year is calculated as a percentage of:
1
The depreciation expense each year is calculated as a percentage of book value of the asset at the
beginning of
the year