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Transcript of Depreciation
PROFILE OF SAHARA INDIA PARIWAR
Sahara India Pariwar is an Indian multi-business conglomerate with
diversified business interests that include financial services, housing finance,
mutual funds, life insurance, city development, real estate activities, print
and television media, film production, sports, information technology, health
care, tourism, hospitality and consumer products. It owns the New IPL team
Sahara Pune Warriors and also sponsors the Indian Cricket and Hockey
teams.
WE CHASE QUALITY, QUANTITY CHASES US
-Sahara India Pariwar
Quality is their essence and they
always stressed on the Qualitative
aspect. Consequently in this run for
quality, quantity has always pursued
by them. They look forward to
reaching the zenith and reaffirm their
commitment to the process of sound
nation-building.
Core Commitments - Their Strength
Emotion: Emotion is in Performance of genuine duties towards the loved
ones primarily in their benefit, from their point of view. EMOTION is THE KEY
that generates the required energy and enthusiasm for desired quality
performance.
Discipline: The enthusiastic obedience of laws and orders, which are given
by the rightful authority.
Duty: The enthusiastic obedience of laws and orders, which are given by
their CONSCIENCE.
Quality: Results from honouring Rules, Regulations, Commitments, Values,
Fairness, Performance of Duties by honestly balancing one's own and others'
reasonable point of view in the matters of Material & Emotional aspects.
Truth: Means total transparency in action, reaction, attitude and all other
expressions and the conviction to follow the right course.
No Discrimination: Never should
they discriminate in any of their
actions, reactions, attitudes,
decisions, conclusions, and in any of
their expressions while caring for the
six healths of other human beings,
namely physical, material, mental,
emotional, social and professional
healths.
Give Respect: To definitely make others feel important and respected by
giving sincere regard to others' feelings, reasonable wishes & thoughts with
an open and receptive mind and warmth.
Religion: There is a religion higher
than religion itself - it is
NATIONALITY. They practise their
religions in the confines of their
homes, but outside, they should be
Indians and only Indians.
'Bharatiyata' or Nationalism thus
becomes our supreme religion.
Collective Materialism: Means to progress and prosper together for
collective sharing and caring and not individually or for a select group.
Absolute Honesty: People
generally manipulate and deceive for
achieving their unreasonable desires
and greed if others do not or cannot
see, hear or understand. But they
firmly believe that their mind inside
knows the truth and they should be
absolutely honest to their mind inside
and accordingly their actions,
reactions, directions, decisions and
all their expressions should be
present in all human dealings.
Self-Respect: To develop a sense of respect for oneself in others' mind, i.e.
to generate genuine & warm feelings for oneself among others on a
continuous basis.
SAHARA INDIA PARIWAR'S PHILOSOPHY - "Collective
Materialism"
In any human relationship, it becomes imperative to take into consideration
the materialistic aspect of life - we do so but by giving it second priority.
The first priority is given to emotional aspect and with perfect blending of
materialism with emotionalism, results in continuous collective growth for
collective sharing and caring, that gives an impetus to our philosophy -
"COLLECTIVE MATERIALISM".
BHARTIYATA
There is a religion higher than
religion itself - it is the INDIAN
NATIONALITY. The swirl of the
Tricolour never fails to move a
Sahara Worker. For they believe, it is
the great feeling that transcends all
castes, creed and sects. Bharat Parva
is Celebrated on every 26th of
January and 15th of August with a
spirit and gaiety rarely seen.It comes
from our heart.
SUBRATA ROY SAHARA-An ENTREPRENEUR
"Saharasri" - Subrata Roy Sahara
Subrata Roy Sahara was born on 10th June 1948 at Araria 40 km. north to
Purnia, Bihar, he is the Managing Worker and Chairman of the Sahara Group
of companies based in India. Sahara is based upon Subrata Roy Sahara’s
belief in the ethos of a family (the reason why the group is called a Pariwar -
family in Hindi) and was termed by the Time magazine as ‘the second largest
employer in India after the Indian Railways’. From an asset base of USD 43 in
1978 when it was founded, the group has today exponentially grown to
become a major business conglomerate in India. He is the Richest Bengali
Person in India after Amar Bose, founder of Bose Corporation, USA
Subrata Roy received his Bachelor of Engineering, Electronics and
Communication Engineering, in 1996 at National Institute of Technology
Durgapur and MS, Computer Engineering from San Jose State University,
USA, in 2007. Subrata Roy married to Swapna in 1974 and they have two
sons. He possesses a huge private property at Lucknow in Uttar Pradesh
called Sahara City. He is well known for his flashy lifestyle. His rise is also
associated with his close proximity with Amar Singh, a business man and
political leader of Samajwadi Party and its President and founder, Mulayam
Singh Yadav.
