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Depreciation means the allocation of the cost of fixed Asset to a period in which services are received from the asset. The principal causes of depreciation are wear and tear, Effluxion of time, depletion, obsolescence.
The following factors must be considered while estimating depreciation:
- Original cost of asset.
- Estimated useful life of the asset.
- Estimated salvage value of the asset.
Methods of Depreciation
1. Straight line method
The straight line method of depreciation is the simplest of all. Every year a fixed amount is written off as depreciation. The amount is arrived at by dividing the original cost(less estimated value salvage value, if any) of the asset by the number of years of the estimated life.
Annual Depreciation = Cost of the asset-Estimated Scrap value
2 .Declining Balance Depreciation
This method is also known as the reducing installment method. The annual charge for depreciation is calculated by applying a fixed percentage on the diminishing value of the asset. Larger amount of depreciation is charged in the earlier years of the asset than in the later years. This method is commonly used and considered prudent as it counter balances the charges for repairs and depreciation. In the earlier years the amount of depreciation is high but the repairs will be light and vice versa.
Entries Required Entries to be made on writing off depreciation
To Asset A/c
The depreciation account goes to the debit of the profit & Loss a/c. The asset appears at its reduced value in the balance sheet. An alternative entry is
To Provision for Depreciation A/c
In this case too, depreciation goes to debit of P/l A/c. The value of asset continues to be the same every year in the balance sheet. The depreciation written off is accumulated in a separate account –Provision for depreciation A/c which appears in the liability side of Balance sheet or as deduction from value of the asset concerned.
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