**Depreciation** is a permanent, continuing, and gradual shrinkage in the book value of fixed assets. It represents the decline in the value of a depreciable asset due to its use, passage of time, or obsolescence.
**Formal Definition (AS-6 by ICAI):** Depreciation is "a measure of the wearing out, consumption or other loss of value of depreciable asset arising from use, effluxion of time or obsolescence through technology and market-change. Depreciation is allocated so as to charge fair proportion of depreciable amount in each accounting period during the expected useful life of the asset."
**Key Characteristics:**
**Example:** A machine purchased for ₹1,00,000 on April 1, 2017, with useful life of 10 years. The depreciation for 2017-18 would be ₹10,000 (1/10th of cost), charged against profit for that year, not the entire ₹1,00,000. This follows the **matching principle** — costs are matched with revenues of the same period.
**Depreciable Assets** include machines, plants, furniture, buildings, computers, trucks, vans, and equipment. These assets must:
**Depletion** refers to the reduction in value of natural resources such as mines, quarries, oil wells, and forests due to extraction or exhaustion of materials.
**Key Distinction from Depreciation:**
**Example:** A coal mine purchased for ₹10,00,000. As coal is extracted, the value declines — this decline is depletion, not depreciation.
**Amortisation** is the process of writing off the cost of **intangible assets** like patents, copyrights, trademarks, franchises, and goodwill over their estimated useful lives.
**Key Points:**
**Example:** A patent purchased for ₹10,00,000 with useful life of 10 years. Amortisation charged annually = ₹1,00,000.
**Comparison Table:**
| Feature | Depreciation | Depletion | Amortisation |
|---------|--------------|-----------|--------------|
| Asset Type | Tangible fixed assets | Natural resources | Intangible assets |
| Cause | Usage, time, obsolescence | Extraction, exhaustion | Time-limited utility |
| Example | Machinery, building | Coal mine, oil well | Patent, goodwill |
**Wear and Tear** means deterioration and diminution in an asset's value from its use in business operations. It reduces the asset's technical capacity to serve its intended purpose.
**Two Aspects:**
1. **Physical Deterioration from Use:** Asset loses capacity through operational wear (machinery running, equipment handling)
2. **Physical Deterioration from Time:** Assets deteriorate due to passage of time and exposure to natural elements (weather, rust, rot) even without use
**Example:** A truck used daily for 3 years suffers wear and tear from use; an idle truck left exposed to rain and sun also deteriorates from time passage.
Certain assets lose value when legal agreements governing their use expire. The asset becomes economically useless without legal backing.
**Examples:**
The utility and revenue generation from such assets ceases immediately upon expiration.
**Obsolescence** means an asset becoming "out-of-date" due to technological or market changes, rendering it less valuable or unusable despite physical durability.
**Factors Causing Obsolescence:**
**Example:** A 5-year-old printing machine becomes obsolete when digital printing technology emerges, even if mechanically sound.
Unexpected events causing permanent loss of asset value though not continuing or gradual. Accidental losses are exceptional.
**Examples:**
**Matching Principle** requires that costs be matched against revenues of the same period. Depreciation is a business cost like salary, postage, or carriage.
When fixed assets are used to generate revenue, their wear and tear is a legitimate expense of that period. The capital expenditure must be systematically allocated over the asset's useful life, not charged entirely in the purchase year.
**Accounting Treatment:** Depreciation is deducted before calculating net profit according to **Generally Accepted Accounting Principles (GAAP).**
**Example:**
```
Profit before Depreciation and Tax ₹50,000
(-) Depreciation (₹10,000)
Profit Before Tax ₹40,000
```
Depreciation is a **deductible cost** for income tax purposes. However, tax rules for calculating depreciation may differ from standard business accounting practices. Businesses must follow tax regulations for tax filing while maintaining separate accounting records if needed.
**Balance Sheet Principle:** Without providing depreciation, assets are **overstated** on the balance sheet, presenting an inflated financial position.