The Man and His Vision:
He has talked about problems and proposed the solutions on 5 social issues
namely Population, Education, Political (Election) system, Media & Religion,
besides interacting on various aspects of life and professional life. According
to him if these five issues are taken care of properly, our beloved country
shall be the best in the world.
“Saharasri” Idealogy
In business profit earnings and overall growth of business get the highest
priority and are certainly creditable, but ultimate credibility of business
enterprise, particularly of larger ones is in the utilisation of profit, be it for
best possible upliftment of its workforce and for espousing Social, National
Development causes or for rendering services to mankind as a whole.
Fulfilling the Qualitative aspect of utilisation of profit, the world's largest
family ‘Sahara India Pariwar' is proud to have reached today new horizons of
growth and development.
On the basis of our philosophy of Collective Materialism we have always
given importance to the fact that profit earning is the Quantitative aspect
whereas the proper utilisation of profit is the Qualitative aspect. Ironically,
we only recognise and get recognised by the Quantitative aspect.
I, therefore earnestly appeal to one and all in Politics, Media, Business etc.
that every action, reaction, selection, appreciation or criticism should be
oriented strictly towards the Qualitative aspect. I appeal to anybody and
everybody to accord top priority to Qualitative aspect in anything and
everything for peaceful, prosperous and progressive co-existence of mankind
anywhere and everywhere.
Today, I feel proud of the fact that I am the Guardian of the World's largest
family. Perhaps, I am the world's only person whose family is so vast, so
disciplined, so dedicated and so committed. Such a vast family as Sahara
India Pariwar has a grand and infinite future and I am sure that we will
sustain our duty, consciousness, discipline and dutifulness with a sense of
dedication, as we have always done in the past, so that together we could
build an India full of energy and radiance.
Subrata Roy Sahara has pursued a large number of philanthropic endeavors,
and his company is involved a activities like monthly financial assistance to
the families of the Martyrs of the Mumbai Nov '08 terror attack and to the
families of Kargil War Martyrs, projects in the fields of rehabilitation of a
million victims of natural disasters, health, education and nutrition
programmes for children and women, adult literacy and vocational training
initiatives, behaviour change communication programmes, rehabilitation of
physically challenged people, mass marriage ceremonies of 101
underprivileged girls on annual basis and support to National Cadet Corps
(NCC) forms part of Sahara’s universe of concern.
Awards/Achievements for Subrata Roy
The ITA TV ICON (2007) Mother Teresa Millennium Award for Renowned Industrialist
(2005) Global Leadership Award (2204) Businessman of the year Award (2002) Best Industrialist (2002) National Citizen Award (2001) Karmaveer Samman (1995) Udyamshree (1994) Baba-E-Rozgar (1992) Noble Citizen Award (1986)
Subrata Roy Sahara has also written two books 'Shanti, Sukh & Santushti’
and ‘Maan, Samman, Atmasamman’ on the philosophy of life.
Shanti, Sukh: Santushti
Through this book it is absolutely convincing that the most dominating need
of every human is strong security feeling of life, health, material, respect and
love and then more material, more respect and more love. 24 hours - 365
days all your actions, reactions, planning and all expressions revolve around
the above needs and continuous achievement of all these depends on you
and you need not depend on others.
Maan-Samman, Atmasamman
Emotions are of two kinds - love and respect. Love is an inferior emotion
which has been given by God to fulfill your reasonable, unreasonable needs.
But in human society since we have the thinking power, respect for others
and sense of self-respect are the most superior emotions.
SAHARA INDIA PARIWAR PRODUCT DIVISION
FINANCE:
Sahara India Life Insurance
Company Limited: The first wholly
Indian Owned Private Life Insurance
Company with presence in most
parts of the country. It has a team of
well trained and committed
professional advisors with special
focus on rural areas and the less
affluent segments of the Indian
society. The company offers an
exhaustive range of competitive
products that caters to individuals of
all ages and segments along with
prompt and quality customer
services and support.
Sahara Asset Management
Company Private Limited: A
disciplined and professional Fund
House bringing World Class
performances in Mutual Fund
Management.
Sahara Housingfina Corporation
Limited: A National Housing Bank
regulated & BSE listed company. In
India, housing finance market is
around Rs. 1, 20,000 crore (USD
25,580 million) with a growth rate of
around 20%.
