ACCOUNTING FOR FIXED ASSETS

► ACQUISITION OF FIXED ASSETS & DETERMINATION OF COSTS

► All Fixed Assets are shown in the books of accounts at their cost of acquisition or
construction
► Additionally, all costs are incurred to bring the assets to their stages of operation, are
also capitalized
► This is because the benefits of such expenditure are enjoyed over a period of years
► There are various types of expenditure capitalized for different long lived assets viz.
Land : The cost price normally includes purchase price, broker’s commission, legal
fees, cost of demolition of old structure, if any, cost of development of land, etc.
Self Constructed Assets : Conventionally, when a factory shed, railway sidings or
equipment is constructed for own use, all costs of materials, direct labour &
chargeable overhead (as also a fair share of company’s indirect expenses) incurred
during construction/installation are capitalized .
Buildings : Apart from actual construction costs, costs of permanent fixtures,
municipal fees for plan approval, stamp costs for execution of Deeds, architect’s fees,
supervision and administration expenses directly attributable to the construction, are
also capitalized.
Plant & Machinery : All costs of installation such as transportation, erection and
commissioning are also to be capitalized along with the costs of purchase.
 DEPRECIATION
An expenditure/Loss/Provision ?
► A provision is created in the final accounts towards :
(i) Wear & Tear of assets caused by usage & passage of time
(ii) technological obsolescence and replacement consideration
► Depreciation does not involve payment of money to any third party,
although shown as an accounting entry in the books
► Cost of Depreciation equals to the acquisition cost of an asset (less
salvage value) spread over the economic life of the asset
► The purpose of charging Depreciation is to match the cost of asset over
the period for which revenue is earned by using the asset.
► There are usually 4 methods for calculating the Depreciation expenditure
- the value of the fixed assets, its useful life and the salvage value, viz.
1. Straight Line Method
2. Declining /Diminishing /Reducing /Written Down Value (WDV) Method
3. Sum of the years’ – digits Method and
4. Units of Production Method
 Straight Line Method
Depreciation = (Asset Value – Salvage Value) / Estimated useful life (in
no. of years)

► Cost of the asset is charged off in equal proportion during its useful life
and the quantum of Depreciation is arrived at by dividing the net asset
cost by no. of years of economic life
► Illustration : Cost of Asset Rs. 1,00,000, Expected Salvage value Rs.
20,000 & Estimated life = 8n years
Thus, Annual Depreciation = Rs. 10,000 or 10 % p.a.
► Advantages of Straight Line Method :
1. The amount of Depreciation and the rate does nopt change over the
useful economic life of the asset
2. The calculation is relatively simple, and
3. It realistically matches the cost and revenue
 Written Down Value Method

► r = 1 – n (s/c)
► Where, r = rate of depreciation, n = no. of years ( useful life of the
asset), s = residual/scrap value and
c = original cost of the asset
Depreciation is charged at a specified rate on the original cost in the 1st
year and on book value or written down value of the previous year
from 2nd year onwards
Usually the rate(%) is higher than the Straight Line Method
Illustration :
Original cost of the machine Rs. 1,00,000
Estimated scrap value Rs. 30,000
Useful life = 6 years

r = 1 – (30,000/1,00,000)^1/6 = 18 %
 Year Book Value Depn. WDV

► 1st 1,00,000 18,000 82,000

► 2nd 82,000 14,760 67,000
► 3rd 67,240 12,103 55,137
► 4th 55,137 9,925 45,212
► 5th 45,212 8,138 37,074
► 6th 37,074 6,673 30,401

The small difference between estimated scrap value and

WDV at the end of 6th year is due to approximation