Chapter 17 – Depreciation
Meaning of Depreciation
Depreciation is the permanent and continuous decrease in the value of a fixed asset due to its use, wear and tear, passage of time, obsolescence, accidents, or depletion (in the case of wasting assets like mines). It’s an accounting method to allocate the cost of a tangible asset over its useful life.
- It applies to tangible fixed assets (e.g., machinery, building, furniture).
- It is a non-cash expense, meaning no actual cash outflow occurs at the time depreciation is charged.
- It reduces the book value of the asset.
Causes of Depreciation
- Wear and Tear: Due to constant use of the asset.
- Passage of Time: Assets lose value even if not used, simply due to time g., expiry of leasehold property.
- Obsolescence: The asset becomes outdated due to technological advancements, new inventions, or changes in fashion.
- Accidents: Damage to the asset due to unforeseen events.
- Depletion: In the case of natural resources wasting assets like mines, quarries, oil wells, the value decreases as the resources are extracted.
- Permanent fall in Market Price: Although depreciation is generally not based on market fluctuations, a permanent decrease in market value can be a factor.
Objectives/Importance of Providing Depreciation
To ascertain the True Profit or Loss: Depreciation is an expense related to using an asset to generate revenue. Charging it ensures that the true cost of production and the actual profit/loss of the business are determined.
To show the True Financial Position: By reducing the asset’s value in the Balance Sheet, it presents a more realistic picture of the company’s financial health.
To ascertain the True Cost of Production: Depreciation is a part of the cost of production.Including it helps in setting appropriate selling prices for goods/services.
To provide funds for Replacement of Assets: Although depreciation is a non-cash expense, it helps in retaining funds within the business by reducing distributable profits. These retained profits can then be used to replace the old assets when they become unusable.
To avoid Overpayment of Income Tax: Depreciation is a recognized expense, and claiming it reduces taxable profit, leading to lower income tax liability.
To comply with Legal Provisions: Various laws like the Income Tax Act, Companies Act require depreciation to be charged.
Factors Determining the Amount of Depreciation
As per AS-10, the amount of depreciation to be changed to Statement of Profit and Loss will depend on the following factors:
- Cost of the Asset: This includes the purchase price plus all expenses incurred to bring the asset to its working condition and location g., installation charges, freight, duties.
- Estimated Useful Life of the Asset: The period over which the asset is expected to be used by the business.
- Estimated Scrap Value (or Residual Value/Salvage Value): The estimated realizable value of the asset at the end of its useful life.
Methods of Calculating Depreciation
- a) Straight-Line Method (SLM) / Original Cost Method / Fixed Instalment Method
Under this method, the amount of depreciation charged remains constant year after year throughout the useful life of the asset.
It is calculated on the original cost of the asset.
The asset’s book value will eventually be reduced to its scrap value or zero if no scrap value.
Formulae:
Annual Depreciation = (Cost of Asset – Estimated Scrap Value) / Estimated Useful Life (in years)
Rate of Depreciation (per annum) = (Annual Depreciation / Original Cost of Asset) * 100
- b) Written Down Value Method (WDV) / Diminishing Balance Method / Reducing Balance Method
Under this method, depreciation is charged at a fixed percentage on the diminishing (or written down) balance of the asset each year.
The amount of depreciation decreases every year.
The asset’s book value never becomes zero under this method.
Formula:
Annual Depreciation = Written Down Value of Asset at the beginning of the year * Rate of Depreciation / 100
Distinction between Straight-Line Method and Written Down Value Method
| Feature | Straight-Line Method (SLM) | Written Down Value Method (WDV) |
| Amount of Depreciation | Constant every year. | Decreases every year. |
| Basis of Calculation | Original Cost of the asset. | Diminishing (Written Down) Balance of the asset. |
| Asset Value at End | Can be reduced to zero or scrap value. | Never reduced to zero. |
| Impact on P&L A/c | Equal charge to Profit & Loss Account each year. | Higher charge in initial years, lower in later years. |
| Suitability | Assets with uniform utility over time (e.g., buildings). | Assets that lose value quickly in initial years (e.g., machinery). |
| Maintenance Cost | Ignores increasing repair costs with age of asset. | Balances total charge (Depreciation + Repairs) over asset life. |
Question 1 (Straight-Line Method)
On April 01, 2023, Mahesh Ltd. purchased a machine for ₹2,50,000. Installation charges amounted to ₹50,000. The estimated useful life of the machine is 10 years and its estimated scrap value at the end of its useful life is ₹20,000. The company closes its books on March 31 every year.
