While maintaining accounts, one has to make sure of the correct values of any increment/decrement. When depreciation happens, that is, the value of fixed assets drops down, it is important to record this decrement carefully. There are various methods by which this can be accounted for, and one of the approaches is 'uniform charge method.' In this method, the value of depreciation is charged in a uniform manner year after year in the form of a fixed instalment method and many more. However, this method is best applicable to productive assets. There are some sub-methods that fall under this. Listed below are their names and a small explanation for each one of them.
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Depreciation Formula
Amount of Depreciation = \[\frac{\text{Cost of an asset – Net residual value}}{\text{useful life}}\]
Various Methods included in Uniform Charge Method
There are four sub-methods that come under this major method.
Fixed Instalment Method
In the fixed instalment method, a particular cost of depreciation is noted down with respect to the utility of the asset's life. When the utility of the asset’s life ends, this depreciation value either lowers down to zero or is changed to its residual value.
Annuity Method
In this method, the depreciation value is derived from the cost of the asset and the interest loss in the capital’s expenditure. This method prevails on the assumption that there might have been a better outcome if the investment was made in some other place. That is why we calculate interest loss, too, to keep a clean record of depreciation value.
Depreciation Fund Method
This method is used when the cost of depreciation is too high, and the new asset can not be bought with the remaining sources. Even though the depreciation cost is noted every year with proper terms and conditions, sometimes the company may lack resources to further buy the next asset. During such times, this method comes in use.
Insurance Policy Method
In this method, the company does not purchase securities; instead, it buys an insurance policy. This insurance policy is equal to the cost of the asset, which needs to be replaced. Every year, in the beginning, the company will have to pay some money, known as premium. In exchange for the premium, the insurance company agrees to pay a specific sum of money to them.
These are the various sub-methods that come under the Uniform Charge Method. All of these have their own advantages and disadvantages. While applying any of these, the company should look upon its resources and capability, and make the correct approach.
The relevance of Uniform Charge Method
In the sector of accounting, this method is very brief, and it is easy to keep a record of this. For a company, the correct cost of depreciation to be noted down is very important, as it adversely affects the economic growth of the company. Any error in this often results because of the use of poor methods. Thus, the Uniform Charge Method is a neat process, which, if applied, yields out correct results, thus being of great help to the company.
Did You Know?
This method is also known as Straight Line Method or Fixed Percentage on the Original Cost Method because this method changes the depreciation cost every year uniformly, thus avoiding any hindrance and abnormalities in the outcome. The original cost plays a vital role while using this method; its other names go along completely with the process.
FAQs on Uniform Charge Method for Depreciation
1. What is the Uniform Charge Method for Depreciation, and why is it also called the Straight-Line Method?
The Uniform Charge Method is a method of calculating depreciation where the cost of an asset is spread evenly over its useful life. A fixed, equal amount of depreciation is charged to the profit and loss account every year. It is also known as the Straight-Line Method (SLM) because if you were to plot the remaining value of the asset over time, the graph would form a straight, downward-sloping line, indicating a constant rate of depreciation.
2. How do you calculate the annual depreciation amount using the Uniform Charge Method formula?
To calculate the annual depreciation using the Uniform Charge Method, you use a simple formula. First, determine the total depreciable amount, and then divide it by the asset's useful life. The formula is:
Annual Depreciation = (Original Cost of Asset - Estimated Salvage Value) / Estimated Useful Life of Asset
Here, Salvage Value is the estimated residual value of an asset at the end of its useful life.
3. Can you provide a practical example of calculating depreciation using the Uniform Charge Method for a Class 11 problem?
Certainly. Suppose a company purchases machinery for ₹2,20,000. The estimated useful life of the machinery is 10 years, and its estimated salvage value after 10 years is ₹20,000. The calculation would be as follows:
- Original Cost: ₹2,20,000
- Salvage Value: ₹20,000
- Depreciable Amount: ₹2,20,000 - ₹20,000 = ₹2,00,000
- Useful Life: 10 years
- Annual Depreciation: ₹2,00,000 / 10 = ₹20,000 per year.
Therefore, the company will charge ₹20,000 as a depreciation expense every year for 10 years.
4. Under what business circumstances is the Uniform Charge Method most suitable for depreciation?
The Uniform Charge Method is most suitable for assets that provide consistent economic benefits throughout their useful life and do not require significant repairs in their later years. It is ideal for assets like:
- Buildings and Leasehold Properties: These assets tend to provide consistent utility over a long period.
- Furniture and Fixtures: Their usage and benefit generation are generally stable over time.
- Intangible Assets: Assets like patents and copyrights that have a fixed legal life are often amortised using this method.
Its simplicity also makes it a preferred choice for smaller businesses that require straightforward accounting practices.
5. How does the Uniform Charge Method compare to the Written Down Value (WDV) Method?
The Uniform Charge Method and the Written Down Value (WDV) Method are the two main methods in the CBSE syllabus, and they differ significantly:
- Basis of Calculation: The Uniform Charge Method calculates depreciation on the original cost of the asset, while the WDV method calculates it on the book value (cost minus accumulated depreciation) of the asset each year.
- Amount of Depreciation: Under the Uniform Charge Method, the depreciation amount is fixed every year. Under the WDV method, the depreciation amount is highest in the first year and decreases in subsequent years.
- Impact on Profit & Loss Account: The Uniform Charge Method results in an increasing charge to the P&L account over time (fixed depreciation + increasing repairs). The WDV method creates a more balanced charge (decreasing depreciation + increasing repairs).
- Asset's Final Value: An asset's book value can become zero under the Uniform Charge Method, but it never becomes zero under the WDV method.
6. What are the main limitations of the Uniform Charge Method, especially concerning repair costs and asset efficiency?
While simple to use, the Uniform Charge Method has some key limitations:
- Mismatch of Costs and Revenue: It assumes an asset works with the same efficiency throughout its life, which is often untrue. An asset is typically more efficient in its early years, but the depreciation charge remains the same.
- Uneven Burden on Profits: In the later years of an asset's life, repair and maintenance costs tend to increase. When these higher repair costs are added to the fixed depreciation amount, the total charge against profit becomes significantly higher in later years compared to earlier ones.
- Ignores Interest Factor: The method does not consider the opportunity cost or interest on the capital invested in the asset.
7. What are the primary factors that determine the depreciable amount of an asset?
Three primary factors are essential for determining the depreciable amount of an asset before applying any method:
- Total Cost of the Asset: This includes the purchase price plus all costs incurred to bring the asset to its intended location and working condition, such as installation charges and freight.
- Estimated Useful Life: This is the period over which a business expects to use the asset to generate revenue. It can be measured in years, production hours, or units produced.
- Estimated Salvage Value: Also known as residual or scrap value, this is the amount the business expects to sell the asset for at the end of its useful life. The depreciable amount is the total cost minus this salvage value.
