Depreciation of Fixed Assets
In bookkeeping terms, depreciation of fixed assets is characterized as the decrease of the recorded expense of a fixed resource in a deliberate way until the estimation of the asset gets zero or unimportant.
Some examples of fixed assets are buildings, furniture, office hardware, machinery and so on. The land is the main special case which cannot be depreciated as the estimation of land acknowledges with time.
Depreciation of fixed assets permits a segment of the expense of a fixed asset for the income created by the fixed resource. This is compulsory under the coordinating guideline as incomes are recorded with their related costs in the bookkeeping time frame when the asset is being used. This helps in getting a total image of the income generation transaction.
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Concept of Depreciation
The concept of depreciation is the part of a fixed resource's cost recorded as a cost during the current bookkeeping time frame. Depreciation concept in accounting means that a fixed asset has a helpful life longer than one bookkeeping period and depreciation signifies the value of its worth spent during the current time frame.
Concept of Depreciation can be determined in numerous ways. We must decide reasonable depreciation for the current bookkeeping time frame as per a fixed asset's valuable life, unique cost, depreciation method and neighbourhood guidelines. After that, the manager will monitor how much depreciation has been amassed for the fixed asset.
Depreciating assets examples include straight-line depreciation which is the least difficult strategy, partitioning the fixed asset's expense by the quantity of bookkeeping periods it is relied upon to last. Different techniques can yield more noteworthy depreciation charges in early bookkeeping periods to perceive fast obsolescence or consider the rescue or scrap estimation of the fixed asset after it is completely depreciated. Duty guidelines may likewise permit quickened deterioration to support business venture or disentangle documenting. Further, laws may indicate which depreciation charge techniques must be utilized or cannot be utilized.
Depreciation Entry Example
The journal entry for depreciation can be a basic entry intended to oblige a wide range of fixed assets, or it might be partitioned into discrete entries for each kind of fixed asset.
The essential depreciation entry example is to charge the Depreciation Expense account (which shows up in the income articulation) and credit the Accumulated Depreciation account (which shows up in the balance sheet as a contra account that lessens the measure of fixed assets). After some time, the balance of accumulated depreciation will keep on expanding as more depreciation is added to it until a time when it rises to the original expense of the asset. Around then, we need to quit recording any depreciation cost, since the expense of the asset has now been decreased to zero.
Concept of Depreciation in Economics
Depreciation is viewed as a cost, yet not at all like most costs. There is no money surge related. This is because an organization has net money outpouring in the whole measure of the advantage when the benefit was initially bought, so there is no further money-related action.
Lastly, depreciation is not planned to lessen the expense of a fixed resource for its fairly estimated worth. Market worth might be generously unique and may even increase after some time. Rather depreciation is only planned to charge the expense of a fixed asset for cost over its valuable life step by step.
Depreciation charge and various other bookkeeping errands make it wasteful for the bookkeeping division to appropriately track and record fixed assets. They lessen this work by utilizing a capitalization breaking point to confine the number of consumptions that are named fixed assets. Any consumption to which the expense is equivalent or more than that, and which has a valuable life traversing more than one bookkeeping period (normally at any rate a year) is delegated to a fixed asset and is then depreciated. This is the depreciation math definition.
FAQs on Understanding Depreciation in Accounting
1. What exactly is depreciation in accounting?
Depreciation is the systematic process of allocating the cost of a tangible asset over its useful life. It represents how much of an asset's value has been used up. It's an accounting method to account for the wear and tear, obsolescence, or decrease in an asset's value over time. It is recorded as an expense in the profit and loss account.
2. Why is it necessary for businesses to account for depreciation?
Accounting for depreciation is crucial for two main reasons. First, it follows the matching principle of accounting, which means matching the expense of using an asset with the revenue it helps to generate in the same period. Second, it ensures that the value of assets shown on the balance sheet is not overstated, presenting a true and fair view of the company's financial position.
3. Can you explain depreciation with a simple, real-world example?
Certainly. Imagine a bakery buys an oven for Rs. 50,000 and expects it to last for 10 years, after which it will have no value. Instead of recording a Rs. 50,000 expense in the first year, the bakery spreads this cost over the 10 years. Using the Straight-Line Method, it would record a depreciation expense of Rs. 5,000 (Rs. 50,000 / 10 years) every year. This expense reflects the oven's value being 'used up' to bake goods and generate revenue.
4. What are the main methods used to calculate depreciation in the Class 11 syllabus?
The two primary methods for calculating depreciation according to the CBSE Class 11 syllabus are:
- Straight-Line Method (SLM): This method charges a fixed amount of depreciation every year throughout the asset's life.
- Written-Down Value (WDV) Method: This method charges depreciation as a fixed percentage on the book value of the asset at the beginning of each year. The amount of depreciation reduces year after year.
5. What is the key difference between the Straight-Line Method (SLM) and Written-Down Value (WDV) method?
The key difference lies in how the depreciation amount is calculated each year. In the Straight-Line Method, the depreciation expense is uniform and constant every year. In the Written-Down Value method, the depreciation expense is highest in the first year and gradually decreases in subsequent years. WDV is often considered more realistic as an asset typically loses more value and requires fewer repairs in its early years.
6. What three factors must be known before calculating the amount of depreciation?
To calculate depreciation accurately, you must consider three essential factors:
- The total cost of the asset, which includes the purchase price plus any costs for installation and transportation.
- The estimated useful life of the asset, which is the period over which the business expects to use it.
- The estimated scrap value (or residual value), which is the expected value of the asset at the end of its useful life.
7. How are 'depreciation', 'amortisation', and 'depletion' different from each other?
While all three terms refer to allocating the cost of an asset, they apply to different types of assets:
- Depreciation is used for tangible fixed assets, like buildings, machinery, and vehicles.
- Amortisation is used for intangible assets, such as patents, copyrights, and trademarks.
- Depletion is used for natural resources, like oil wells, coal mines, and forests, as they are consumed.
8. Does charging depreciation mean a business is setting aside cash to buy a new asset?
No, this is a common misconception. Depreciation is a non-cash expense, meaning it reduces the company's reported profit without any actual cash leaving the business. It is simply an accounting entry to spread the initial cost of an asset over its useful life. It does not create a fund of cash for replacing the asset.
