DEPRECIATION OF FIXED PLANT & PROPERTY

ASSETS (As per IAS-16)

Fixed Assets/Non-Current Assets:-
Those assets which are purchased not for the purposes of re-sale them and their service life is of
longer duration and remain in use in the business for longer duration to operate the business
efficiently and conveniently are known as Fixed/Non-Current Assets.

SALIENT FEATURES OF FIXED ASSETS

• More or less permanent in nature.

• Used in the business operation for longer period of time.
• Not held for the purpose of re-sale.

CLASSIFICATION OF FIXED ASSET/NON CURRENT ASSETS

Fixed Assets are classified as under:-

1) Tangible Fixed Assets

2) Intangible Fixed Assets

TANGIBLE FIXED ASSETS

Assets with physical existence i.e. which can be touched and seen physically are known as Tangible
Fixed Assets. “Tangible” means with the “Physical Existence” (Assets which can be seen and touched).
These assets can again be divided in to two categories:-

1) Plant & Equipment

EXAMPLES:-Land, Building, Machinery, Tools, Motor Vehicles/Automobiles, Equipment (Delivery or

Office equipment), Furniture and Fixture etc.............................. All of these assets are subject to
depreciate with the exception of land, which is not depreciated in the books of accounts.

2) Natural Resources/Natural Assets ( IAS-38)

EXAMPLES:-Mines, timber, tracks, oil and gas wells, Other Natural Treasures etc., these are subject to
Depletion.

INTANGIBLE FIXED ASSETS

Assets without the physical existence i.e. which cannot be touched or seen are known as Intangible
Fixed Assets. Intangible means without the physical existence. These assets can again be divided in to
two categories:-
1) Copyrights, Franchises and Patents and etc. which have no physical existence but have got use
value. They are amortized over their expected useful life.
2) Goodwill and Trademarks etc. are usually not subject to amortization but to revaluation.

DEPRECIATION, DEPLETION AND AMORTIZATION OF FIXED ASSETS

A fixed asset has a limited life. The allocation of its cost over its useful life is termed as either
Depreciation or Depletion or Amortization. These are explained as under:-

Depreciation (Fixed Plant Assets and Property)

The cost of permanent fixed tangible assets, which has been used/decline/decrease, is called
“Depreciation”. It is charged on the permanent fixed assets. We can say that the expired cost of fixed
tangible assets within a year or period is known as “Depreciation”.

Fixed Intangible Assets

The cost of Fixed Intangible Assets, which has been used, is called Amortization it is always charged on
Intangible Fixed Assets. We can say that the expired cost of fixed intangible asset is known as
“Amortization”.

Depletion (Natural Resource/Natural Assets)

The exhaustion (Physical shrinkage, lessening or waste) of a natural asset or natural resources is called
“Depletion”. It is always charged on wasting fixed assets.

EFFECT OF DEPRECIATION ON THE INCOME STATEMENT & BALANCE SHEET

Depreciation expense must be recorded in the books of accounts because it is one of the costs which
are incurred in the production of periodic income. If it was not recognized upon the books, the net
income of the business would be overstated and depreciable assets would appear in the balance
sheet at value greater than their real values. Errors of this kind constitute serious misrepresentation
of fact.

CAUSES OF DEPRECIATION

Major causes of Depreciation of Fixed Tangible Assets are as follows:-

• Physical deterioration.
• Obsolescence.
• In-adequacy.

METHODS OF DEPRECIATION

The following methods are used to compute the periodic depreciation charge of a Fixed Asset.

1) Straight Line/Fixed Rate/Fixed Installment Method.

2) Declining balance/Reducing Balance/Diminishing Balance Method.
3) Sum of the years digits Method.
4) Units of Output Method/Service Mileage Method(Motor Vehicles/Automobiles)
5) Working Hours Method
6) MACRS (Modified Accelerated Cost Recovery System)
7) ACRS (Accelerated Cost Recovery System)
8) Half Year Convention Method and etc.

1) STRAIGHT LINE METHOD

This method provides for equal periodic charges to expenses over the estimated life of the assets.

Annual depreciation=Cost- Residual Value/Salvage Value/Scrape Value

Estimated useful life in years

-OR-

Annual Deprecation= (Cost-Salvage value) x Rate (NOTE:-If Rate would be given with this method)

SCRAPE VALUE/SALAGE VALUE/RESIDUAL VALUE

The estimated value/cost which will be recovered after the expiration of the estimated useful life in
years.

