Depreciation AS 6 Notes and Summaries
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 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.
- To ascertain true results of operations
- To present true and fair view of the financial position
- To accumulate funds for the replacement of asset
- 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
- Cost of asset
- Expected useful life
- Estimated residual value
There are two alternative approaches for recording accounting entries for depreciation:
A provision for depreciation account is opened to accumulate the balance of depreciation and the assets are carried historical cost.
Profit and Loss Account ------------------Dr.
To Provision for Depreciation Account
Amount of Depreciation is credited to the Asset Account every year and the Asset Account is carried at historical cost less depreciation.
Depreciation Account -----------------Dr.
To Asset Account
Profit and Loss Account---------------Dr.
To Depreciation Account
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