**Legal Requirement:** Accounting Standards and company law provisions require depreciation to be shown to present a **true and fair view** of financial position.
**Example:** If a ₹50,000 machine is shown at full cost after 5 years instead of reduced book value, assets appear inflated by the depreciation amount.
Corporate and other regulated enterprises must comply with specific legislation requiring depreciation provision. This includes Companies Act provisions and Accounting Standards issued by ICAI.
Depreciation calculation depends on three parameters:
**Cost** (original cost or historical cost) includes:
**AS-6 Definition:** "Total cost spent in connection with its acquisition, installation and commissioning as well as for addition or improvement of the depreciable asset."
**Example:** Photocopier purchased for ₹50,000, transportation and installation ₹5,000. **Total Cost = ₹55,000**
**Net Residual Value** (also called scrap value, salvage value, or terminal value) is the estimated net amount realizable from selling the asset at the end of its useful life.
**Calculation:**
```
Net Residual Value = Expected Sale Value - Disposal Expenses
```
**Example:** Machine purchased for ₹50,000, expected sale value after 10 years = ₹6,000, disposal expenses = ₹1,000
```
Net Residual Value = ₹6,000 - ₹1,000 = ₹5,000
```
**Depreciable Amount** is the amount to be charged as depreciation over the asset's useful life.
```
Depreciable Amount = Cost of Asset - Net Residual Value
```
**Example (continuing above):**
```
Depreciable Amount = ₹50,000 - ₹5,000 = ₹45,000
```
This ₹45,000 is distributed and charged as depreciation expense over 10 years.
**Critical Point:** Total depreciation charged over the useful life **must equal** the depreciable amount. Under-recovery means capital expenditure is not fully written off; over-recovery means depreciation exceeds actual decline.
**Useful Life** is the period over which a depreciable asset is expected to be used by the enterprise. It may be measured as:
**Determination Factors:**
**Example:** A machine's useful life might be 10 years or 100,000 units of production, whichever comes first.
According to AS-6, there are **two main methods** of calculating depreciation:
1. **Straight Line Method (SLM)**
2. **Written Down Value Method (WDV)**
**Selection Criteria:**
**Important Requirement:** The selected method must be applied **consistently** from period to period. Changes are allowed only under specific and justifiable circumstances.
**Definition:** Equal amount of depreciation is charged every year throughout the useful life of the asset.
**Formula:**
```
Annual Depreciation = (Cost of Asset - Net Residual Value) / Useful Life in Years
= Depreciable Amount / Useful Life in Years
```
**Also Expressed As:**
```
Annual Depreciation = Original Cost × Depreciation Rate (%)
Where, Depreciation Rate (%) = (100 / Useful Life in Years)
```
**Depreciation Expense:** Charged to Profit and Loss Account
**Book Value Reduction:** Equal reduction each year
**Final Book Value:** Equal to net residual value at end of useful life
**Numerical Example 1:**
A machine costs ₹1,00,000, useful life 5 years, net residual value ₹20,000.
```
Annual Depreciation = (₹1,00,000 - ₹20,000) / 5 = ₹80,000 / 5 = ₹16,000
Depreciation Rate = 100/5 = 20% per annum
Annual Depreciation = ₹1,00,000 × 20% = ₹20,000
(Note: This applies to original cost without deducting residual value)
```
**Depreciation Schedule:**
| Year | Opening Book Value | Depreciation | Closing Book Value |
|------|-------------------|--------------|-------------------|
| 1 | ₹1,00,000 | ₹16,000 | ₹84,000 |
| 2 | ₹84,000 | ₹16,000 | ₹68,000 |
| 3 | ₹68,000 | ₹16,000 | ₹52,000 |
| 4 | ₹52,000 | ₹16,000 | ₹36,000 |
| 5 | ₹36,000 | ₹16,000 | ₹20,000 |
**Characteristics:**
**When SLM is Preferred:**
**Journal Entry for SLM:**
```
Dr. Depreciation Expense/Profit & Loss Account ₹16,000
Cr. Accumulated Depreciation/Provision for Depreciation ₹16,000
(To record annual depreciation on machine)
```
OR
```
Dr. Depreciation Expense ₹16,000
Cr. Machine Account ₹16,000
(To record depreciation directly reducing asset value)
```
**Definition:** A constant depreciation rate is applied to the **reducing book value** (written down value) of the asset each year. Depreciation amount decreases annually as the book value decreases.
