Depreciation Accounting
What this domain tests
Depreciation questions test the meaning and causes of depreciation, the straight line and written down value methods, treatment of additions and disposals, and the provisions of the Companies Act, 2013 on useful lives.
Core rules
- Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life; it is a non-cash charge against profit.
- Straight line method: (Cost + installation and freight − residual value) ÷ useful life; equal charge every year.
- Written down value method: a fixed percentage applied to the opening book value; the charge falls each year and the book value never reaches zero.
- Companies Act, 2013, Schedule II prescribes useful lives - for example plant and machinery 15 years, furniture and fittings 10 years, computers 3 years, factory buildings 30 years. A different life requires technical justification and disclosure.
- Depreciation on additions is charged from the date the asset is put to use; land is not depreciated.
- Under the provision for depreciation method the asset stays at cost and a separate provision account accumulates the charge; the asset account is not reduced each year.
Worked example
A machine is bought for ₹5,00,000 with installation of ₹20,000 and residual value ₹20,000 over 8 years. Depreciable amount = 5,20,000 − 20,000 = ₹5,00,000; SLM charge = ₹62,500 a year. Under WDV at 10%: year 1 = ₹52,000, year 2 = ₹46,800, year 3 = ₹42,120. Reasoning: installation is capitalised because it is necessary to bring the asset to working condition; the residual value is excluded from the depreciable base; under WDV the percentage is applied to the reducing balance, not to cost.
Traps
Expensing installation and freight instead of capitalising them; depreciating land; computing profit on sale against original cost instead of book value; forgetting depreciation for the part of the year since purchase; applying the WDV rate to cost every year.