📑 Topics on this page (Jump to Topic):
📌 1. Depreciation: Meaning, Causes & Factors
Depreciation = systematic allocation of the depreciable amount (cost − residual value) of a tangible fixed asset over its useful life. It is a non-cash expense debited to the P&L account.
| Term | Related asset |
|---|---|
| Depreciation | Tangible fixed assets — machinery, building, furniture |
| Depletion | Natural resources / wasting assets — mines, oil wells, quarries |
| Amortisation | Intangible assets — patents, copyright, goodwill |
- Causes: wear and tear, efflux of time (lease), obsolescence (new technology), depletion, accidents.
- Factors: cost of the asset, estimated useful life, estimated residual (scrap) value.
- Land is generally not depreciated (unlimited life).
- Objectives: true profit, true asset value, retaining funds for replacement, tax benefit.
📌 2. Methods of Depreciation
| Method | Formula / basis | Feature |
|---|---|---|
| Straight line / fixed instalment / original cost (SLM) | (Cost − residual value) ÷ useful life | Same charge every year; asset can be written down to nil/scrap |
| Written down value / diminishing balance / reducing balance (WDV) | Opening book value × fixed rate | Charge falls each year; book value never reaches zero; accepted for income tax |
| Sum of years' digits | Remaining life ÷ sum of digits × depreciable amount | Higher charge in early years |
| Units of production / machine hour | In proportion to usage | For machines with varying use |
| Depletion method | Quantity extracted ÷ total estimated quantity × cost | Mines, quarries |
| Annuity method | Interest on cost is also considered | For leases |
| Sinking fund / depreciation fund | Equal amount invested yearly in outside securities | Funds ready for replacement |
| Insurance policy method | Premium paid; policy maturity funds replacement | For leases etc. |
| Year (WDV 20%, cost ₹1,00,000) | Opening value | Depreciation | Closing value |
|---|---|---|---|
| 1 | 1,00,000 | 20,000 | 80,000 |
| 2 | 80,000 | 16,000 | 64,000 |
| 3 | 64,000 | 12,800 | 51,200 |
SLM example: cost ₹1,00,000, residual ₹10,000, life 5 years → annual depreciation = 90,000 ÷ 5 = ₹18,000; rate = 18% (on cost).
📌 3. Recording & Legal Provisions
| Method | Entry | Balance sheet |
|---|---|---|
| Charging to asset account | Depreciation A/c Dr. To Asset A/c | Asset at reduced value |
| Provision for depreciation / accumulated depreciation A/c | Depreciation A/c Dr. To Provision for Depreciation A/c | Asset at original cost less provision |
- AS 10 (revised) — Property, Plant and Equipment covers depreciation; the old AS 6 was withdrawn. A change in depreciation method = a change in accounting estimate (prospective).
- Schedule II of the Companies Act 2013 prescribes useful lives (not rates); companies may use SLM or WDV.
- Under income tax, depreciation is allowed on a block of assets on the WDV basis.
⚠️ Exam Traps:
- Depreciation is a process of cost allocation, not of valuation.
- Depreciation is not a cash outflow — it lowers profit but no cash leaves.
- Under WDV the book value never becomes zero; under SLM it can.
💡 Memory Tip: SLM = "same instalment, straight line"; WDV = "falling balance, falling charge".
📌 4. Worked Examples
Example: straight line vs written down value
Machine cost ₹1,00,000, scrap ₹10,000, life 5 years. SLM depreciation = (1,00,000 − 10,000) ÷ 5 = ₹18,000 a year. WDV rate 20%.
| Year | SLM depreciation | SLM book value | WDV depreciation (20%) | WDV book value |
|---|---|---|---|---|
| 1 | 18,000 | 82,000 | 20,000 | 80,000 |
| 2 | 18,000 | 64,000 | 16,000 | 64,000 |
| 3 | 18,000 | 46,000 | 12,800 | 51,200 |
At the start of year 4 the WDV machine is sold for ₹48,000: loss = 51,200 − 48,000 = ₹3,200 (debited to P&L). With a provision account the entry is Depreciation A/c Dr. To Provision for Depreciation A/c; the machine account stays at original cost.