INFRASTRUCTURE & HOUSING
Aamby Valley City is planned as an
exclusive City nestled across 10,600
acres of the majestic Sahayadris in
the pristine Western Ghats. The
project envisages development of a
premium, self-contained City with a
well laid out world class
infrastructure and facilities for
premium living, leisure and
entertainment, sports and adventure,
knowledge and education, hospitality
and fine dining, advanced
healthcare, meetings and
conferences etc. in a highly secured
environment.
SAHARA CITY HOMES: The world's
largest chain of integrated townships
ranging from approx. 80-300 acres
offering amenities superbly matched
to international standards being
developed in number of Tier I, Tier II
& Tier III cities across India. A Sahara
City Homes Integrated township shall
typically consist of a gated
community with residential units in
the form of apartment towers,
townhouses and individual houses.
Sahara Grace: The premium
residential complexes typically
designed on 10-30 acres, comprising
solely of residential units like
apartments, villas and penthouses.
SAHARA STAR, MUMBAI: A world-
class 5-Star Hotel spread over 7.42
acres and located adjacent to the
Mumbai domestic airport, it is the
flagship hotel project of Sahara India
Pariwar. Currently, it has 210 guest
rooms, 13 suites and 9 restaurants
which are expandable to 412 rooms
and 13 restaurants. It contains some
of the best modern features like
World's largest pillarless clear-to-sky
dome of its kind, World's first
Hemisphere-shaped Glass Elevators,
Marine Aquarium, Lagoon area,
Inward and Outward facing rooms,
Glass Roof rooms, Spacious Parking
and shall have amenities like Sahara
Health and Wellness Centre, Multi-
cuisine restaurants and Preview
theatre.
SAHARA HOSPITAL, LUCKNOW: A
state-of-the-art, multi-speciality,
tertiary care hospital providing world
class facilities with more than 50
super specialities and latest
generation equipments under one
roof. This hospital got operational in
February 2009 and is currently
operating with approximately 350
beds, including 120 bed Critical Care
Infrastructure and expandable to 554
beds. It is spread on 31 acres and
contains ultra-modern centre for
preventive and alternative medicines
like Ayurveda, Homoeopathy,
Naturopathy and Yoga for Holistic
approach.
MEDIA & ENTERTAINMENT:
SAHARA ONE: 24 hours digitally
encrypted Entertainment Channel
spread globally.
FILMY: 24 hours digitally encrypted
Movie Channel.
SAHARA ONE MOTION PICTURES:
Has always provided a platform for
unique and quality cinema and
continues its quest to entertain all
kind of audience. It has released over
35 films and won 5 National Awards
Geon Studios: Designs, develops and
delivers cutting - edge digital visual
effects for domestic and international
feature film and television projects.
SAMAY: Round-the-clock free-to-air
National Hindi news channel.
SAHARA SAMAY: Round-the-clock
36 city specific Regional news
channels.
RASHTRIYA SAHARA: 38 Editions of
Hindi Daily Newspaper with 6 Printing
Centers.
SAHARA TIME: 1 National Edition –
72 pages English Weekly with Pan
India News Network.
ROZNAMA RASHTRIYA SAHARA:
15 Editions of Urdu Daily Newspaper
with 9 Printing Centers.
AALMI SAHARA: AALMI SAHARA: 28
pages International Urdu Weekly.
BAZM-E-SAHARA: 100 Pages
Monthly Magazine.
Cinema Halls: Developing Largest Chain of Multiplexes in India. Around 230
x 3 screens throughout the country
Film City: Developing world-class film city on around 100 acres of land with
an investment of 180 crores (USD 41.74 million) approximately and with an
Academy.
News Section: 50 Bureaus, 1000 Correspondents across the globe & over
1600 V-SATs for news collection.
COMMODITY SALES WITH SERVICES AND RETAIL CHAIN:
SAHARA COMOSALE
SAHARA COMSERVS
SAHARA CARE
India’s largest commodity sales and Services Company. We shall soon be
having our full-fledged working bases with staff at over 2800 offices in India
and 16 more countries with 23 offices having 100 franchisees in each
country like England, China, Germany, South Africa, Saudi Arabia, West
Indies, Sri Lanka, New Zealand, USA, Australia, Japan, Qatar, Dubai, Russia,
Nepal, and Bangladesh.
