# Financial Accounting

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Financial Accounting (Mgt-101)
VU
Lesson-18
DEPRECIATION
It is a systematic allocation of the cost of a depreciable asset to expense over its useful life".
GROUPINGS OF FIXED ASSETS
Major groups of Fixed Assets:
·  Land
·  Building
·  Plant and Machinery
·  Furniture and Fixtures
·  Office Equipment
·  Vehicles
No depreciation is charged for `Land'. In case of `Leased Asset/Lease Hold Land' the amount paid for it is
charged over the life of the lease and is called Amortization.
RECORDING OF JOURNAL ENTRIES
Purchase of fixed asset:
Debit:
Relevant asset account
Credit:
Cash, Bank or Payable Account
For recording of depreciation, following two heads of accounts are used:
·  Depreciation Expense Account
·  Accumulated Depreciation Account
Depreciation expense account contains the depreciation of the current year. Accumulated depreciation
contains the depreciation of the asset from the financial year in which it was bought. Depreciation of the
following years in which asset was used, is added up in this account. In other words, this head of account
shows the cost of usage of the asset up to the current year. Depreciation account is charged to profit & loss
account under the heading of Administrative Expenses. In the balance sheet, fixed assets are presented at
written down value. i-e.
WDV = Actual cost of fixed asset ­ Accumulated Depreciation.
Journal entry for the depreciation is given below:
Debit:
Depreciation Account
Credit:
Accumulated Depreciation Account
METHODS OF CALCULATING DEPRECIATION
There are several methods of calculating depreciation. At this stage, we will discuss only two of them
namely:
·  Straight line method
·  Reducing balance method
STRAIGHT LINE METHOD
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Financial Accounting (Mgt-101)
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In this method, a fixed amount is calculated by a formula. That fixed amount is charged every year
irrespective of the written down value of the asset. The formula for calculating the depreciation is given
below:
Depreciation = (cost ­ Residual value) / Expected useful life of the asset
Residual value is the cost of the asset after the expiry of its useful life.
REDUCING BALANCE METHOD
In this method, depreciation is calculated on written down value. In the first year, depreciation is calculated
on cost. Afterwards written down value is calculated by deducting accumulated depreciation from the cost of
that asset(cost ­ accumulated depreciation) and depreciation is charged on that value.
·
Cost of Asset ­ Price at which the asset was initially recorded.
·
Written Down Value / Book Value ­ Cost minus Accumulated Depreciation.
In reducing balance method, a formula is used for calculation of depreciation rate. i e.
·
Rate = 1 ­
n RV / C
Where:
"RV" = Residual Value
"C" = Cost
"n" = Life of Asset
Calculate the rate if:
·
Cost
= 100,000
·
Residual Value (RV)
= 20,000
·
Life
= 3 years
·
Rate = 1 ­ 3 20000/100000
= 42%
Year 1
Cost
100,000
Depreciation
100,000 x 42%
(42,000)
WDV  (Closing Balance)
58,000
Year 2
WDV  (Opening Balance)
58,000
Depreciation
58,000 x 42%
(24,360)
WDV  (Closing Balance)
33,640
Year 3
WDV  (Opening Balance)
33,640
Depreciation
33,640 x 42%
(14,128)
WDV  (Closing Balance)
19,511
Disposal of Asset
Cost of Asset
= 100,000
Life of the Asset
= 5 Years
Depreciation Method
= Straight Line
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Financial Accounting (Mgt-101)
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Residual Value
= Rs.10000
Sale Price after Five Years
= Rs.15000
Depreciation per year = (100000-10000) / 5
= Rs.5000 per year
Total Depreciation in Five Years
= 18,000 x 5
= 90,000
Book Value after Five Years
= 100,000- 90,000
= 10,000
Profit on Disposal
= 15,000 ­ 10,000
= Rs.5000
Recording of Disposal
Debit
Fixed Asset Disposal A/c
100,000
Credit
Fixed Asset Cost A/c
100,000
(With the cost of asset)
Debit
Accumulated Dep. A/c
90,000
Credit
Fixed Asset Disposal A/c
90,000
(With the depreciation accumulated to date)
Debit
Cash / Bank / Receivable A/c  15,000
Credit
Fixed Asset Disposal A/c
15,000
(With the price at which asset is sold)
[Note: one group to appear at a time]
Disposal of Asset Account
Fixed Asset Disposal Account
DEBIT
CREDIT
Cost Account
100,000
Acc. Dep. Account
90,000
Cash / Bank
15,000
P & L Account
5000
( Balancing Figure)
Total
105000
Total
105000
POLICY FOR DEPRECIATION
The management of the business selects the policy for charging depreciation. There is no law binding on the
management. The management is free to choose method of depreciation and policy of charging
depreciation. Normally two policies are commonly used:
·  Depreciation on the basis of use
·  In the year of purchase, full year's depreciation is charged; where as, in the year of sale no
depreciation is charged.