📌 5. Practice MCQs
📝 Practice MCQs (prepared by SF Prep — not PYQs)
Q1. Under the straight line method, annual depreciation is: Practice
Correct answer: (C)
(Cost − residual) ÷ life — a fixed amount.
(Cost − residual) ÷ life — a fixed amount.
Q2. Cost ₹1,00,000, residual ₹10,000, life 5 years. Annual SLM depreciation is: Practice
Correct answer: (D)
90,000 ÷ 5 = 18,000.
90,000 ÷ 5 = 18,000.
Q3. Under the WDV method, depreciation is calculated on the: Practice
Correct answer: (B)
A fixed rate on the falling balance each year.
A fixed rate on the falling balance each year.
Q4. On a ₹1,00,000 machine at 20% WDV, depreciation in year 3 is: Practice
Correct answer: (B)
Value: 1,00,000 → 80,000 → 64,000; 64,000 × 20% = 12,800.
Value: 1,00,000 → 80,000 → 64,000; 64,000 × 20% = 12,800.
Q5. The suitable method for wasting assets like mines and oil wells is: Practice
Correct answer: (C)
In proportion to quantity extracted.
In proportion to quantity extracted.
Q6. Writing off the cost of intangible assets like patents is called: Practice
Correct answer: (D)
Tangible = depreciation, natural = depletion, intangible = amortisation.
Tangible = depreciation, natural = depletion, intangible = amortisation.
Q7. Which asset is generally not depreciated? Practice
Correct answer: (A)
Land is taken to have unlimited life.
Land is taken to have unlimited life.
Q8. An asset becoming useless due to new technology is called: Practice
Correct answer: (D)
Technological change ends usefulness.
Technological change ends usefulness.
Q9. Under which method does the book value never become zero? Practice
Correct answer: (A)
A percentage of the balance is removed each time, never all of it.
A percentage of the balance is removed each time, never all of it.
Q10. Depreciation is a: Practice
Correct answer: (B)
Profit falls but no cash goes out.
Profit falls but no cash goes out.
Q11. Under the provision for depreciation method, the yearly entry is: Practice
Correct answer: (C)
The asset stays at original cost.
The asset stays at original cost.
Q12. In India, depreciation is now covered by: Practice
Correct answer: (C)
The old AS 6 was withdrawn and merged into AS 10.
The old AS 6 was withdrawn and merged into AS 10.
Q13. Which schedule of the Companies Act 2013 gives useful lives of assets? Practice
Correct answer: (D)
Schedule III gives the format of financial statements.
Schedule III gives the format of financial statements.
Q14. Which is NOT a factor in computing depreciation? Practice
Correct answer: (A)
Depreciation allocates cost; it does not track market value.
Depreciation allocates cost; it does not track market value.
Q15. For an asset with a 5-year life, the first-year fraction under SYD is: Practice
Correct answer: (B)
Sum of digits 1+2+3+4+5 = 15; first year 5/15.
Sum of digits 1+2+3+4+5 = 15; first year 5/15.
Q16. For machines whose use varies widely year to year, the suitable method is: Practice
Correct answer: (A)
Depreciation follows hours used.
Depreciation follows hours used.
Q17. For leasehold property, the method that also considers interest is the: Practice
Correct answer: (C)
Cost plus interest written off in equal yearly amounts.
Cost plus interest written off in equal yearly amounts.
Q18. Changing the depreciation method is treated under AS 10 as a: Practice
Correct answer: (D)
Its effect is applied prospectively.
Its effect is applied prospectively.
Q19. One objective of providing depreciation is to: Practice
Correct answer: (B)
It matches asset cost with the revenue of the years of use.
It matches asset cost with the revenue of the years of use.
Q20. At 10% SLM on a ₹50,000 machine, the book value after 3 years is: Practice
Correct answer: (B)
₹5,000 a year; ₹15,000 in 3 years; 50,000 − 15,000.
₹5,000 a year; ₹15,000 in 3 years; 50,000 − 15,000.