Financial Accounting - Depreciation

Depreciation reduces the value of assets on a residual basis. It also reduces the profits of the current year.

Depreciation indicates reduction in value of any fixed assets. Reduction in value of assets depends on the pfe of assets. Life of assets depends upon the usage of assets.

There are many deciding factors that ascertain the pfe of assets. For example, in case of a building, the deciding factor is time. In case of leased assets, the deciding factor is the lease period. For plant and machinery, the deciding factor should be production as well as time. There can be many factors, but the pfe of assets should be ascertained on some reasonable basis.

Why Do We Need to Account for Depreciation?

Here is why we need to provide depreciation:

To ascertain the true profit during a year, it is desirable to charge depreciation.

To ascertain the true value of assets, depreciation should be charged. Without calculating the correct value of assets, we cannot ascertain the true financial position of a company.

Instead of withdrawal of overstated profit, it is desirable to make provisions to buy new assets to replace old asset. The accumulated value of depreciation provides additional working capital.

Depreciation helps in ascertaining uniform profit in each accounting year.

Depreciation allows to take the advantage of tax benefit.

Accounting Entries Related to Assets and Depreciation

Let us see the accounting entries related to assets and depreciation:

Method of Depreciation

Depreciation can be calculated using any of the following methods, however the most popular methods remain (a) Straight Line Method and (b) Written Down Value Method.

Straight Line Method

Written Down Value Method

Annuity Method

Insurance Popcy Method

Machine Hour Rate Method

Depletion Method

Revaluation Method

Depreciation Fund Method

Format

Format of ledger accounts