2) DECLINING/REDUCING/DIMINISHING/WRITTEN DOWN BALANCE METHOD

Depreciation Expense for 1st Year=Cost x Rate %

Depreciation Expense for 2nd Year= Book Value x Rate % &

Book Value=Cost-Accumulated Depreciation.

And for every next year depreciation= Book Value x Rate %

COMPUTATION OF DIMINISHING BALANCE RATE

Diminishing Balance Rate= 1/Estimated useful Life in Years x 100=----------%

Double Diminishing Balance Rate=1/Estimated useful Life in years x 100 x2=-------%

3) WORKING HOURS METHOD/HOURS METHOD

Per Hour Depreciation = (Cost – Salvage Value)/Estimated Useful Life in Hours

4) UNITS PRODUCTION METHOD/UNITS OUTPUT METHOD

Per Unit Depreciation = (Cost – Salvage Value)/Estimated Useful Life in Units =Rs. ---------/Unit
NOTE:-

In Working hours and Units production methods the dates and months will not be considered in the
determination of Depreciation.

5) SUM OF YEARS DIGITS METHOD(SYDM)

Depreciable cost=Cost ---Salvage Value.

Estimated useful life in years=n=--------Years.

Sum of the years digits=-----+--------+-------+------+------+ and etc.

Annual Depreciation=Depreciable Cost x Fraction

Note:-

Fraction= Life in years /Sum of the years digits.

Depreciable Cost:

It is the estimated cost of Fixed Asset which would be depreciated within the estimated useful life in
years.

MACRS (MODIFIED ACCELERATED COST RECOVERY SYSTEM)-THE DEPRECIATION METHOD

In 1986, Congress adopted the Modified Accelerated Cost Recovery System; called MACRS (Pronounced
“Makers”) Companies may use Straight Line Method for Income Tax purposes, but most prefer to use
an Accelerated method. MACRS is the only accelerated depreciation method that may be used in federal
income tax returns for all assets placed in service/use after 1986.

Under MACRS, all plant assets are assigned one of nine property periods: - 3, 5, 7, 10, 15, 20, 27.5
31.5 or 39 years.

Estimated life for Manufacturing Tools= 3 years, Automobiles, Light Trucks and Computers = 5 Years,
Any depreciable asset that is not assigned a specific class life is treated as 7 year property life.

POINTS TO BE NOTED FOR MACRS

1) It is based on fixed percentage of declining balance method.

2) There is no provision for Salvage Value( Residual Value)
3) 100 % of the asset’s cost is allocated to expense over the specific recovery period.
4) Assets with recovery period of 10 years or lesser are depreciated by the 200 % double declining
balance method.
5) Assets with the recovery period of 15 or 20 years are depreciated by 150% declining balance method
6) The half year convention normally is applied in all recovery periods of 20 years or less.

COMPUTATION OF COST OF FIXED PLANT ASSET & EQUIPMENT

 List Price of an Asset----------------------------------------------------------------Rs.xxxx
Less: Trade Discount (If Any) ---------------------------------------------------------xxx
Net Purchase Acquisition Price------------------------------------------------------xxxx
Cash Discount (If any on Credit Terms) -------- -----------------------------------xxx
Net Cash Price of an Asset-------------------------------------------------------------xxx
Add: - Sales Tax (If Any) ------------------------------------------------------------ +xxxx
Net Invoice/Billed Price of an Asset-----------------------------------------------xxxx

Add:-ADDITIONAL EXPENSES/OTHER EXPENSES\DIRECT EXPENSES

Custom and Import Duty-------------------------------Rs.xxx

Installation and Testing Charges-------------------------xxx
Freight in/Transportation Expenses--------------------xxx
Registration Charges----------------------------------------xxx
Foundation Charges----------------------------------------xxx

Insurance In Transit-----------------------------------------xxx

Packing Charges--------and Etc. -------------------------xxxx

Total Other Expenses---------------------------------------------------------------xxx

Total Cost of the Fixed Asset------------------------------------------------------xxxx

HALF YEAR CONVENTION METHOD

The Practice of taking six months depreciation in the year of acquisition and the year of disposition ,
rather than computing depreciation for partial periods to the nearest month. This method is widely
used and is acceptable for both income tax reporting and financial reports, as long as it is applied to
all the assets of a particular type acquired during the year. Half year convention method is generally
not used for buildings.

ACRES

The Accelerated Cost Recovery System, the only accelerated depreciation method permitted in
Federal Income Tax returns for assets acquired/bought from 1981 to 1986.

