Depreciation

1. Meaning

‘Depreciation’ means decline in the monetary value of a fixed asset due to use,
passage of time or obsolescence. An example of fixed assets are buildings,
furniture, office equipment, machinery etc. A land is the only exception which
cannot be depreciated as the value of land appreciates with time.

Causes of Depreciation

Various causes of depreciation, spelt out as part of the definition of depreciation

in are as follows:

1. Physical wear and tear

2. Passage or efflux of time
3. Expiry of legal rights
4. Obsolescence
5. Abnormal reasons

Depreciation methods
Straight-line depreciation is the simplest method of depreciation. It assumes the expense is the
same for every year the asset is in use. The formula for the straight-line depreciation is: Depreciation
Expense = (Cost - Salvage Value) / Useful Life. Salvage value is the remaining value something has
at the end of its useful life. Useful life is the expected number of years the asset can serve the
business.

For example, assume that a major office printer has a cost of $5,000 and is expected to have a
useful life of seven years. At the end of seven years, it may have a salvage cost of $500. Thus, the
straight-line depreciation method allows the company to write off $642.85 each year for seven years:
$642.85 = ($5,000 - $500) / 7.
Example

Consider a piece of equipment that costs $25,000 with an estimated useful life
of 8 years and a $0 salvage value. The depreciation expense per year for this
equipment would be as follows:

Depreciation Expense = ($25,000 – $0) / 8 = $3,125 per year

Reducing balance depreciation

Reducing balance depreciation is a method of calculating depreciation whereby an
asset is expensed at a set percentage. The reducing balance method of
depreciation results in declining depreciation expenses with each accounting
period. In other words, more depreciation is charged at the beginning of an
asset’s lifetime and less is charged towards the end.

Reducing balance depreciation is also known as declining balance depreciation or

diminishing balance depreciation.

3 Units of Production Depreciation Method

The units-of-production depreciation method depreciates assets based on the

total number of hours used or the total number of units to be produced by
using the asset, over its useful life.

The formula for the units-of-production method:

Depreciation Expense = (Number of units produced / Life in number of
units) x (Cost – Salvage value)

Example

Consider a machine that costs $25,000, with an estimated total unit

production of 100 million and a $0 salvage value. During the first quarter of
activity, the machine produced 4 million units.

To calculate the depreciation expense using the formula above:

Depreciation Expense = (4 million / 100 million) x ($25,000 – $0) =

$1,000

Date: 25-9-19 2nd mid sem exam-2019-2HS02

Q-2. A machine is purchased at rs.2 lakhs .salvage value -20,000
Produces 10 lakhs Units .calculate depreciation in 1st & 2nd year when
machine produces 50,000 units in 1st year and 80,000 units in second
year.
ANS :( Number of units produced / Life in number of units) x (Cost –
Salvage value)
Cost: 2, 00,000 salvage value -20,000 Produces 50,000 units
2, 00,000-20,000/10, 00,000 = 0.18
50,000 x 0.18 =
80,000 x 0.18 =
Ans: 2
1000000/1.121 + 1000000/1.122 +1000000/1.123 +2000000/1.124 +
2000000/1.125