- Calculate the amount of annual depreciation using the Straight-Line Method.
- Pass the necessary Journal Entry for depreciation for the year ended March 31, 2024.
- Show the Machine Account for the first year (2023-24).
Working Notes:
Cost of Machine = Purchase Price + Installation Charges
Cost of Machine = ₹2,50,000 + ₹50,000 = ₹3,00,000
Annual Depreciation = (Cost of Asset – Estimated Scrap Value) / Estimated Useful Life
Annual Depreciation = (₹3,00,000 – ₹20,000) / 10 years
Annual Depreciation = ₹2,80,000 / 10
Annual Depreciation = ₹28,000
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
| 2024 Mar 31 | Depreciation A/c Dr. | 28,000 | ||
| To Machine A/c | 28,000 | |||
| (Being depreciation charged on machine) | ||||
| 2024 Mar 31 | Profit & Loss A/c Dr. | 28,000 | ||
| To Depreciation A/c | 28,000 | |||
| (Being depreciation transferred to P&L A/c) |
Machine Account
| Date | Particulars | J.F. | Amount (₹) | Date | Particulars | J.F | Amount (₹) |
| 2023 Apr 01 | To Bank A/c | 2,50,000 | 2024 Mar 31 | By Depreciation A/c | 28,000 | ||
| 2023 Apr 01 | To Bank A/c | 50,000 | 2024 Mar 31 | By Balance c/d | 2,72,000 | ||
| Total | 3,00,000 | Total | 3,00,000 | ||||
| 2024 Apr 01 | To Balance b/d | 2,72,000 |
Question 2 Priya Enterprises bought furniture for ₹60,000 on October 01, 2022. The estimated useful life of the furniture is 5 years. At the end of its life, it is expected to fetch ₹10,000 as scrap value. The accounting year closes on March 31.
- Calculate the rate of depreciation per annum under the Straight-Line Method.
- Calculate the depreciation for the financial year 2022-23.
- Calculate the book value of the furniture as on April 01, 2023.
Working Notes:
Annual Depreciation = (Cost of Asset – Estimated Scrap Value) / Estimated Useful Life
Annual Depreciation = (₹60,000 – ₹10,000) / 5 years
Annual Depreciation = ₹50,000 / 5
Annual Depreciation = ₹10,000
Now, calculate the Rate of Depreciation:
Rate of Depreciation (per annum) = (Annual Depreciation / Original Cost of Asset) × 100
Rate of Depreciation = (₹10,000 / ₹60,000) × 100
Rate of Depreciation = (1/6) × 100
Rate of Depreciation = 16.67%
- The furniture was used for 6 months (October 2022 to March 2023) in the financial year 2022-23.
Depreciation for 2022-23 = Annual Depreciation × (Months Used / 12)
Depreciation for 2022-23 = ₹10,000 × (6 / 12)
Depreciation for 2022-23 = ₹10,000 × 0.5
Depreciation for 2022-23 = ₹5,000
- Book Value = Original Cost – Total Depreciation till date
Book Value on April 01, 2023 = Original Cost – Depreciation for 2022-23
Book Value on April 01, 2023 = ₹60,000 – ₹5,000
Book Value on April 01, 2023 = ₹55,000
Question 1 (Written Down Value Method)
On April 01, 2023, Amit & Co. purchased machinery for ₹4,00,000. Depreciation is to be charged at 10% per annum on the Written Down Value Method. The company closes its books on March 31 every year.
- Calculate the depreciation for the first two financial years 2023-24 and 2024-25.