**Formula:**
```
Annual Depreciation = Book Value at Beginning of Year × Depreciation Rate (%)
Where Depreciation Rate (%) = 1 - (Salvage Value / Cost)^(1/n)
(Nth root formula for precise rate)
Alternatively (Simplified):
Depreciation Rate must be given in the problem or can be calculated as:
Depreciation Rate (%) = (1 - n√(Salvage Value / Cost)) × 100
```
**Characteristics:**
**Numerical Example 2:**
A machine costs ₹1,00,000, useful life 5 years, net residual value ₹20,000. Assuming a depreciation rate of 15% per annum using WDV method.
```
Formula: Annual Depreciation = Book Value at Start × Rate
```
**Depreciation Schedule:**
| Year | Opening Book Value | Depreciation Rate | Depreciation Amount | Closing Book Value |
|------|-------------------|------------------|--------------------|--------------------|
| 1 | ₹1,00,000 | 15% | ₹15,000 | ₹85,000 |
| 2 | ₹85,000 | 15% | ₹12,750 | ₹72,250 |
| 3 | ₹72,250 | 15% | ₹10,838 | ₹61,412 |
| 4 | ₹61,412 | 15% | ₹9,212 | ₹52,200 |
| 5 | ₹52,200 | 15% | ₹7,830 | ₹44,370 |
**Calculation Detail (Year 1):**
```
Opening Book Value = ₹1,00,000
Depreciation = ₹1,00,000 × 15% = ₹15,000
Closing Book Value = ₹1,00,000 - ₹15,000 = ₹85,000
```
**Calculation Detail (Year 2):**
```
Opening Book Value = ₹85,000
Depreciation = ₹85,000 × 15% = ₹12,750
Closing Book Value = ₹85,000 - ₹12,750 = ₹72,250
```
**When WDV is Preferred:**
**Journal Entry for WDV:**
```
Dr. Depreciation Expense ₹15,000
Cr. Accumulated Depreciation/Provision for Depreciation ₹15,000
(To record depreciation in Year 1)
```
**Comparison Between SLM and WDV:**
| Aspect | SLM | WDV |
|--------|-----|-----|
| Annual Depreciation | Constant/Equal | Decreasing |
| Applied On | Original Cost | Reducing Book Value |
| Early Years | Lower charge | Higher charge |
| Later Years | Higher charge | Lower charge |
| Book Value | Reaches salvage value exactly | Approaches salvage value |
| Calculation | Simple | Complex |
| Tax Benefit | Spread evenly | Front-loaded |
| Obsolescence | Not suitable | Suitable |
| Best For | Buildings, structures | Machinery, vehicles |
**Standard Entry:**
```
Dr. Depreciation Expense/Profit & Loss A/c [Amount]
Cr. Accumulated Depreciation/Provision for Depreciation [Amount]
Narration: (To record depreciation on [asset name] for the year)
```
OR
```
Dr. Depreciation Expense [Amount]
Cr. [Asset Name] A/c [Amount]
Narration: (To record depreciation for the year)
```
**Example Entry:**
```
Dr. Depreciation on Machinery A/c ₹10,000
Cr. Provision for Depreciation on Machinery A/c ₹10,000
(To record depreciation on machinery for the year 2024-25)
```
**Method 1: Using Provision/Accumulated Depreciation Account**
**Machinery Account (Asset Side):**
```
Machinery A/c
Date Particulars Dr. Cr. Date Particulars Dr. Cr.
