Financial Accounting Depreciation - Accounting Basics

What is depreciation in Financial Accounting?

The value of the assets is reduced on a residual basis which is known as Depreciation. The profits of the current year are also reduced by Depreciation.

The reduction in the value of the fixed assets in indicated by Depreciation and the reduction value depends on the life of the asset and the life of the asset depends on the usage of the assets.

The life of assets is ascertained by many factors. For instance, For building, the deciding factor is time and for leased assets, the deciding factor is lease periods and for plant and machinery the deciding factor is production and time.

Why Do We Need to Account for Depreciation?

Depreciation is provided for the following reasons:

  • Depreciation is charged to ascertain the true profit during a year.
  • Depreciation is charged to ascertain the true value of the asset, True financial position of a company cannot be ascertained without calculating the correct value of the assets.
  • It is always advisable to make provisions for buying new assets for replacing the old assets. Additional working capital is provided by the accumulated value of depreciation.
  • Uniform profit in each of the accounting year is ascertained by using deprecation.
  • Advantage of tax benefit is facilitated by depreciation.

What are the accounting Entries related to Assets and Depreciation?

The accounting entries related to assets and depreciation are as follows:

S.No.
Particulars
Journal Entries
1
Purchase of Fixed Assets
Asset A/c
Dr.
To Bank A/c
2
Expenses on purchase of Fixed Assets
Related Asset A/c
Dr.
To Cash/Bank A/c
3
For Providing depreciation
Depreciation A/c
Dr.
To Assets A/c
4
Transfer of depreciation to Profit & Loss a/c
Profit & Loss A/c
Dr.
To Depreciation A/c
5
Sale of Assets
Bank A/c
Dr.
To Assets A/c

Depreciation =

Cost of Assets−Scrap Value of AssetsEstimated Life of Assets

What are the methods of Depreciation in Financial Accounting?

There are many methods for calculating depreciation but among then, the popular methods are (a) Straight Line Method and (b) Written Down Value Method. Some of the methods are as follows:

  • Straight Line Method
  • Written Down Value Method
  • Annuity Method
  • Insurance Policy Method
  • Machine Hour Rate Method
  • Depletion Method
  • Revaluation Method
  • Depreciation Fund Method

Format

DEPRECIATION CHART
Desc.
Opening Value
Addition during the year
Sale
Balance
Rate of Depreciation
Value of Depreciation
Closing Value
1
2
3
4
5
(2+3-4)
6
7
8
(5-7)

Format of ledger accounts

ASSET ACCOUNT
Date Particulars L.F. Amt Date Particulars L.F. Amt
25-06-13 To Bank 31-03-2014 By Depreciation
By Balance c/d
Total xxx Total xxx
01-04-2014 To Balance By Depreciation

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