Depreciation AS 6 Notes and Summaries

Introduction

Depreciation is a measure of wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortisation of  assets  whose  useful life is predetermined

Depreciable Assets

Depreciable Assets are those which

(i)     are expected to be used during more than one accounting period; and
(ii)    have a limited useful life; and
(iii)   are held by an enterprise for use in the production or supply of goods and services for rental to other or for administrative purposes and not for the purpose of sale in the ordinary course of business.

OBJECTIVES – Depreciation

(1)   Correct income measurement: Depreciation should be charged for proper estimation of periodic profit or loss.

(2)   True position statement: Value of the fixed assets should be adjusted for depreciation charged in order to depict the actual financial position

(3) Funds for replacement: Generation of adequate funds in the hands of the business for replacement of the asset at the end of its useful life.

(4) Ascertainment of true cost of production: For ascertaining the cost of the production, it is necessary to charge depreciation as an item of cost of production.

Objectives

1. To ascertain true results of operations
2. To present true and fair view of the financial position
3. To accumulate funds for the replacement of asset
4. To ascertain true costs of production

 

Factors in the measurement

Estimation of exact amount of depreciation is not easy. Generally following factors are taken into  consideration for  calculation of depreciation.

1.     Cost   of   asset   including   expenses   for installation, commissioning, trial run etc.

2.     Estimated useful life of the asset.

3.     Estimated scrap value (if any) at the end of useful life of the asset.

                 

Depreciation =  Depreciable Amount /  Estimated useful life

Factors affecting the Amount of depreciation

1. Cost of asset      
2. Expected useful life  
3. Estimated residual value

 

Accounting Entries

 

There  are  two  alternative  approaches  for recording accounting entries for depreciation:

First Alternative

A provision for depreciation account is opened to accumulate the balance of depreciation and the assets are carried historical cost. 

Accounting entry:

Profit and Loss Account ------------------Dr.
To Provision for Depreciation Account

Second Alternative

Amount of Depreciation is credited to the Asset Account every year and the Asset Account is carried at historical cost less depreciation.

Accounting entries:

Depreciation Account      -----------------Dr.
To Asset Account

Profit and Loss Account---------------Dr.
To Depreciation Account

 

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