Offering a range of Consumer Products
At present our product division offers a range of products of everyday use as
well as objects of desire through a chain of showrooms called 'Unique' in
various locations of India. The number of these showrooms is proposed to be
increased to 6000. The products offered come under three categories
1. Sahara Select - Fashion & Lifestyle Products
2. Sahara Care - Daily Need Products and
3. Sahara Sports - Fitness & Leisure Products
MANUFACTURING:
ARARIA JUTE PROJECT : Is engaged
in creating self- employment to bring
forth socio-economic development of
the people of Araria, through its
training-cum-R&D centre and
produces eco-friendly, biodegradable
top export quality diversified jute
products e.g. Blankets, Carpets, Floor
covering, Handicrafts, Jute Chappals
etc. and successfully creating high
demands both in Domestic and
International Market.
INFORMATION TECHNOLOGY:
SAHARA NEXT: Providing IT
Services, Outsourcing, Web Media
and Mobile Interactivity & Application
Solutions.
Depreciation
Meaning
The value of assets gradually reduces on account of use. Such reduction in value is known as depreciation. A non-cash 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's depreciation 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.
Definitions
Different authors have given different definitions of depreciation, such as:
"Depreciation may be defined as the permanent continuous diminution in the quality, quantity or value on an asset." (By Pickles)
"Depreciation is the gradual permanent decrease in the value of an asset from any cause." (By Carter)
"Depreciation may be defined as a measure of the exhaustion of the effective life of an asset from any cause during a given period." (By Spicer & Pegler)
Depreciation is the diminution in intrinsic value of an asset due to use and/or the lapse of time." (By Institute of Cost and Management Accountants, England)
"Depreciation is the reduction in the value of a fixed asset occasioned by physical wear and tear, obsolescence or the passage of time." (Northcott & Forsyth)
Characteristics of Depreciation:
Depreciation has the following characteristics:
1. Depreciation is charged in case of fixed assets only. e.g., building, plant and machinery, furniture etc. There is no question of depreciation in case of current assets - such as stock, debtors, bills receivable etc.
2. Depreciation causes perpetual, gradual and continual fall in the value of assets.
3. Depreciation occurs till the last day of the estimated working life of the asset.
4. Depreciation occurs on account of use of asset. In certain cases, however, depreciation may occur even if the assets are not used, e.g., leasehold, property, patent, copyright etc.
5. Depreciation is a charge against revenue of an accounting period.
6. Depreciation does not depend on fluctuations in market value of assets (see difference between depreciation and fluctuation page).
7. The amount of depreciation of an accounting year cannot be determined precisely - it has to be estimated. In certain cases, however, it may be ascertained exactly, e.g., leasehold property, patent right, copyright etc.
8. Total depreciation of an asset cannot exceed its depreciable value (cost less scrap value).
Causes of Depreciation:
The main causes of depreciation may be divided into two categories, namely:
1. Internal Cause and2. External Causes
Internal Causes
Depreciation which occurs for certain inherent normal cause, is known as internal depreciation. The main causes of internal depreciation are:
Wear and Tear:
Some assets physically deteriorate due to wear and tear in use. More and more use of an asset, the greater would be the wear and tear. Physical deterioration of an asset is caused from movement, strain, friction, erosion etc. An obvious example of this is motor car which rapidly wears out. Other assets like this are building, plant, machinery, furniture, etc. The wear and tear is general but primary cause of depreciation.
Depletion:
Some assets declines in value proportionate to the quantum of production, e.g. mine, quarry etc. With the raising of coal from coal mine the total deposit reduces gradually and after sometime it will be fully exhausted. Then its value will be reduced to nil.
External Causes
Depreciation caused by some external reasons is called external depreciation. The main external causes are as follows:
Obsolescence:
Some assets, although in proper working order, may become obsolete. For example, old machine becomes obsolete with the invention of more economical and sophisticated machine whose productive capacity is generally larger and cost of production is therefore less. In order to survive in the competitive market the manufacturers must must install new machines replacing the old ones. Again, it may happen that the articles produced by old machine are no longer saleable in the market on account of change of habit and taste of the people. In such a case the old machine, although in good working condition, must be discarded and the new one purchased.
Efflux of Time:
Some assets diminish in value on account of sheer passage of time, even though they are not used e.g., leasehold property, patent right, copyright etc. Suppose we take a lease of a house for 10 years for $10,000. Its annual depreciation will be $1,000 (10,000/10), irrespective of the the whether the house has been used or not. Because with the end of lease after 10 years, the house will go out of possession.
Accident:
Assets may be destroyed by abnormal reasons such as fire, earthquake, flood etc. In such a case the destroyed asset must be written off as loss and a new one purchased.
