DEPRECIATION POLICY

1. DEPRECIATION POLICY

2. Meaning of depreciation • the decrease in value of assets (fair value depreciation), and • the allocation of the cost of assets to periods in which the assets are used (depreciation with the matching principle).

3. Characteristics Of Depreciation • Depreciation is always a fall in the value of asset • This fall is always gradual • The fall is of permanent character and it cannot be recorded afterwards • The depreciation is a continuous process and it does not matter weather the asset was put to use during the period or not • Depreciation is always in fixed assets and not on current or floating assets • Depreciation is the fall in the book value of the asset and not in market or exchange value • Depreciation is the result of the assets passage of time and obsolescence

4. Causes Of Depreciation • Use of the assets or wear and tear • Accident • Expiration of certain legal rights • Obsolescence • Inadequancy • Depletion

5. Basic Factors In Estimating Depreciation • Cost off the asset • Useful Life of the Asset • Salvage value • Method of Depreciation

6. Methods of depreciation • Straight line method • Diminishing Balance method • Annuity method • Depreciation fund method • Insurance policy method • Revaluation method • Depletion method • Machine hour rate method

7. 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

8. 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.

9. Insurance Policy Method • This method endeavors the supply of required cash at the retirement of a specified asset in return of periodic contribution (premium). Under this a trader takes a 'Capital Redemption Insurance Policy' from an insurance company which undertakes to pay at a given date a certain sum if the trader, paying a fixed number of premiums after regular intervals. The trader treats the periodic payment as depreciation and charges it to profit and loss account. In this case, depreciation is charged at the end of the year, whereas, the premium is paid at the beginning of the year. At maturity, the insurance company pays the policy money which is normally sufficient to replace the retired set. Normally, amount received is more than total premium paid as the policy yields interest.

10. Machine Hour Rate • Under this method, the total number of working hours of a machine during the whole of its effective life is estimated, and then the cost of machine is divided by the expected number of hours of useful life, this gives the rate per hour. The annual depreciation is calculatedly multiplying this rate by the number of hours, the machine actually runs in a year.

11. Depreciation Fund method or Sinking 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.

12. Revaluation Method • Under the system, each year the asset is valued and the value is compared with that in the beginning of the year. The fall is treated as depreciation. Suppose if the value of the tools at the beginning of the year was Rs. 8,000, during the year tools worth Rs. 6,000 were purchased and at the end of the year, on valuation these amounted to Rs. 11,000. The amount of depreciation for the year will be : 8,000 + 6,000-11,000 = Rs. 3,000 . This method is useful for charging depreciation on livestock and loose tools.

13. Factors influencing the choice of a depreciation method • Original cost of fixed asset i.e., purchase price plus freight and installation expenses; • Estimated amount of expenditure on repairs during the useful life; • Estimated useful life of asset after which it will be discarded; • Estimated residual or scrap value; • Interest on investment-the amount invested on purchase of asset, if it had been invested in some other investment what interest would have been earned; • Possibility of obsolescence.

14. Developing Depreciation Policy The purpose of depreciation policy is to write off the cost of assets systematically during their economic life. The schedule of depreciation should be prepared at the time of purchase of asset and it should be revised according to needs of changes. The maximum rates of depreciation allowed under income-tax laws should not be the sold criterion for amortizing assets