As you are aware that during various accounting courses fixed asset accounting is highly stressed upon. Fixed assets like plant and machinery are used in the business for the purpose of production of goods or for providing useful services in the course of production. Value of such fixed assets decreases with time and its utilization i.e. wear and tear. Vale of the portion of fixed assets utilized for generating revenue must be recovered during the particular accounting year to ascertain true income. This portion of the cost of fixed assets allocated to a particular accounting year is called Depreciation. Hence, all accounting courses state it imperative to understand how to calculate depreciation.
Depreciation means a diminution in the value of assets, due to natural wear and tear, exhaustion of subject-matter or similar causes.
The loss in the value of assets employed for carrying on the business being an essential element of business expenditure, it is necessary to calculate the amount of such loss, to get a stipulation, and hence, come at the amount of profit or loss obtained by the business.
Reasons for Depreciation:
- Physical wear and tear resulting from the use
Tangible fixed assets like machinery, building, furniture, etc. can get exhausted or discarded on account of resistance, pressure, weathering, the power of use, chemical reaction, handling, etc. - Physical deterioration resulting in exposure to the element
Number of assets deteriorates with the mere passage of time, being continually exposed to forces of nature, like wind, weather, etc. - Disuse
A machine kept continuously idle become potentially less useful by the passage of time. - Depletion
Wasting assets such as mines and quarries lose their value because they get exhausted on account of continuous extraction. - Obsolescence
Some equipment will be rendered out of date by more efficient equipment, which reduces the usability of the original equipment. - Accident
If an asset meets an accident, the value of an asset may go down.
But now the question arises, why do we need to provide Depreciation? The following are the objectives for providing Depreciation.
- Funds for replacement
Generation of adequate funds in the hand of business for replacement of the asset at the end of its useful life. - Correct income measurement
Depreciation must be charged for proper estimation of periodic profit or loss. - True position statement
Value of fixed assets should be adjusted for depreciation charged in order to depict the actual financial position. - Ascertainment of true cost of production
For ascertaining the true cost of production, it is necessary to charge depreciation as an item of cost of production.
Too much theory… Uh… Ok. So our institute runs various accounting courses in Ahmedabad and focuses on learning practical accounting. So, let us learn accounting entries related to depreciation.
When the depreciation is directly charged to an asset account, the entry to be made on writing off depreciation is:
Alternatively, when the asset continues to be shown at its original cost till discarded or destroyed or sold the following entries may be passed:
However, where the assets are sold or discarded or exchanged for the new asset. The total accumulated depreciation for the asset in the provision for depreciation account is transferred to the asset account by the following journal entry
In the balance sheet, the asset account is shown at its original cost less accumulated balance in the provision for depreciation account.
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