Need for Depreciation
The Need for depreciation arises for the following reasons:
Ascertainment of True Profit or Loss:
Depreciation is a loss. So Unless it is considered like all other expenses and losses, true profit or loss cannot be ascertained. In other words, depreciation must be considered in order to into out true profit or loss of a business.
Ascertainment of True Cost of Production:
Goods are produced with the help of plant and machinery which incurs depreciation in the process of production. This depreciation must be considered as a part of the cost of production of goods. Otherwise, the cost f production would be shown less than the true cost. Sales price is fixed normally on the basis of cost of production. So, if the cost of production is shown less by ignoring depreciation, the sale price will also be fixed at low level resulting in a loss to the business.
True Valuation of Assets:
Value of assets gradually decreases on account of depreciation, if depreciation is not taken into account, the value of asset will be shown in the books at a figure higher than its true value and hence the true financial position of the business will not be disclosed through balance sheet.
Replacement of Assets:
After sometime an asset will be completely exhausted on account of use. A new asset must then be purchased requiring a large sum of money. If the whole amount of profit is withdrawal from business each year without considering the loss on account of depreciation, necessary sum may not be available for buying the new asset. In such a case the required money is to be collected by introducing fresh capital or by obtaining loan or by selling some other assets. This is contrary to sound commerce policy.
Keeping Capital Intact:
Capital invested in buying an asset, gradually diminishes on account of depreciation. If loss on account of depreciation is not considered in determining profit or loss at the year end, profit will be shown more. If the excess profit is withdrawal, the working capital will gradually reduce, the business will become weak and its profit earning capacity will also fall.
Basic Factors of Determination of Depreciation
For calculation depreciation the basic factors are:
1. The original cost of the asset.2. The estimated working life of the asset or the number of
years the asset is expected to last.
3. The estimated residual or scrap value at the end of its life. It is the value which the asset will fetch when discarded as useless.
4. The amount to be spent periodically for repairs and renewals. If the repairs necessary to keep the asset in a proper state of efficiency are regularly carried out, the life of the asset is prolonged and the amount of annual depreciation is proportionately lowered.
5. The possibility of the asset becoming obsolete. If there are great chances of improvements being made in a particular asset on account of inventions, higher depreciation should be written off such an asset.
Usually engineers and experts give their opinion about these and they are accepted by businessmen. After getting information on all these points, it is easy to access the rate of depreciation.
Methods of Calculating Depreciation
The charge of depreciation can impact the net profit in the income statement, so the methods of calculating depreciation are very important. Adopting different methods of calculation, the result will be different. And it'll refer to the expense and tax in the income statement. Choosing the fit methods of calculating depreciation, it needs to be faced by the finance staff.
There are several possible methods of calculating depreciation:
1. Straight line method
2. Written Down Value Method
3. Annuity Method
4. Depreciation Method
5. Insurance Policy Method
6. Revaluation Method
7. Depletion Method
Fixed Installment or Original Cost or Straight Line Method, reducing/Diminishing Balance method
Under this method depreciation is not calculated on cost of asset. It is computed on the book value. of asset. The book value of the asset is obtained by deducting depreciation from its cost. The book value of asset gradually reduces on account of depreciation charge. Since the depreciation percent rate is applied on reducing balance of asset. this method is called reducing balance or diminishing installment method or written down value method.
Advantages of Straight-Line Depreciation
Straight-line depreciation, also known as the fixed or equal-installment depreciation method, is the simplest and most widespread form of depreciation used by businesses. It is suitable for assets that operate uniformly and consistently over the life of the item. The fixed method is straightforward, uncomplicated, easy to understand and simple to apply. Each year the same amount of money is taken as a depreciable business expense on the company's tax return. Straight-line depreciation is suitable for less expensive items, such as furniture, that can be written off within the asset's defined legal, estimated or commercial life. The IRS sets guidelines for estimating an asset's useful life.
Disadvantages of Straight-Line Depreciation
Most pieces of office equipment, machinery and other items purchased do not perform exactly the same each year. As
assets age they become less efficient. Repair costs usually increase over time. Straight-line depreciation does not account for the loss of efficiency or the increase in repair expenses over the years and is, therefore, not as suitable for costly assets such as plant and equipment. The functional life span of some assets cannot clearly be estimated. The straight-line depreciation method should not be used when the useful life of an asset is unpredictable.
Yearly Depreciation= Original cost of asset- Estimated Scrap Value/Estimated Life of the asset
For example, a company purchased a car on 1 January at a cost of $24,000. The company estimates that its useful life is four years, after which he will trade it in for $4,000. The annual depreciation charge is to be calculated using the straight line method.
