meaning and methods calculation of Depreciation

WHAT IS DEPRECIATION?

Depreciation is the reduction in the value of assets due to wear and tear.

Every asset is subject to wear and tear in the ordinary course of its use and also with the passage of time. The cost of the asset is allocated over time and considered as expense.

It is applied on long term assets which give benefits for many years. For example on plant & machinery, vehicles, computers, furniture, building etc. Land is not subject to wear and tear and thus depreciation is not levied on land but applicable on a building.

onsidering depreciation as an expense is very much required for successful financial management. For example, a driver gives his car for tourism purpose, he has to consider the fact that car has a limited useful life and he needs to replace that after some years. For that, while calculating its operation cost, he has to consider the cost of car, its life, the resale value after useful life and add it to other expenses for calculating total cost.

COMMON METHODS OR TYPES OF DEPRECIATION

Written Down Value (WDV) Method

WDV method  is the most common used method of depreciation. Also in income tax act, depreciation is allowed as per WDV method only.

In this method depreciation is charged on the book value of asset and book value is decreased each year by the depreciation.For eg- Asset is purchased at rs. 1,00,000 and depreciation rate is 10% then first year depreciation is rs. 10,000(10% of rs. 1,00,000), second year depreciation is rs. 9,000 ( 10% of 90,000 [1,00,000 – 10,000]) and third year depreciation is rs. 8,100 ( 10% of rs. 81,000 [90,000 – 9,000]).

This method is also called reducing balance method. In the WDV method, the amount of depreciation goes on decreasing with time. An asset gives more value to a business in initial years then later year, therefore, this method is considered as the most logical method of depreciation.

 Straight Line Method (SLM)

In this method, equal amount of depreciation is charged on the asset over its useful life. For Example – asset is purchased for rs. 1,00,000 and useful life is 10 years with salvage value of Rs. 10,000 then depreciation is charged at Rs. 9,000 for each of the 10 years. (1,00,000 – 10,000)/10.

Formula for calculating depreciation rate (SLM) = (100 – % of resale value of purchase price)/Useful life in years
Depreciation = Purchase Price * Depreciation Rate or (Purchase price – Salvage Value)/Useful Life

There are also other methods of depreciation but they are not often used such as depreciation on the basis of units of production.

In companies act the depreciation rate is also based on the number of shifts. Logically an asset is expected to have a shorter life if it used extensively.Example –

Cost of asset = 2,00,000
Salvage value = 30,000
Useful Life = 10 Years

And thus Depreciation rate as per SLM = (100-15)/10 = 8.5%
Depreciation rate as per WDV = 17.28

year	Depreciation as per SLM	Depreciation as per WDV
1	17,000	34,560.53
2	17,000	28,588.38
3	17,000	23,648.23
4	17,000	19,561.75
5	17,000	16,181.43
6	17,000	13,385.24
7	17,000	11,072.23
8	17,000	9,158.92
9	17,000	7,576.24
10	17,000	6,267.04
Total Depreciation	1,70,000	1,70,000