Depreciation Accounting: Methods, Accounting Treatment, Disposal of Asset and Change in Method

Depreciation is one of the most scoring topics in Business Accountancy because it is repeatedly asked in theory and numerical form. The key is to understand:

• what depreciation means and why it is charged
• how it affects profit and asset valuation
• the difference between Straight Line Method (SLM) and Written Down Value Method (WDV/Reducing Balance)
• accounting entries and presentation in final accounts

Meaning of depreciation

Depreciation is the gradual and permanent decrease in the value of a fixed asset due to use, passage of time, wear and tear, obsolescence, etc.

Important points:

• it is related to fixed assets (machinery, furniture, building, vehicle)
• it is treated as an expense of the accounting period (matching principle)
• it reduces the book value of asset to show realistic value

Need and objectives of charging depreciation

Why we charge depreciation:

• to match cost of using asset with revenue of that period (matching concept)
• to show true profit (otherwise profit is overstated)
• to show true financial position (asset value is not overstated)
• to provide funds for replacement of asset in future (indirectly through retained profits)

Causes of depreciation

Main causes:

• wear and tear due to usage
• passage of time (e.g., leasehold assets)
• obsolescence due to technology changes
• accident or abnormal damage
• depletion (for natural resources) is similar but separately named

Depreciation vs depletion vs amortisation (brief)

• Depreciation: fixed tangible assets (machinery, furniture).
• Depletion: natural resources (mines, oil wells) due to extraction.
• Amortisation: intangible assets (patents, goodwill in some cases) over useful life.

Straight Line Method (SLM): concept and formula

In SLM, depreciation charged is same amount every year.

Formula:

• Annual Depreciation = (Cost of Asset − Scrap Value) / Useful Life (years)

Characteristics:

• simple and easy
• best where asset gives equal benefit every year
• book value reduces uniformly

Written Down Value (WDV) Method: concept and formula

In WDV, depreciation is charged at a fixed percentage on opening book value every year, so depreciation decreases over time.

Formula:

• Depreciation = Rate × Opening Book Value

Characteristics:

• higher depreciation in early years, lower in later years
• suitable when repairs increase in later years (total cost becomes balanced)

SLM vs WDV (comparison table)

Accounting treatment: entries and ledger effects

Two common ways:

1) When maintaining asset account at cost (using Provision for Depreciation A/c)

• Depreciation A/c Dr
  To Provision for Depreciation A/c

At year end:

• Profit & Loss A/c Dr
  To Depreciation A/c

2) When reducing asset account directly

• Depreciation A/c Dr
  To Asset A/c

At year end:

• Profit & Loss A/c Dr
  To Depreciation A/c

Exam tip: Always mention Depreciation is charged to P&L and asset value is reduced in Balance Sheet.

Presentation in final accounts

In Profit & Loss A/c:

• depreciation appears on debit side as an expense.

In Balance Sheet:

• fixed asset shown at cost less accumulated depreciation (or written down value).

Mini worked example (SLM and WDV)

Example:

• Machinery cost = Rs. 1,00,000
• Scrap value = Rs. 10,000
• Useful life = 5 years
• WDV rate = 20% p.a.

SLM depreciation:

• (1,00,000 − 10,000) / 5 = Rs. 18,000 per year

WDV depreciation (Year 1):

• 20% of 1,00,000 = Rs. 20,000 Year 2 opening book value = 1,00,000 − 20,000 = Rs. 80,000 Year 2 depreciation = 20% of 80,000 = Rs. 16,000

So, WDV gives decreasing depreciation amounts.

Mini tables & flowcharts for exam answers

Table: Depreciation’s effect

Flow: Where depreciation goes

Charge depreciation → Debit P&L (expense) → Reduce asset / build accumulated depreciation → Show in Balance Sheet

Quick Recap (1-minute revision)

• Depreciation is fall in value of fixed assets due to use/time/obsolescence.
• SLM: equal depreciation each year; WDV: depreciation decreases each year.
• Depreciation is an expense in P&L and reduces asset value in Balance Sheet.