2024-01 Cash/Bank 50,000 2024-03-31 Balance c/d 50,000
2025-01 Balance b/d 50,000
```
**Provision for Depreciation on Machinery (Separate Account):**
```
Provision for Depreciation on Machinery A/c
Date Particulars Dr. Cr. Date Particulars Dr. Cr.
2024-03 Balance c/d 10,000 2024-03-31 Depreciation 10,000
2025-01 Balance b/d 10,000 2025-03-31 Depreciation 10,000
Balance c/d 20,000
```
**Method 1: Separate Presentation (Most Common)**
```
Balance Sheet as on 31st March 2025
ASSETS
Fixed Assets:
Machinery ₹50,000
Less: Provision for Depreciation (₹10,000)
₹40,000
```
**Method 2: Direct Reduction (Less Common)**
```
Balance Sheet as on 31st March 2025
ASSETS
Fixed Assets:
Machinery (₹50,000 - ₹10,000) ₹40,000
```
When a depreciable asset is sold, exchanged, scrapped, or otherwise disposed of, accounting treatment depends on difference between book value and proceeds.
**At Time of Sale:**
```
Dr. Cash/Bank A/c [Proceeds]
Dr. Loss on Disposal of Asset A/c (if book value > proceeds) [Loss]
Cr. Asset A/c [Cost]
Cr. Provision for Depreciation A/c [Accumulated Depreciation]
Cr. Gain on Disposal A/c (if proceeds > book value) [Gain]
Narration: (To record sale of [asset] at [proceeds])
```
**Example: Machine Disposal**
A machine was purchased for ₹1,00,000. After 5 years, accumulated depreciation is ₹60,000 (book value ₹40,000). Sold for ₹45,000.
```
Dr. Cash A/c ₹45,000
Cr. Machinery A/c ₹1,00,000
Cr. Provision for Depreciation on Machinery A/c ₹60,000
Cr. Gain on Sale of Machinery A/c ₹5,000
(To record sale of machinery at ₹45,000)
```
**Calculation:**
```
Sale Price = ₹45,000
Less: Book Value = ₹40,000 (₹1,00,000 - ₹60,000)
Gain on Sale = ₹5,000
```
**If Loss on Disposal:**
Machine cost ₹1,00,000, accumulated depreciation ₹60,000 (book value ₹40,000), sold for ₹35,000.
```
Dr. Cash A/c ₹35,000
Dr. Loss on Sale of Machinery A/c ₹5,000
Cr. Machinery A/c ₹1,00,000
Cr. Provision for Depreciation on Machinery A/c ₹60,000
(To record sale of machinery at ₹35,000 loss)
```
**Calculation:**
```
Sale Price = ₹35,000
Less: Book Value = ₹40,000
Loss on Sale = ₹5,000
```
**Provision** is an **estimated liability** of uncertain amount or timing, created against a known or anticipated loss or expense that will likely occur during the business operations.
**Formal Definition:** A provision is a charge made against profits to provide for an estimated loss, liability, or diminution in value of assets.
1. **Application of Prudence/Conservatism Principle:** Recognizing potential losses before they are confirmed
2. **True Profit Calculation:** Matching estimated expenses with revenue
3. **True Financial Position:** Showing accurate asset values and liabilities
4. **Legal Compliance:** Meeting statutory requirements
5. **Business Prudence:** Protecting business against future uncertainties
1. **Provision for Depreciation:** Written-off cost of fixed assets
2. **Provision for Doubtful Debts:** Estimated bad debts from credit sales
3. **Provision for Warranty:** Expected warranty claim costs
4. **Provision for Legal Claims:** Anticipated legal liability payments
5. **Provision for Tax:** Estimated tax liability
6. **Provision for Repairs and Maintenance:** Expected major repairs
7. **Provision for Obsolescence:** Stock expected to become unsaleable
```
Dr. Expense A/c (or Profit & Loss A/c) [Amount]
Cr. Provision A/c [Amount]
Narration: (To create provision for [specify type])
```
**Example: Provision for Doubtful Debts**
```
Dr. Provision for Doubtful Debts Expense A/c ₹5,000
Cr. Provision for Doubtful Debts A/c ₹5,000
(To create provision for doubtful debts at 5% of debtors)
```
**Method 1: Shown as Liability**
```
LIABILITIES
Current Liabilities:
Provision for Doubtful Debts ₹5,000
```
**Method 2: Shown as Deduction from Related Asset**
```
ASSETS
Current Assets:
Debtors ₹1,00,000
Less: Provision for Doubtful Debts (₹5,000)
₹95,000
```
**Reserve** is a portion of profit appropriated and retained in the business for specific future needs, expansion, or strengthening of financial position. It is **not a charge against profit** but an **appropriation of profit.**
**Formal Definition:** Reserves are amounts set aside out of profits and other surpluses for specific or general purposes, with the intention that they may be used for the business development and expansion or to meet contingencies.
