Question

8. What is depreciation. Explain the different methods of depreciation in brief? Also, explain the main points of difference between straight line method and reducing balancing method.

500-600 words please

Answer 1

The value asset which we buy today has a different value tomorrow. This is due to depreciation. Depreciation is such decrease in value of asset from the cost of asset to the value of asset today. It is the reduction in the value of asset due to time, wear and tear, depletion etc. Depreciation represents how much of an assets value has been used up till the end of the year. The fixed assets are expensive. So instead of charging whole cost to revenue in the year of purchase, depreciation can be calculated and it helps to spread out the cost to the useful life of the asset. Depreciation is calculated on the cost of purchase of the asset and the factors are useful life of Asset , depreciation rate and salvage value.It is a non cash expense. Depreciation is a fixed cost and charged to the expense side of income statement to arrive the net profit or loss. It helps companies to ascertain the proper revenue by expensing the portion of the cost for the asset in use. Business can depreciate asset for both tax and accounting purposes. The types of depreciation generally used are Straight line method, Reducing balance method, Double declining method and Units of depreciation method.

Types of depreciation are :

1. Straight Line Method

Depreciation is calculated by dividing the difference between the cost of asset and residual value of the asset. i.e..  (Cost of asset - Salvage value of asset / Useful life of asset.

In this method depreciation expense is same for every year and value at end of useful life is salvage value. This is the easiest method to use.

2. Reducing balance Method

In this method a depreciation rate is fixed by the enterprise and depreciation is charged on the book value on the Beginning of the year. Depreciation is calculated as Book value at beginning of year X depreciation rate fixed.

3. Units of depreciation

The depreciation is calculated on the basis of number of units produced or number of hours used for production,

Depreciation Rate is calculated as Number of units produced in the year / Total units that can be produced using the Asset. The Rate is charged to book value at the beginning of the year and depreciation is calculated for each year accordingly.

4. Double declining method

In this method higher depreciation is charged on the earlier years and depreciation amount declines in the later years because book value declines drastically in the later years. The rate of depreciation is calculated as

Depreciation Rate = ( 1/ Useful life ) X 2

This rate is applied on Book value on the beginning of the year.

Difference between Straight Line method and Reducing balance Method