MACRS

The Modified Accelerated Cost Recovery System, the only accelerated method permitted in Federal
Income Tax returns acquired/bought after December 31st 1986(From Jan1 1987 and onwards).
Depreciation is based upon prescribed recovery periods and depreciation rates.

CREDIT TERMS (Cash Discount received on the basis of Credit Terms)

3/10,n/30==Means 3% discount will be given to the buyer party if the party makes the Cash payment
within 10 days, otherwise the total credit given to the buyers is for 30 days and after 10 days no discount
will be given to the buyer. Other Credit Terms are:-2/10, n/45 OR 3/10, n/60 and etc.

GENERAL JOURNAL

ENTRY FOR THE CAPITAL EXPENDITURES

1) Fixed Asset Cost ---------------------------DR

Cash/Bank/Accounts P/A---------CR

ENTRY FOR THE REVENUE EXPENDITURES

-------------Expense--------------------------DR

-------------Expense--------------------------DR

-------------Expense--------------------------DR

Cash/Bank/Accounts P/A-------CR

ADJUSTING ENTRY TO RECORD DEPRECIATION EXPENSE

END OF THE YEAR/PERIOD

• Depreciation Expense---------------------------------DR
Allowance for/Accumulated Depreciation (------------) ----CR

CLOSING ENTRY TO CLOSE DEPRECIATION EXPENSE

END OF THE YEAR/PERIOD

• Income Summary------------------------------------DR
Depreciation Expense (---------------) ------CR

--------------------------------Company

PARTIAL BALANCE SHEET

AS ON----------------------------------201X
ASSETS AMOUNTS

Fixed Asset (Machine or Building Or Equipment and etc.) Rs.xxxxxx

Less:-Accumulated Depreciation (Total depreciation) (xxxxx)
Book Value/Present Value xxxxx
CAPITAL EXPENDITURE & REVENUE EXPENDITURE:

CAPITAL EXPENDITURE:

All those expenditures due to which the capacity, efficiency or life of the fixed asset increased or the
value of the asset increased. These expenses are not shown in the income statement but these are to
be added to the fixed asset and are recorded in assets account. Such expenditure is expected to benefit
more than one year of accounting period.

EXAMPLES:-

• Replacement of engine of a factory truck/any automobile.

• Purchase of office furniture for business use.
• Purchase of the hard disk for a computer to increase its storage capacity and Etc.

REVENUE EXPENDITURE

All those expenditures due to which the capacity, efficiency or the life of the fixed asset is not increased
or the value of the assets does not increased. These expenses are shown in the income statement and
are not added to the cost of fixed asset. These expenditures are recorded by debiting expense account.

EXAMPLES

• Change of driving seat of a truck /any automobile of the business.

• Monthly maintenance charges of a factory truck.
• Painting charges of any picture on the truck used in the business.
• Cost of replacing a spark plugs of an automobile.
• Annual maintenance of plant and equipment.
• Three years insurance paid on equipment for fire risk
• Cost of repainting a building.

PROPERTY/PLANT & EQUIPMENT EXPENDITURE

The expenditures which are more or less required on behalf of Fixed Assets in order to increase
operating efficiency are called “Property Expenditures”. These expenditures may be classified as
follows:-

1) ORDINARY/MINOR EXPENDITURES( REVENUE EXPENDITURES)

All the regular expenses incurred to maintain a fixed asset in its normal good condition are
considered as Ordinary Repairs and are called as ordinary or Minor or Revenue Expenditures.

ENTRY FOR ORDINARY REPAIR EXPENSE

• ---------------Repair Expense-----------DR
Cash/Bank-------------CR
2) EXTRA ORDINAARY/MAJOR OVERHAULING EXPENDITURES (CAPITAL EXPENDITURES)

If major repair or replacement of a part of a fixed asset increases the book value of fixed asset as well
as the period or useful life of the fixed asset is called “Extra Ordinary Repair Expenditures or Capital
Expenditures”. The expenditures so incurred may change to a fixed asset account instead of an
expense account.

ENTRY FOR EXTRA ORDINARY REPAIR EXPENSE

Allowance for Depreciation/Asset Cost-----------D

Cash/Bank---------------------------------CR

DISPOSAL/REMOVAL OF FIXED PLANT ASSETS FROM THE BUSINESS

The fixed plant asset can be disposed of/removed from the business by three different ways. They are
as follows:-

1) Sale of Fixed Assets 2) Trade in or Exchange of Fixed Assets 3) Discard or Retirement or Scrape
of Fixed Assets.

MULTIPLE CHOICE QUESTIONS