1. **Business Growth:** Funding expansion and modernization
2. **Financial Stability:** Strengthening liquidity and solvency
3. **Contingency Funds:** Meeting unexpected business needs
4. **Dividend Stability:** Maintaining consistent dividend payments
5. **Regulatory Compliance:** Meeting statutory reserve requirements
6. **Investor Confidence:** Showing financial prudence
7. **Risk Management:** Protecting against business uncertainties
```
Dr. Profit & Loss A/c (or Retained Earnings) [Amount]
Cr. Reserve A/c (Specific Type) [Amount]
Narration: (To transfer profit to [type of reserve])
```
**Example: General Reserve Creation**
```
Dr. Profit & Loss A/c ₹10,000
Cr. General Reserve A/c ₹10,000
(To transfer ₹10,000 to General Reserve)
```
**Capital Reserves** are created from **capital profits** (profits not arising from ordinary business operations) and generally **cannot be distributed as dividend.**
**Examples:**
**Restriction:** Cannot be used for paying dividends under most jurisdictions
**Example Entry:**
```
Dr. Profit on Sale of Machinery A/c ₹20,000
Cr. Capital Reserve A/c ₹20,000
(To transfer profit from fixed asset sale to Capital Reserve)
```
**Revenue Reserves** are created from **revenue profits** (ordinary business profits) and can be **distributed as dividend** at management's discretion.
**Types of Revenue Reserves:**
**A. General Reserve (Unspecified Reserve)**
**B. Specific Reserves (Special Reserves)**
**C. Statutory Reserves**
**Journal Entries for Revenue Reserves:**
```
Dr. Profit & Loss A/c ₹15,000
Cr. General Reserve A/c ₹15,000
(To transfer ₹15,000 to General Reserve)
```
```
Dr. Profit & Loss A/c ₹25,000
Cr. Contingency Reserve A/c ₹25,000
(To create Contingency Reserve for unforeseen circumstances)
```
**Secret Reserve** is an intentional and deliberate understatement of asset values or overstatement of liabilities to **conceal the true financial position** of business.
**How Created:**
**Example of Secret Reserve Creation:**
```
Actual stock value = ₹1,00,000
Shown in Balance Sheet = ₹75,000
Secret Reserve created = ₹25,000
Or
Actual Debtors = ₹80,000
Shown in Balance Sheet = ₹60,000
Secret Reserve created = ₹20,000
```
**Journal Entry (Intentional):**
```
Dr. Profit & Loss A/c ₹25,000
Cr. Provision for Stock Obsolescence A/c ₹25,000
(To create excessive provision masking secret reserve)
```
1. **Lacks Transparency:** Hides true financial position
2. **Misleads Stakeholders:** Provides false information to investors, creditors, tax authorities
3. **Legal Non-Compliance:** Violates accounting standards and company law
4. **Tax Evasion:** Used for tax avoidance
5. **Fraud:** Considered a form of financial fraud
6. **Lack of Accountability:** Management hides performance
**Important Note:** Creating secret reserves is **illegal and unethical.** Modern accounting standards, audit requirements, and company law strictly prohibit secret reserves.
