CONCEPT AND ACCOUNTING OF DEPRECIATION

Introduction:- Fixed Assets( property, plant and equipment) like Plant & Machinery, furniture etc. purchased, used for production or providing services for number of accounting years, but its value decreases with passage of time and utilization .i.e. by normal wear and tear, change in technology etc. So this diminution in value must be charged from P & L A/c for calculating exact profit. This charge to Profit and loss Account called Depreciation.

Characteristics of depreciation:

- It is related to depreciable fixed assets only.

- It is fall in the book value of depreciable fixed assets.

- The fall in the book value of an asset is due to the use of the asset

- It is a permanent decrease in the book value of an asset.

- It is continuous decrease in the book value of an asset.

Concept of Depreciation:- Property , plant and equipment are tangible items that:
(a) Are held for use in the production or supply of goods and services, for rentals to other, or for administration purposes; and (b) Are expected to be used during more than a period of 12 months.

These are also called fixed assets in common parlance. When a fixed asset is purchased, it is recorded in books of account at its original cost/acquisition cost. However fixed assets are used to earn revenues for a number of accounting periods in future with the same acquisition cost until the concerned fixed assets is sold or discarded. It is therefore necessary that a part of the acquisition cost of the fixed assets is allocated as an expense in each of the accounting period in which the asset is utilised. The amount of fixed assets allocated in such manner to respective accounting period is called depreciation. Value of such assets decreases with passage of time mainly due to following reasons:

Diminution – it means decrease in market value of asset.

Wear and Tear – Due to actual use of assets.

Efflux Of time – Due to passage of time, even if assets are not used.

Obsolescence- Due to technological changes, improvement in production method, changes in market demand for product and service and legal and other restriction.

Depletion- decrease in value of assets (natural resources) due to consumption i.e. coal mines, etc.

Objective for providing Depreciation:- Prime objectives for providing Depreciation are:-

(1) Correct Income Measurement: - Depreciation should be charged for proper estimation of periodic Profit or Loss.

(2) True position statement: - Depreciation should be charged to know actual financial position.

(3) Funds For replacement: - Charging depreciation help to General adequate fund in the hand of business for replacement of asset at the end of its useful life.

(4) Determine True Cost of production:- For determining true Cost of production, it is necessary to charge depreciation since it’s a item of cost.

Factors affecting the amount of depreciation Measurement:

Following factors require to be considered for calculating depreciation.

(1) Cost of assets

(2) Estimated useful life of asset.

(3) Estimated scrap value (if any) at the end of useful life of asset.

(1) Cost of property plant and equipment (Fixed assets):-

(a) Purchase price of assets including non-refundable import duties and purchase taxes, after deducting trade discounts and rebates.

(b) Any cost directly attributable to bring the asset to the location and condition necessary for it to be capable of operating in a manner intended by the enterprise.

(c) The initial estimate of the costs of dismantling, removing the item and restoring the site on which asset is located.

Examples of costs directly attributable to costs are:

(a) Cost of employees benefits arising directly from acquisition or construction of an item of property, plant and equipment.

(b) Cost of site preparation

(c) Initial delivery and handling costs

(d) Installation and assembly costs

(e) Cost of testing whether the asset is functioning properly.

(f) Professional fees e.g. engineers hired etc.

Following expenses should not become part of the cost of asset:

(a) Cost of opening new facility or business, such as inauguration costs,

(b) Cost of introducing new product or service( for eg cost of advertisement or promotional activities)

(c) Cost of conducting business in a new location or with new class of customers( including cost of staff training)

(d) Administration and other general overheads costs.

2)Useful life:-The period over which depreciable assets is expected to be used by enterprises. The total number of units expected to be produced or obtained from use of asset of enterprises.

3)Scrap value:- Determination of scrap value is matter of estimation based on many factors. If its value is not significant then it is not considered, if its value is significant its value is considered for charging depreciation at the time of acquisition/installation or at the time of subsequent revaluation of assets.

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