Depreciation and its types/ Meaning, Methods, Examples
Depreciation and its types
To understand what is balance sheet its quite important depreciation and it's types.So first we should know what is depreciation? Depreciation is an important head amongst the most significant heads in records.
This method helps in calculating the genuine value of assets now and again. To put it in simple words, Depreciation and its types. Depreciation is a decrease in the value of an asset after some time, due specifically to wear and tear.
For instance - An association acquired a plant worth Rs. 10 crores and its life is for 10 years. in this manner, the value of a plant will diminish by Rs. 1 crore every year consistently (straight-line method).
The assets are of two sorts - Tangible Assets and Intangible Assets, the value of Tangible Assets (plant, apparatus, building, and so on.) dependably declines with time. however, the value of Intangible Assets (trademark, copyright, and so on.) might be expanded or diminished.
What are Various Methods of Depreciation
There are various methods of charging depreciation of a company's tangible assets. Every business chooses its own depreciation method for tax purposes depending on the nature and size of the business. The different asset depreciation rates are prescribed by the Canada Revenue Agency (CRA) keeping in view their categories. Sometimes the companies defer their appreciation of some products to improve their tax responsibilities.
The Common Types/Methods of Depreciation are:
1. Straight Line Method
Under this method, the total value of assets is divided by their useful life. The depreciation is charged with an equal amount every year until its useful life.
For Example, if The total value of machinery is $ 100,000, the scrape value is nil and its lifespan is 10 years then the depreciation will be charged $ 10,000 each year ($100,000/10=$10,000).
In this case, $ 10,000 will be shown as expenses of that machinery and the value of that asset and owner's equity will be decreased by that amount.
2. Decline Value Method
This method of depreciation is most suitable for assets which have lost their value faster in the previous years. some examples of these assets are computers, laptops and mobiles which become obsolete with the technology change. This is the best method to book the expenditure of assets quickly and reduce tax liability. It is known as a type of increased depreciation.
For example, suppose a company purchased a plant worth $ 100,000 and decided to choose the decline depreciation method the estimated life of that plant is 10 years and the savage value is $ 10,000.
In this case, the company has to calculate depreciation as under:
Strate-line rate = 1 / useful life = 1/10 = 1/10 or 10%
= $ 100,000/10 = 10,000 (1st year)
$ 90,000/10 = $ 9,000, and the residual value of assets is $ 81,000 (at the end of 2nd year).
Now the depreciation expenses are charged in the same way up to 10 years i.e. the useful life of the assets.
3. Double Decline (Reducing) Balance Method
This is also a quick depreciation method and charges the depreciation of assets at a double rate as the decline balance method. This method is also commonly used by companies.
This method of depreciation is most suitable for assets which lose their value more quickly than at the beginning of their useful life. This method of depreciation is applied by companies who had assets that become obsolete quickly.
The formula to charge depreciation under the double decline balance method is:
2 X depreciation rate X Current Book Value
Example - suppose the book value of an asset at the end of the year is:
Suppose the life of assets is $ 1000,000 and the lifespan is 10 years then the depreciation will be charged as under:
$ 1000,000/10 = 10,000, and the residual value of assets is $ 90,000 (in the first year).
$ 90,000/10 = $ 9,000, and the residual value of assets is $ 81,000 (at the end of 2nd year).
$ 81,000/10 = 8,100, and the balance value of assets is $ 72,900 (at the end of 3rd year)
The depreciation will be charged in the same way until the useful life of the assets.
4. Sum of the Year' Digit (SYD) Methods of Depreciation
This method of depreciation is suitable for assets which are depreciated very fast in the earlier years of their useful life.
Example - A company buy a petrol filling truck worth $ 100,000 and the useful life of that truck is 5 years with zero salvage value this organization selected the sum of the year digit method of depreciation.