Depreciation charge = ($24,000 - $4,000)/4= $5,000 p.a.
Written Down Method
Under this method the depreciation charge will be higher in the earlier years of the life of the asset. Here needs a percentage to apply. And in the first year the percentage is applied to cost but in subsequent years it's applied to the asset's net book value (alternatively known as written down value).
Advantages Of Reducing Balance Method Of Depreciation
The main advantages of reducing balance method of depreciation are listed below
* Reducing balance method is easy to understand and simple to implement. Depreciation is calculated every year on the opening balance of asset.* Reducing balance method equalizes the yearly burden on profit and loss account in respect of both depreciation and repairs. The amount of depreciation goes on decreasing while the expenses on repairs goes on increasing, so that the total charge against revenue over different years remains more or less the same.
* Reducing balance method is acceptable for income tax purposes
* Reducing balance method matches the cost and revenue of the business. The greater amount of depreciation provided in initial years is matched against the higher amount of revenue generated by increased production by the use of new asset.
Disadvantages Of Reducing Balance Method Of Depreciation
The main demerits of reducing balance method are as follows:
* Reducing balance method charges heavy amount of depreciation in earlier years.
* The formula to obtain rate of depreciation can be applied only when there is residual value of the asset.
Reducing balance depreciation method
Using the straight line depreciation method, the calculation of the annual depreciation charge is as follows:
31 December Rs.
Original machine cost 75,000
2003 Depreciation in 2003 (40% cost) 30,000
Written down value at 31 December 2003 45,000
2004 Depreciation in 2004 (40% of WDV @ 31 December 2003) 18,000
Written down value at 31 December 2004 27,000
2005 Depreciation in 2005 (40% of WDV @ 31 December 2004) 10,800
Written down value at 31 December 2005 16,200
2006 Depreciation in 2006 (40% of WDV @ 31 December 2005) 6,480
Written down value at 31 December 2006 9,720
2007 Depreciation in 2007 (40% of WDV @ 31 December 2006) 3,888
Written down value at 31 December 2007 5,832
The reducing balance method can result in significant differences in the annual depreciation charge, depending on the "percentage" of written-down value that is used to calculate the charge.
In the example above, the total amount charged to depreciation in the first three years of owning the machine (2003-2005) was £58,800 (compared with £39,000 if a straight line depreciation method has been used).
To compare the reducing balance method with the "straight line" method, we have provided a worked example using the
Annuity method
The method recognizes the time value (Interest) of money and hence regards the real cost of using a long-lived asset equivalent to the actual amount invested thereon plus the interest lost on the acquisition of asset. Under this method, so much depreciation is written off each year as after debiting the asset account with interest upon the diminishing value, will reduce the asset to nil at the end of its life. Thus, the amount written off as depreciation is the same every year, but the interest will diminish each year.
The amount of annual depreciation to be written off by Annuity method will be ascertained from Annuity Tables
Advantages:
Useful method to use in respect to long-term lease which generally involve considerable capital outlay
Interest on capital investment is taken into account. This method is perceived to the most exact, precise and scientific form from the point of view of calculations.
Disadvantages:
Though interest is taken into consideration but the rate is still arbitrary and not based on law
Computation using this method becomes more complicated where there are frequent additions, dismantling, etc taking place. Not so suitable for assets like Plant & Machinery.
Depreciation Fund Method
Under this method, a fixed amount is charged as depreciation every year. It endeavors to provide the required lump sum cash at the retirement of a long, lived asset by annually setting aside and investing a fixed sum in readily realizable securities. These securities earn interest at fixed rate and the same being reinvested along with successive fixed installments of depreciation, allowed to accumulate at compound interest. The sinking fund method thus takes into account of this probable income from interest while fixing the annual depreciation and
investing the same which together with compound interest accumulated to the asset's depreciable cost by the end of its useful life. Obviously, the fixed installment of annual depreciation is here smaller as compared to straight line method. Its magnitude, however, rests on the asset's life span and interest rate. Longer the span and higher the rate, smaller is the annual depreciation per rupee of depreciable cost.
Advantages of Depreciation Fund Method Or Sinking Fund Method:
The most important advantages of this method is that it makes available a sum of money for the replacement of the asset, which has become useless. If separate provision was not made, the sum required to purchase the new asset will have to be drawn from the business which might effect the financial position of the concern adversely.