| Aspect | Provision | Reserve |
|--------|-----------|---------|
| **Source** | Charge against current profit | Appropriation of profit |
| **Nature** | Estimated liability or loss | Retention of profit |
| **Amount** | Definite/Measurable | Arbitrary/Discretionary |
| **Purpose** | Meet known/probable loss | Growth, expansion, contingencies |
| **Timing** | Before profit finalization | After profit calculation |
| **Deductible** | From profit (reduces profit) | Not deducted from profit |
| **Necessity** | Mandatory for prudence | Optional, discretionary |
| **Accounting Treatment** | Expense account | Appropriation account |
| **Legality** | Mandatory by principles | Generally legal |
| **Balance Sheet Position** | Liability or Asset deduction | Part of Equity/Capital |
| **Examples** | Depreciation, Doubtful Debts | General Reserve, Contingency Reserve |
| **Reversibility** | May be reduced if provision unused | Can be reversed if needed |
**Scenario:** A company earned profit of ₹1,00,000 during the year. Management estimates:
1. Doubtful debts loss ₹5,000 (provision)
2. Wants to retain ₹15,000 for expansion (reserve)
**Journal Entries:**
```
For Provision (Charge Against Profit):
Dr. Provision for Doubtful Debts Expense A/c ₹5,000
Cr. Provision for Doubtful Debts A/c ₹5,000
Effect: Profit reduced from ₹1,00
Q1. Which of the following is NOT a characteristic of a depreciable asset according to AS-6?
Answer: B — AS-6 explicitly states depreciable assets are held for business operations (production/supply/rental/admin), NOT for resale in ordinary business course.
Q2. A machine is purchased for ₹50,000 on 1 April 2023 with an estimated useful life of 5 years and salvage value of ₹5,000. Using the straight-line method, what is the annual depreciation?
Answer: B — SLM depreciation = (Cost − Salvage Value) ÷ Useful Life = (₹50,000 − ₹5,000) ÷ 5 = ₹45,000 ÷ 5 = ₹9,000.
Q3. The journal entry to record depreciation of ₹8,000 on machinery using the accumulated depreciation method is:
Answer: B — Depreciation is an expense (debit) matched against revenue in P&L; accumulated depreciation (credit) accumulates the expired cost without reducing the asset's original cost directly.
Q4. Equipment has a book value of ₹10,000. If depreciation using written-down value method at 20% p.a. is charged, what is the depreciation for the next year?
Answer: A — WDV method: Depreciation = Book Value × Rate = ₹10,000 × 20% = ₹2,000; remaining book value becomes ₹8,000 for next year's calculation.
Q5. Which statement correctly describes the relationship between matching principle and depreciation?
Answer: B — The matching principle requires revenue of a period to be matched with related expenses of that period; depreciation allocates asset cost fairly across its benefit-generating periods.
Q6. Book value of an asset is ₹20,000 and accumulated depreciation is ₹30,000. What is the original cost of the asset?
Answer: B — Original Cost = Book Value + Accumulated Depreciation = ₹20,000 + ₹30,000 = ₹50,000.
Q7. Both straight-line and written-down value methods must be applied consistently to ensure comparability. Which of the following statements is correct? Assertion (A): Change in depreciation method is never allowed once selected. Reason (R): Consistency in accounting methods ensures meaningful comparison across periods.
Answer: C — While consistency is important (R is true), AS-6 allows change in depreciation method under specific circumstances; therefore A is false.
Q8. A building is purchased for ₹5,00,000 with useful life of 25 years and no salvage value. After 10 years, what is the book value using the straight-line method?
Answer: B — Annual depreciation = ₹5,00,000 ÷ 25 = ₹20,000; Accumulated depreciation after 10 years = ₹20,000 × 10 = ₹2,00,000; Book Value = ₹5,00,000 − ₹2,00,000 = ₹3,00,000.
