“Depreciation” Represents the systematic allocation of the cost of a capital asset over a period of time for financial reporting purposes, tax purposes, or both

It can be defined as a part of the cost of the fixed assets which has expired on a particular account of it usage.

Characteristics of the Depreciation:

The depreciation is only used for the tangible assets. Depreciation is used for the fixed assets. Which life is longer than one year, Depreciation reduces the book value of an asset. Reduce the book values not the market value of an asset. Depreciation is a continuing process.

Causes of Depreciation:

Physical deterioration. Obsolescence. Depletion of an asset. Passage of time.

Physical deterioration:

Caused by the physical wear and tear.

Erosion. Rust. Rot and decay.

For E.g. Office furniture.

Obsolescence:

When fixed assets become out of data.

Mean when new technology and new models

Or more efficient tools can into existence.

For examples: Computers.

Depletion of the fixed assets:

Any fixed assets that depletes over period of time as resources are extracted from it.

For example: Gold mines,

Passage of time:

Some assets confer upon their holders the exclusive rights to enjoy certain privileges for a fixed period of time.

For example: copyrights, leases on land.

Types OF the Depreciation: Book Depreciation. Tax Depreciation

Book Depreciation: BD is provided as per the prevailing accounting standards and the necessary law of land.

Tax Depreciation:

TD is provided as per the prevailing taxation laws.

What Can Be Depreciated?

A qualifying asset for depreciation must satisfy all these conditions:

Should be used in business.

Must wear out, become obsolete or lose value.

Should have a definite useful life and a life longer than 1 year.

Required Factors in Calculating Asset Depreciation.

Useful life of asset.

Residual value.

Cost basis.

Method of depreciation.

Methods to Calculate Depreciation:

There are three major methods for calculating the deprecation.

Straight-Line Method.

Declining Balance Method.

MACRS Method.

1. Straight-Line (SL) Method:Principle: A fixed asset provides its service in a uniform fashion over its life.

Formula: Annual Depreciation = Cost – residual value Useful life

Annual Depreciation Expense 1 2 3 4 years

2. Declining Balance Method:

Principle:

A fixed asset provides its service in a decreasing fashion. The book value is reduced by a fixed percentage each year.

Formula:

Annual Depreciation = Depreciation rate * Book value at start of year.

DBM = 100% 2

5years Annual Depreciation

DBM= 40% Expenses

.

1 2 3 years

3. MACRS Method:

Principle:

An asset has a fixed life according to the category in which it falls.

The residual value is always zero.

Formula:

Annual Depreciation = cost x appropriate MACRS % rate.

MACRS Schedule

“Practical Study of the Organization”

“Star Collection Colors”

Star collection colors is a company which is making the different furniture Colors.

Varity of the colors are orange, yellow, green, and red, black, brown.

The “Star Collection Colors” company using the Straight-Line (SL) Method for the annually accounting period depreciation.

Formula

Annual Depreciation = cost – residual value

Useful life

SCC purchase a machinery for increasing the production.

Cost of machinery = Rs 45,000.

Residual value = Rs 5,000.

Useful life = 5 years.

Calculate annual cost of depreciation?