GROUPINGS OF FIXED ASSETS

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Financial Accounting (Mgt-101)

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

134

Financial Accounting (Mgt-101)

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

135

Financial Accounting (Mgt-101)

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

business.

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Financial Accounting (Mgt-101)

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

137

Financial Accounting (Mgt-101)

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

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

138

Financial Accounting (Mgt-101)

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 n√Rv/c

_____________

=1-

5√20,000/200,000

= 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

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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