Disadvantages of the Depreciation Fund Method Or Sinking Fund Method:
1. The burden on profit and loss account goes on increasing as years pass by since the amount of depreciation every year remains same but the amount spent on repairs goes on increasing as the asset becomes old.
2. It can also be said that the work of investing money is complicated.
3. Prices of securities may fall at the time when they are to be realized as a result of which loss may have to be suffered.
Insurance Policy Method
Insurance policy method is a slight modification of the depreciation fund method or sinking fund method. Under this method the amount represented by the depreciation fund, instead of being used to buy securities, is paid to an insurance company as premium. The insurance company issues a policy promising to pay a lump sum at the end of the working life of the asset for its replacement.
The advantage of insurance policy method is that risk of loss on the sale of investment and the trouble and expense of buying investment are avoided, while disadvantage lies that the interest received on the premiums paid is comparatively very low.
When insurance policy method is employed the policy account will take the place of the depreciation fund investment account and no interest will be received at the end of each year, but the total interest on the premiums will be received when the policy matures.
Entries:
Every years two entries will be made:
1. In the beginning:
Depreciation insurance policy account
To Cash account
(Being the payment of premium on depreciation policy)
2. At the end of the year:
Profit and loss account
To Depreciation fund account
(Being the amount of depreciation charged to profit and loss account)
When the policy will mature i.e., to say the amount of the policy
will be received. The entry is:3. Cash account
To Depreciation insurance policy account
(Being the policy amount realized)
The depreciation insurance policy account will show some profit. This will be transferred to depreciation fund account, the entry being.
4. Depreciation insurance policy account
To Depreciation fund account
(Being the policy amount realized)
The asset account will have been shown throughout at its original cost. It now be written off by transfer to depreciation fund account. The entry is:
5. Depreciation fund account
To Asset account
Insurance Policy Method Example:
On 1st January, 1990 a business purchases a three year lease of premises for $20,000 and it is decided to make a provision for replacement of the lease by means o an insurance policy purchased for annual premium.
Show the ledger accounts dealing with this matter.
Solution:
Leasehold Account
Dr. Side Cr. Side1990 1990
Jan. 1To Cash 20,000Dec. 31
By Depreciation fund
20,000
Depreciation Fund Account
Dr. Side Cr. Side
1990 199
0
Dec. 31
To Balance c/d 6,400 Dec. 31
By Profit and loss a/c
6,400
1991
Dec. 31
To Balance c/d 12,800 Jan. 1
By Balance b/d
6,400
Dec. 31
By Profit and loss a/c
6,400
12,800 12,800
1992 199
2
Dec. 31
To Leasehold Property
20,000 Jan. 1
By Balance b/d
12,800
Dec. 31
By Profit and loss a/c
6,400
"By Leasehold
800
20,000 20,000
Leasehold Policy Account
Dr. Side Cr. Side
1990 199
0
Dec. 31
To Cash 6,400 Dec. 31
By Balance c/d
6,400
1991 199
1
Jan. 1
To Balance b/d 6,400 Dec. 31
By Balance c/d
12,800
Dec. 31
To Cash 6,400
12,800 12,800
To Balance b/d 12,800 By Cash 20,000
To Cash 6,400
800
20,000 20,000
Revaluation Method
As the name implies under revaluation method, the assets are valued at the end of each period so that the difference between the old value and the new value, which represents the actual depreciation can be charged against the profit and loss account. This method is mostly used in case of assets like bottles, horses, packages, loose tools, casks etc. On rare occasions when on revaluation the value of an asset is found to have increased, it being of temporary nature not taken into account.
Revaluation method is open to various objections.
Firstly, the method do not specify as to which is the value that the experts are to estimate at the end of each year. It however appears that this is the market value. If so, to assess depreciation with reference to market value is against the basic principles and theory of depreciation. A fixed asset has nothing to do with market value.
Secondly, the charge against profit and loss account on account of depreciation will vary year to year through the asset renders the same service throughout of its life time.
Thirdly, this method is unscientific, because there are great chance of manipulations.
Depletion Method
Depletion method of depreciation is especially suited to mines, quarries, sand pits, etc. According to it the cost of the asset is divided by the total workable deposits. In this way, rate of depreciation per unit of output is ascertained. Depreciation in any particular year is charged on the basis of the output during that year.
Example:
A mine was acquired at a cost of $20,00,000 the quantity of minerals expected to be mined is 5,00,000 tons, the rate of depreciation per unit will be $4 i.e., (20,00,000 / 5,00,000). If during the year 25,000 tons minerals is extracted, the amount of depreciation will be 25,000 × 4 = $1,00,000.