Q9. Which of the following statements about provisions and reserves is correct? Statement 1: A provision is a likely future liability charged against profit. Statement 2: A reserve is retained profit appropriated for specific future needs.
Answer: C — Under conservatism principle, provisions (e.g. bad debts) are charged to P&L as likely future liabilities; reserves are amounts retained from profit for future growth—both definitions are accurate.
Q10. Why is depreciation considered an 'expired cost' rather than a current cash expense?
Answer: A — Depreciation is an 'expired cost' because the capital expenditure cash outflow occurred in a past period; in the current period, only a portion of that historical cost is matched as expense against revenue earned.
Define depreciation in accounting terms.
Depreciation is the permanent, gradual reduction in book value of a fixed asset due to its use, passage of time, or obsolescence, allocated fairly over its useful life.
What are the three factors that determine depreciation amount?
Cost of asset, useful life of asset, and net realisable value (salvage value) are the three factors affecting depreciation calculation.
State the matching principle and its link to depreciation.
The matching principle requires revenue of a period to be matched against expenses of the same period; depreciation ensures capital cost is spread across periods that benefit from the asset.
What is the difference between straight-line method and written-down value method?
Straight-line charges equal depreciation yearly: (Cost − Salvage) ÷ Life; written-down value charges a fixed percentage on the remaining book value, resulting in decreasing annual depreciation.
Give the standard journal entry to record depreciation.
Debit Depreciation Expense/Profit & Loss Account; Credit Accumulated Depreciation (or the Asset Account itself depending on method).
Define a depreciable asset according to AS-6.
A depreciable asset is used over more than one accounting period, has limited useful life, and is held for business operations—not for resale in ordinary course.
Why is depreciation charged despite no cash outflow in the current period?
Depreciation represents an expired cost of a capital expenditure already paid in a past period; it is charged to match the revenue generated by using that asset.
Distinguish between a provision and a reserve.
A provision is a likely future liability charged against profit in the current period under conservatism principle; a reserve is retained profit appropriated for future needs without being a liability.
What does 'obsolescence' mean in the context of depreciation?
Obsolescence is the loss of value due to technological changes, market changes, or arrival of new models that make an asset outdated or less useful.
How is book value of a fixed asset shown in the balance sheet?
Book value is displayed as: Cost of Asset minus Accumulated Depreciation, representing the unexpired portion of the asset's original cost.
Define depreciation and explain why it is charged despite being an expired cost and not a cash outflow in the current accounting period. [2 marks]
State that depreciation is permanent shrinkage in book value of fixed assets; explain that capital expenditure cash was paid in prior period, and current period expense allocation matches revenue earned from using that asset.
A company purchased machinery for ₹1,00,000 on 1 January 2023. The estimated useful life is 10 years and salvage value is ₹10,000. Calculate annual depreciation using the straight-line method and prepare the journal entry for the year ended 31 December 2023. Also show how the asset will appear in the Balance Sheet as on 31 December 2023. [5 marks]
Use formula: (Cost − Salvage Value) ÷ Useful Life = (₹1,00,000 − ₹10,000) ÷ 10. Journal entry debits Depreciation Expense and credits Accumulated Depreciation. Balance Sheet shows Machinery at cost less accumulated depreciation to arrive at book value.
Explain the difference between the straight-line method and written-down value method of depreciation. A company has three assets: a building used steadily for 50 years, a vehicle expected to depreciate faster in early years, and computer equipment subject to rapid technological obsolescence. Recommend and justify the appropriate depreciation method for each asset, citing how AS-6 guides method selection. [6 marks]
SLM charges equal depreciation yearly based on (Cost − Salvage) ÷ Life; WDV charges fixed percentage on remaining book value annually, resulting in decreasing charges. Building: SLM (even benefit use); Vehicle & Computer: WDV (faster early depreciation reflects actual pattern). Justify selection based on asset type, nature of use, and circumstances as per AS-6; consistency principle also applies.
Practice with interactive flashcards, mind maps, upload your own chapters and get AI study kits instantly
Try StudyOS Free →