Now before calculating the depreciation under this method first we have to understand the formula of this depreciation method as under:
The remaining useful life of the assets/SYD (Real Cost of the Assets - Salvage Value)
SYD = (n*(n+1))/2
Now the calculation of the value of a petrol-filling truck is:
For Ist year depreciation expenses are (5/15)*100,000 = 33,334
For 2nd year depreciation expenses are (4/15)*100,000 = 26,666
For 3rd year depreciation expenses are (3/15)*100,000 = 20,000
For 4th year depreciation expenses are (2/15)*100,000 = 13,334
For 5th year depreciation expenses are (1/15)*100,000 = 6,666
At the end of 5 years, the total value of depreciation and book value of the petrol fill truck will be equal.
5. Unit Production Method
Under this method, the depreciation expenses are charged based on the total number of units produced by the company in a year and the total number of units the assets can produce in their lifetime. This method of depreciation is very useful for manufacturing companies. Under this method the depreciation expenses are calculated as under:
Example - Suppose a company buy a plant worth $ 100,000 and its production capacity in the first year is 500,000 units. The company produced 50,000 units.
The formula to calculate depreciation changes is as under:
Per Unit Depreciation = ( Assets Cost - Salvage Value ) / the estimated items produced over the lifespan of the asset.
Depreciation on items of production x per item depreciation x total items produced.
per unit depreciation = $ 100,000 - $ 10,000 /500,000, = $ 90,000 /500,000, = $ 0.18, = $ 0.18 X 50,000 = $ 9,000
Thus the depreciation on items production is $ 9,000. Therefore, the balance value of the plant will be $ 91,000 ( 100,000 = 9000 ) at the end of the year.
Which is the Best Method of Depreciation
It is very difficult to decide which is the best method of depreciation as it depends on the nature and size of the company. For example, the unit production method of depreciation is the best for manufacturing companies and every company has to choose its own depreciation method keeping in view the lifespan of the assets and high tax savings.
In most cases, the company's top management decides the method of depreciation to be adopted in consultation with the finance department and the financial advisor. In case any company still have any confusion it can take advice from tax and financial experts by hiring them or by outsourcing.
Arrangements identifying depreciation
Indian Companies Act, 2013 has brought a lot of changes and difficulties for each organization. One such test changes in the arrangements identifying with Depreciation. The key features of the arrangements according to the Act, principles, and direction notes issued in this way are as under:
Here, the systematic portion implies division or apportioning as indicated by a framework or a method, for example, organizations are presently allowed to utilize their method for estimation of depreciation (SLM or WDV or some other).
Depreciable amount is the cost of the asset or some other amount substituted for cost, less lingering value, for example, depreciable amount will be the authentic cost or the revalued cost if any revaluation is completed or other such amount substituted for cost, decreased by its lingering value.
1. Be that as it may, the useful life of the asset will not conventionally be the same as the useful life indicated in Part C to Schedule
2. Where the cost of the piece of the asset is noteworthy to the all-out cost of the asset and the useful life of the part is not the same as the useful life of the rest of the asset, the useful life of that critical part will be resolved independently and depreciation be charged on that part as needs be.
This implies organizations need to embrace the part of bookkeeping. For instance, a structure might be part of the auxiliary plan, lifts, water framework, warming framework, and so forth.
An organization needs to recognize just critical/material segments independently for depreciation. Materiality involves judgment, be that as it may, an organization may think about 10% of the unique cost as an edge to deciding materiality/essentialness.
1. In addition, where the part can't be utilized independently from the asset, similar should determine the rate dependent on the useful life of the asset.
2. It is willful for every one of the organizations to embrace the above changes (for segment bookkeeping) in budget reports regarding the budgetary year 2014-15 however required financial reports of monetary years starting on or after the first of April 2015.
3. In the event of Second-hand assets, the depreciable amount will be the cost of the asset for example cost to the principal proprietor and the count of staying useful life will likewise be done from the date of its buy by the primary proprietor.
4. The useful life of the assets taking a shot at the ove premise has been indicated in Part C dependent on their single move working.
