What is Depreciation Accounting
Depreciation means a permanent and continuing fall in the value of the asset. According to the Institute of Chartered Accountants of England, “Depreciation is that part of the cost of a fixed asset to its owner which is not recoverable when the asset is finally put out of use by him. Provision against this loss of capital is an integral cost of conducting the business during the effective commercial life of the asset and is not dependent upon the amount of profit earned.” The term depreciation is used only in respect of fixed assets.
Method of Depreciation Accounting
Straight Line Method
Under this methods, depreciation remains same throughout the life of the asset. The total amount of depreciation is allocated to the useful life of ‘the asset in equal proportion. This is most simple and widely used method of depreciation.
Reducing Balance Method
Also, known as Written Down Value method, the depreciation is high in the initial years and less in the subsequent years. Since the maintenance expenditure is low in initial years and high in later years, this method leads to more or less uniform expenditure on depreciation and maintenance taken together. throughout the life of the asset. Though, the calculation of percentage of depreciation is complex, it is widely used and even for Income Tax purposes,only this method is used to calculate depreciation In this method the value of the asset never become Zero.
In this method, the depreciation is calculated based on the annuity table, considering the amount to be required to replace the asset at the end of the useful life of the asset. Here also, the amount of depreciation remains same in all the years.
Depreciation Fund Method
It is actually not a method of calculating depreciation but a method of providing depreciation in the books. In this method, the depreciation amount is calculated using the straight line or annuity method. The annual depreciation amount is set aside in an account called Depreciation Fund account and it is invested in safe and liquid securities.
The annual depreciation amount is decided in such a way that the total amount accumulated from the depreciation and the income from the investments is nearly equal to the amount required to replace the assets at the end of the useful life. The journal entries are similar to the debenture redemption fund method, which is explained in the chapter of company accounts.
It is used for peculiar assets like mines, quarries etc. where an estimate of total quantity of output by the asset can be fairly known. The depreciation per unit of the asset is calculated based on the availability of total units year depreciation is calculated according to the number of units extracted out of the asset.