How do you xxplain different method of providing depreciation?

Answer 1

DEPRECIATION-A noncash expense that reduces the value of an asset as a result of wear and tear, age, or obsolescence. Most assets lose their value over time (in other words, they depreciate), and must be replaced once the end of their useful life is reached. There are several accounting methods that are used in order to write off an asset'sdepreciation cost over the period of its useful life. Because it is a non-cash expense, depreciation lowers the company's reported earnings while increasing free cash flow.

(i) Fixed Installment or Straight Line Method

(ii) Fixed Percentage on Diminishing Balance Method

(iii) Sum of the years Digits Method.

(iv) Annuity Method.

(v) Depreciation Fund Method.

(vi) Insurance Policy Method.

(vii) Revaluation Method.

(viii) Machine Hour Rate Method.

(ix) Depletion Method.

(x) Repairs Provision Method.

(i) Fixed Installment or Straight Line or Fixed Percentage on Original Cost. Under this method, the Depreciation is calculated on the basis of either a fixed percentage of the original value of the asset or divides the original value of asset by the number of years of its estimated life. Every year, the same amount is written off as Depreciation so as to reduce the asset account to nil.

Depreciation =

(Cost of the Asset + Installation Charges - Scrap Value + Removal Cost) / Estimated useful Life of the Asset

(ii) Diminishing Balance Method. Under the diminishing Balance method, depreciation is calculated at a fixed percentage on the opening balance of each year. Each year the opening balance may be decreasing in value. This decreasing book value is commonly known as written down value of the asset. While applying the depreciation rate both salvage or scrap value and removal costs are ignored. There are no possibilities to reduce the book value to zero.

(iii) Sum of the Years Digits Method. It gives decreasing depreciation charge year by year. For the purpose of obtaining yearly depreciation diminishing percentages to the cost of the asset, less salvage value is applied. Under this method, the rate of depreciation is a fraction having the sum of the digits representing the useful life of the asset as its denominator and individual year as its numerator.

(iv) Annuity Method- Under the Annuity method, the annual depreciation charges would be ascertained with the help of Annuity table. This method gives importance to interest factor. Other methods do not take into account the interest factor while investing the assets. Fixed interest rate is charged on the opening balance of each year and then cost of asset together with interest thereon is written off equally over the life of the asset.

(v) Depreciation Fund Method-Depreciation fund method provides an adequate financial requirement for the replacement of the asset when the asset is replaced by a new one. Depreciation fund account is opened and the amount of depreciation is credited to that account. The asset account stands year after year at its original cost. At the end of each year, the amount of depreciation is debited and depreciation fund account is credited and the corresponding amount is invested in securities of some reputed companies, for the purpose of mobilizing funds for replacement.

(vi) Insurance Policy -Method. Under this method, an insurance policy is taken from the insurance company for the purpose of replacement of an asset. At the end of the definite period, the insurance company will pay the assured sum with the help of which asset can be repurchased.

(vii) Revaluation Method.-This method is suitable for small and diverse items of asset such as bottles, corks, trade marks, loose tools, livestock etc. Under this method the amount of depreciation is ascertained to find the difference between the book value of the asset and the real value of the asset. At the end of the year the difference is taken as depreciation.

(viii) Machine Hour Rate Method- The Economic Life of the asset is estimated in terms of working hours. Hourly rate is determined by dividing total cost of the asset by total number of hours to be operated in its life time. The annual depreciation charge is calculated by applying this rate to the actual number of hours operated in the particular accounting period.

Machine hour rate = (Cost - Scrap Value ) / Total hours (who1e lifetime)

Depreciation for the year = Machine Hour value x Estimated Hours in a year.

(ix) Depletion Method-The Economic Life of the asset is determined by geographical survey methods in terms of total units of resource deposits. The depletion rate per unit is calculated by dividing the total cost of the asset by the estimated available number of units.

(x) Repairs Provision Method- Under this method, first the total repair and renewal costs are determined for the whole life of the asset and then it is added to the capital cost to get a total value. Then, this value is divided by its estimated life. The resultant value is treated as Repair, Renewals and depreciation. It has to be charged to the profit and loss Account each year. The corresponding Credit is given to provision for depreciation and Repairs account.