Depreciation

Depreciation

🟢 Lite — Quick Review (1h–1d)

Rapid summary for last-minute revision before your exam.

Depreciation is the systematic allocation of the depreciable amount of a tangible fixed asset over its useful life. Under AS-6, it arises from wear and tear, obsolescence, passage of time, or accident.

Key formula:

SLM Depreciation = (Cost − Residual Value) / Useful Life

WDV Depreciation = Depreciation Rate × Book Value at beginning of year

High-yield pointers:

• Depreciable amount = Cost − Residual Value
• Land is NOT depreciated (it has unlimited life); all other fixed assets are depreciated
• Depreciation is a non-cash expense — it reduces profit but involves no cash outflow
• SLM produces a constant charge each year; WDV (Written Down Value) produces a decreasing charge
• On sale of an asset: Profit/Loss = Sale Proceeds − Book Value on date of sale
• Accumulated Depreciation + Book Value = Original Cost

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🟡 Standard — Regular Study (2d–2mo)

Standard content for students with a few days to months.

Definition and Legal Basis

Depreciation, per AS-6 (now partially revised), is the permanent and continuing decrease in the quality, quantity, or value of a tangible fixed asset. It is not a reserve or a fund — it is an allocation of cost. The depreciable amount equals Cost minus Residual Value, spread over the useful life (estimated years the asset will remain productive).

Methods of Depreciation

Straight Line Method (Fixed Installment Method)

Under SLM, the same amount is charged every year:

Depreciation = (Cost − Residual Value) / Estimated Useful Life

A key advantage is simplicity and consistency of charge. Useful when an asset generates equal benefits each period.

Written Down Value Method (Reducing Balance Method)

A fixed percentage is applied to the reducing Book Value at the start of each year:

Depreciation = Rate × Book Value at beginning of year

The Companies Act prescribes the rate as:

r = [1 − (Residual Value / Cost)^(1/n)] × 100, where n = useful life

Because the base declines, the annual charge falls each year. Higher charges in early years match higher repairs costs that also accrue early in an asset’s life.

Sum of Years Digits Method

An accelerated method where:

Denominator = n(n+1)/2; Depreciation for Year m = (Remaining life at start of Year m / Sum of years) × (Cost − Residual Value)

Accounting Treatment

Account Debited	Account Credited
Depreciation A/c (transferred to P&L)	Asset A/c or Provision for Depreciation A/c

On the Balance Sheet, the asset appears at Cost, reduced by Accumulated Depreciation, to show Book Value (also called Written Down Value or Net Book Value).

Common Examination Traps

• Confusing scrap value with residual value (synonymous terms — both mean estimated realisable value at end of useful life)
• Forgetting that land is excluded from depreciation
• Mistaking depreciation for a provision or reserve fund
• Calculating WDV on cost instead of on the reduced book value

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🔴 Extended — Deep Study (3mo+)

Comprehensive coverage for students on a longer study timeline.

Distinction from Related Concepts

Depletion applies to natural resources (mines, quarries, oil wells) — the cost is allocated based on units extracted relative to total estimated reserves. Amortization handles intangible assets such as patents, copyrights, and goodwill. Neither is the same as depreciation, which governs tangible fixed assets. Under revised AS-6, the term “Depreciation” encompasses all three in practice, though examination questions distinguish them explicitly.

Sale of a Depreciated Asset

When an asset is sold mid-year, depreciation must be charged for the period of use before calculating the book value at the date of sale:

Book Value at sale = Cost − Accumulated Depreciation (including partial year) Profit on sale = Sale Proceeds − Book Value at sale Loss on sale = Book Value at sale − Sale Proceeds

This transaction is tested repeatedly in CA Foundation — a common error is calculating profit/loss on original cost rather than on written-down book value.

Change in Depreciation Method

AS-6 permits a change in depreciation method only if justified by changed circumstances. The carrying amount of the asset at the date of change is then depreciated prospectively using the new method. Retrospective adjustment is not permitted without strong justification acceptable to auditors.

Worked Numerical Example

A machine costs ₹1,00,000; estimated residual value = ₹10,000; useful life = 5 years.

SLM annual charge = (1,00,000 − 10,000) / 5 = ₹18,000 per year

WDV rate (assuming 39.6% under Companies Act for 5-year life) → Year 1 charge = 39.6% × 1,00,000 = ₹39,600; Year 2 charge = 39.6% × ₹60,400 = ₹23,918; and so on.

Notice SLM spreads cost evenly; WDV front-loads it — this affects reported profits and tax liability differently.

Practice Prompts

1. A plant was purchased for ₹2,50,000 on 1 April 2022. Residual value estimated at ₹10,000; useful life 8 years. Show depreciation schedule under SLM and WDV for the first 3 years. Calculate book value at the end of Year 3 under each method.
2. The same plant is sold on 30 September 2024 for ₹1,60,000. Calculate profit/loss on sale under each method, charging depreciation for the period of use in 2024.

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