Difference Between Depreciation and Fluctuation:
Depreciation of asset and fluctuation in its market value are not the same. For example, a businessman purchase a machine the life of which is estimated at 10 years and charges depreciation accordingly each year. If for certain reasons the market value of the machine decreases by say 20%, the businessman need not consider this decrease at all. Because the productive capacity or the utility of the machine to the businessman has not been reduced on account of fall in its market value. So he will not have to suffer any loss, unless he sells the machine. But the machine is not intended for sale - it will be used permanently in the business. So the business will ignore the fall in market price. But depreciation cannot be ignored - it must be considered. Thus we see that there is no relationship between depreciation and fluctuation. The points of difference between depreciation and fluctuation are stated below in a tabular form:
Depreciation Fluctuation
1. It reduces productive capacity or utility of asset.
1. It does not reduce productive capacity or utility of asset.
2. It must occur 2. It may not occur
3. It reduces value of asset gradually.
3. The value of asset may arise or fall on account of fluctuation.
4. Loss by way of depreciation must be
4. Generally it is not taken into account. However, in case of
considered. current assets permanent fall in price is considered.
5. It is a regular loss - it must be charged throughout the working life of asset.
5. It is generally irregular.
6. It always indicates loss 6. It may indicate either profit or loss. Increase in market value means profit, while decrease means loss.
Depreciation of Various Assets:
Freehold Land and Building:
It means that land and building which has been purchased out right and not on lease. In the case of building it will be seen that in its early life, few repairs will be needed. These repairs will keep the building in proper order. But after sometime the building will begin to decay and even the repairs will not succeed in keeping it in proper working order. Efficient repairs, no doubt, add to the life of the building, but they cannot make it everlasting. After some considerable time the building will practically fall in spite of all the repairs. Hence it is absolutely necessary to charge depreciation on such building, so that by the time it falls down, its book value also disappears from the books of accounts. As this asset possesses a long life, the method of depreciation employed should be such as it provides a fund for its reconstruction on its dilapidation. Thus either of the straight line method or reducing installment method may be adopted to depreciate this asset.
One of the peculiarly of the land is that it does not generally depreciate. Its value may and does fluctuate from time to time,
but such fluctuations do not influence depreciation in any way. Consequently older accountants were of the opinion that land should be left at the cost price in the books. According to modern opinion the idea of the depreciation with regard to land cannot be ruled out entirely. Agricultural land may loss its fertility. Brick land may depreciate. as such, in some cases at least land must be depreciated.
Leasehold Land and Building:
By leasehold is meant the land that is taken on lease for a certain number of years. The most general duration is 99 years, but may of course be less or much more. If the lease under which the property is acquired is short, the fixed installment method or straight line method of depreciation can be applied conveniently. If on the other hand, it be a long lease, the annuity method of depreciation would be more suitable. The value of the leasehold property should be written off during the term of the lease and the rate of depreciation should be fixed accordingly.
Plant and Machinery:
This term includes machinery of different kinds e.g., engines, boilers, fixed plant, running machinery, etc. As the working life of each one of them is different, the rate of depreciation should also be different. Though fixed installment method or straight line method can be suitably applied to depreciating plant and machinery but owing to the difficulty of calculating depreciation on additions made during the year, the diminishing balance method is generally employed to depreciate this asset.
Loose Tools:
As this asset is liable to breakage and pilferage, it should be annually valued. The difference between the present value and the value as per last balance sheet should be treated as depreciation.
Furniture and Fixture:
The diminishing balance method is usually employed to depreciate this asset. The rate of depreciation should be high enough to reduce it to its residual value at the end of its working life.
Patents and Copyrights:
There is a maximum legal life of such assets but the commercial life (during which such assets can be effectively exploited) may even be shorter. The assets should be depreciated by the straight line method so that it is written off within the legal or commercial life whichever is shorter.
Mines, Oil Well, Quarries, Etc:
The depreciation should be estimated by the depletion method.
Goodwill:
Goodwill has been defined as the benefit or advantage arising from regular public patronage on account of facilities offered. The name under which the business is carried on acquires a reputation and consequently a saleable value. It can be sold only when entire business is sold off. It is an intangible asset. Though goodwill is a fixed asset it does not depreciate on account of wear and tear like plant and machinery etc. As goodwill is not consumed in the process of earning income, it is not necessary to depreciate it. But as no business, howsoever well established, can have perpetual life, it is advisable to create a reserve from the profit and loss account in prosperous years because when profits fall and goodwill depreciates it may be difficult to write it off.