- Depreciation is a reduction in the value of a tangible fixed asset due to normal usage, wear and tear, new technology, or unfavorable market conditions. Unlike amortization which does not have any sub-types, there are different types of depreciation methods.
- Assets such as plant and machinery, furniture, building, vehicle, etc. which are expected to last more than one year, but not for infinity, are subject to such reduction. It is an allocation of the cost of a fixed asset in each accounting period during its expected time of use.
ENTRY:
Depreciation A/C Dr
To Fixed Asset A/C Cr
Types of method of Depreciation
Straight Line Method
- First, among types of depreciation methods is the straight-line method, also known as the Original cost method, Fixed instalment method, and Fixed percentage method.
- The simplest, most used and popular method of charging such a reduction is the straight-line method. An equal amount is allocated in each accounting period.
- Depreciation Amt = (Cost of an asset − Salvage Value) / Useful life of the asset in years
Example:
Asset cost = 1,000,000
Depreciation Rate = 20%
1st year = 20/100*1,000,000
2nd year = 20/100*1,00,000 for
Advantage
- Simple and easy to understand.
- The book value of an asset can be reduced to Zero.
- A fair evaluation of an asset each year on the balance sheet.
Diminishing Value Method
- Second, among types of depreciation methods is the diminishing value method and is also known as Written down value method, Reducing installment method and Fixed percentage on diminishing balance.
- According to the diminishing value method, it is charged on reducing balance & a fixed rate. In this case, written down value is spread between the useful life of the asset.
- The percentage, at which the shrink happens, remains fixed, however, the amount of depreciation goes on diminishing year after year.
diminishing value method of depreciation formula:
Depreciation for the Year = (Asset Cost – Salvage Value) × factor
Advantages
- More practical and easy to apply.
- The decreasing charge for depreciation cancels out increasing charges for repairs.
- This method is applicable for income tax purposes.
3. Double Declining Balance Method
Double declining balance depreciation method causes a higher amount of expenses in the previous years when compared to the latter years of the lifespan of a particular asset. It shows that such classes of assets are significantly more productive in its earlier years.
