Application of Depreciation

  • Assets account is prepared in the books to record all transactions relating to assets like further cost of assets, sale of assets, etc. Cost of the asset includes its purchase price, transportation cost, installation etc.
  • Depreciation account is prepared to record the total amount of depreciation charged on a particular asset for different accounting periods. It is a nominal account.
  • Factors affecting the depreciation of an asset are cost of an asset, scrap value and useful life.
  • Different methods of providing depreciation are Straight Line Method, Diminishing Balance Method, etc.  
  • Under Straight Line Method, fixed amount of depreciation is charged on the asset every year. The amount of depreciation remains same throughout the life of fixed asset. This method is also called Equal Installment Method or Original Cost Method.
  • In this case, annual depreciation is equal to cost of the asset minus estimated scrap value divided by useful life of the asset.
  • Under Diminishing Balance Method, depreciation is charged at fixed rate on the reducing balance every year.
  • This method is based upon the assumption that the benefit accruing to business from assets keeps on diminishing as the asset becomes old.
  • The difference between straight line method and diminishing balance method is that, in case of straight line method the value of an assets can reduce to zero, while in case of diminishing balance method the book value of an asset can never be zero, etc.
  • Under Diminishing Balance Method, depreciation is charged at fixed rate on the reducing balance every year. Since book value keeps on reducing by the annual charge of depreciation, it is also known as reducing balance method.
  • Amount of depreciation is equal to diminished value of asset multiplied by rate of depreciation.
  • Sale of an asset can take place either at the end of its useful life or during its useful life.
  • Depreciation is provided on such asset up to the date of sale.
  • Profit or loss on sale of asset is also computed. When provision for depreciation account is maintained, the amount of depreciation is accumulated in this account only. For recording sale of assets sometimes,
  • Asset Disposal Account is opened. It gives a full picture of all the transactions related to asset disposal at one place.

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