Now it is up to the management to decide, what method and what policy is better and effective for their
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Financial Accounting (Mgt-101)
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DISPOSAL OF FIXED ASSET
When depreciable asset is disposed off at any time during the financial year, an entry should be made to give
effect of the disposal. Since, the residual value of asset is only estimated, it is common for asset to be sold at
price that differs from its book value at the date of disposal. When asset is sold, any profit or loss is
computed by comparing book value with the amount received from sale. As you know, book value is
obtained by deducting accumulated depreciation from original cost of the asset. A sale price in excess of the
book value produces profit; a sale price below the book value produces loss. This profit or loss should be
shown in the profit & loss account.
ENTRIES FOR RECORDING DISPOSAL
Debit
Fixed Asset Disposal A/c
Credit
Fixed Asset Cost A/c
(With the cost of asset)
Debit
Accumulated Dep. A/c
Credit
Fixed Asset Disposal A/c
(With the depreciation accumulated to date)
Debit
Cash / Bank / Receivable A/c
Credit
Fixed Asset Disposal A/c
(With the price at which asset is sold)
Example
·
An asset is purchased for Rs. 500,000 on Nov. 01, 2001.
·
Depreciation rate is 10% p.a.
·
The Asset is sold on Apr. 30, 2004.
·
Financial Year is July 1 to June 30
Question
·  Calculate the WDV For both policies
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Financial Accounting (Mgt-101)
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Depreciation is Charged on the Basis of USe
Year
On the Basis of Use
Rs.
1-11-2001
Cost
500,000
2001-2002
Dep. 500,000 x 10% x 8 / 12
(33,333)
30-6-2002
WDV
466,667
2002-2003
Dep. 466,666 x 10%
(46,667)
30-6-2003
WDV
420,000
2003-2004
Dep. 420,000 x 10% x 10 / 12
(35,000)
30-4-2004
WDV
385,000
Full Dep. In the Year of Purchase
Year
Full Dep. in year of Purchase
Rs.
1-11-2001
Cost
500,000
2001-2002
Dep. 500,000 x 10%
(50,000)
30-6-2002
WDV
450,000
2002-2003
Dep. 450,000 x 10%
(45,000)
30-6-2003
WDV
405,000
2003-2004
Dep. 00 in the year of sale
00
30-6-2004
WDV
405,000
Contents of Fixed Assets Register
·  Different record for each class of assets
·  Date of purchase
·  Detailed particulars of asset
·  Location of asset
·  Record of depreciation
ILLUSTRATION
Cost of asset
Rs. 200,000
Life of the asset
5 years
Depreciation method
Straight line
Residual value
Rs. 20,000
Sale price after 5 years
30,000
Calculate profit/Loss on the sale of the asset?
SOLUTION
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Financial Accounting (Mgt-101)
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Written down value = 200,000 ­ 20,000 = 180,000
Depreciation/year = 180,000/5 = 36,000 (Straight line method)
Particulars
Depreciation
Written
(Rs)
Down
Value (Rs.)
200,000
Depreciable cost
st year
(36,000)
164,000
Dep. Of the 1
Dep. Of the 2nd year
(36,000)
128,000
Dep. Of the 3
(36,000)
92,000
rd year
(36,000)
56,000
Dep. Of the 4th year
Dep. Of the 5th year
(36,000)
20,000
Book value after five years
Rs. 20,000
Sale price
Rs. 30,000
Profit on sale
Rs. 10,000 (30,000 ­ 20,000)
Same illustration is solved by reducing balance method
Cost of asset
Rs. 200,000
Residual value
Rs. 20,000
Estimated useful life
5 years
Calculation of depreciation rate
____
Depreciation Rate = 1 ­ nRv/c
_____________
=1-
520,000/200,000
= 37%
Allocation of depreciation is given below:
Particulars
Depreciation
Accumulated
Written
(Rs)
Depreciation
Down
(Rs.)
Value (Rs.)
200,000
Depreciable cost
Dep. Of the 1st year
200,000 x 37%
74,000
74,000
126,000
Dep. Of the 2nd year
126,000 x 37%
46,620
120,620
79,380
Dep. Of the 3rd year
29,371
149,991
50,009
79,380 x 37%
Dep. Of the 4th year
50,009 x 37%
18,503
168,494
31,506
Dep. Of the 5th year
31,506 x 37%
11,657
180,151
19,849
Book value after five years
Rs. 19,849
Sale price
Rs. 30,000
Profit on sale
Rs. 10,151 (30,000 ­ 19,849)
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