- Pass the necessary Journal Entries for depreciation for the year ended March 31, 2024, and March 31, 2025.
- Show the Machinery Account for the first two years 2023-24 and 2024-25.
Solution:
- Calculation of Depreciation:
For the financial year 2023-24:
Original Cost of Machinery (as on Apr 01, 2023) = ₹4,00,000
Depreciation for 2023-24 = 10% of ₹4,00,000 = ₹40,000
Written Down Value (WDV) as on Mar 31, 2024 = ₹4,00,000 – ₹40,000
= ₹3,60,000
For the financial year 2024-25:
Written Down Value (WDV) as on Apr 01, 2024 = ₹3,60,000
Depreciation for 2024-25 = 10% of ₹3,60,000 = ₹36,000
Written Down Value (WDV) as on Mar 31, 2025 = ₹3,60,000 – ₹36,000
= ₹3,24,000
- Journal Entries for Depreciation:
In the books of Amit & Co.
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
| 2024 Mar 31 | Depreciation A/c Dr. | 40,000 | ||
| To Machinery A/c | 40,000 | |||
| (Being depreciation charged for 2023-24) | ||||
| 2024 Mar 31 | Profit & Loss A/c Dr. | 40,000 | ||
| To Depreciation A/c | 40,000 | |||
| (Being depreciation transferred to P&L A/c) | ||||
| 2025 Mar 31 | Depreciation A/c Dr. | 36,000 | ||
| To Machinery A/c | 36,000 | |||
| (Being depreciation charged for 2024-25) | ||||
| 2025 Mar 31 | Profit & Loss A/c Dr. | 36,000 | ||
| To Depreciation A/c | 36,000 | |||
| (Being depreciation transferred to P&L A/c) |
- Machinery Account:
Machinery Account
| Date | Particulars | J.F. | Amount (₹) | Date | Particulars | J.F. | Amount (₹) |
| 2023-24 | |||||||
| 2023 Apr 01 | To Bank A/c | 4,00,000 | 2024 Mar 31 | By Depreciation A/c | 40,000 | ||
| 2024 Mar 31 | By Balance c/d | 3,60,000 | |||||
| Total | 4,00,000 | Total | 4,00,000 | ||||
| 2024-25 | |||||||
| 2024 Apr 01 | To Balance b/d | 3,60,000 | 2025 Mar 31 | By Depreciation A/c | 36,000 | ||
| 2025 Mar 31 | By Balance c/d | 3,24,000 | |||||
| Total | 3,60,000 | Total | 3,60,000 | ||||
| 2025 Apr 01 | To Balance b/d | 3,24,000 |
Question 2 Mittal Ltd. bought a truck on July 01, 2022, for ₹8,00,000. The company decides to charge depreciation at 15% per annum on the Written Down Value Method. The accounting year ends on March 31.
- Calculate the depreciation for the financial year 2022-23.
- Calculate the depreciation for the financial year 2023-24.
- Determine the book value of the truck as on April 01, 2024.
Solution:
- Calculation of Depreciation for the financial year 2022-23:
Cost of Truck: ₹8,00,000
Date of Purchase: July 01, 2022
Accounting Year End: March 31
Depreciation for 2022-23 = ₹8,00,000 × 15% × (9 / 12)
= ₹8,00,000 × (15/100) × (3/4)
= ₹1,20,000 × (3/4)
= ₹90,000
- Calculation of Depreciation for the financial year 2023-24:
WDV as on April 01, 2023 = Original Cost – Depreciation for 2022-23
= ₹8,00,000 – ₹90,000
= ₹7,10,000
Depreciation for 2023-24 = WDV as on April 01, 2023 × Rate of Depreciation
= ₹7,10,000 × 15%
= ₹7,10,000 × (15/100)
= ₹1,06,500
- Determination of Book Value of the truck as on April 01, 2024:
Book Value as on April 01, 2024 = WDV as on April 01, 2023 – Depreciation for 2023-24
= ₹7,10,000 – ₹1,06,500
= ₹6,03,500