Are There Any Assets Which Can Not Be Depreciated
Generally, all the assets of the company whether plant and machinery, Vehicles, Computers, Laptops or Mobiles can be appreciated over the years due to wear and tear or obsolescence. But some assets are never appreciated according to the accounting principles and standards. Some of them are:
1. Land - The value of land is never depreciated because it has no lifespan. The life of the land can not be estimated because its life is limitless. Though some renovations made on the land by way of construction of a building can be depreciated the land in itself can never be depreciated.
2. Assets bearing very low cost/Life - Assets have very little life and can be consumed within a year and can not be depreciated. The assets which have very low costs are also not depreciated but are considered as an expense during the year in which it is purchased.
3. Inventory/Accounts Receivables - These types of assets are also not depreciable because they are supposed to be encashed in a short period probably during the year.
Brief Provision for Depreciation
From the date these arrangements become effective, if the organization proceeds with the method of charging depreciation (for example WDV or SLM); the conveying amount (for example the net shutting value of the square as showing up in books in the wake of charging depreciation of earlier year) of the asset as on that date:
Where the staying useful life of the asset is nil, conveying the amount in the wake of holding the leftover value, might be perceived in the opening equalization of the held income or charged to the benefit and misfortune account (given the board choice).
If the organization selects to change the method of charging depreciation (for example other than WDV or SLM), such change will prompt a change in the bookkeeping approach and must be managed as per Accounting Standard – 6, appropriately a review re-calculation of depreciation should be finished. Its impact ought to be evaluated and unveiled.
Disclosure of Depreciation
The accompanying data will be uncovered in records:
a) Depreciation methods utilized. Whether an adjustment in method revelation ought to be as per AS 6
b) The useful life of the assets for processing depreciation, in the event, that they are not the same as the life determined in the Schedule.
c) Leftover Value, if unique about what is determined.
Pragmatic Example of Depreciation
The momentary arrangements can all the more likely be clarified by method for models:
The useful life of general furnishings and installations has been decreased from 15 years to 10 years in Schedule II. Two distinct situations for various pages of a household item may emerge.
The furniture is 8 years old – the remaining WDV of the furnishings will be devalued over the outstanding 2 years.
A Company obtained plant and apparatus for Rs.10,00,000 in April 2009. The useful life of the asset, a part of balance sheet, according to Schedule XIV was 20 years and according to Schedule II is 15 years and the leftover value is 5% for example Rs.50,000
1. The organization pursues the SLM method – The carrying amount as of 31st March 2014 is 762500.00. Presently as the useful life has changed, the conveying amount is to deteriorate over the residual 10 years (5 years lapsed on 31st March 2014).
The yearly depreciation would now be determined as – Depreciation = (Carrying Value – Residual Value)/Remaining useful life = (7,62,500-50,000)/1 = Rs.71,250
2. The organization pursues the WDV Method – Carrying amount as of 31st March 2014 after charging depreciation @ 13.91% p.a. is 4,72,894. Presently another rate is required to be determined as under – Rate of Depreciation = {1-(Residual value/Carrying Value) Remaining Useful Life}*100{1(50,000/4,72,894)^10}*100
Depreciation for the year 2014-15 = 4,72,894*20% = Rs.94,579.
Subsequently, the depreciation gives a genuine and reasonable image of the budgetary position of an association which isn't useful for the administration, partners, investors, speculators, money related organizations yet, in addition, the statutory necessity as given under the Indian just as International Accounting Standards.
CONCLUSION
Thus, every organization has to adopt a depreciation method to show the true and fair picture of financial statements. The most common depreciation method is the straight-line depreciation method in which depreciation is divided over the useful life of the assets and remains the same each year.
An example: an asset costing Rs. 1 crore Android the useful life is 10 years. In this case, the depreciation will be Rs. 10 lakh every year and the value of the asset will become nil at the end of the 10th year.