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Depreciation


The value of fixed assets reduce after year because of usage and passage of time. It is well known that fixed assets are used for earning revenue. Therefore, decrease in their value is considered as an expense or loss incurred in earning revenue and like other expenses or losses, is charged to the Profit and Loss Account. Otherwise, profit will be overstated. The value of the fixed asset should also be reduced by the depreciation amount. It is important to note that depreciation is not recognized on a day to day basis but is charged at the end of an accounting period. Depreciation is usually computed on the basis of the life of the asset. Suppose, a machine costs Rs. 10, 000 and has a life of 5 years. Then each year 1/5th of the cost ie., Rs.2,000 should be transferred as an expense; only the remaining amount is to be shown in the balance sheet.

 

The entries for charging depreciation and transferring to Profit and loss Account are as follows:
 
When provision for depreciation account is not maintained:
Depreciation A/c Dr.
To Asset A/c
Profit and Loss A/c Dr.
To Depreciation
 
When Provision for Depreciation Account is maintained:
Depreciation A/c Dr.
To Provision for Depreciation
Profit and Loss A/c Dr.
To Depreciation A/c
 
Accounting Treatment of Depreciation when it is given as an adjustment ie., Outside the Trial Balance.
 
When Depreciation is given as an adjustment, first the depreciation amount is calculated as per the rate and method specified in the question and then it is debited to the Profit and Loss Account. The amount so calculated is also deducted from the asset account in the Balance Sheet to which the depreciation relates, if provision for depreciation account is not maintained.
 
If provision for depreciation account is maintained, amount of depreciation is added to Provision for Depreciation Account and then total accumulated depreciation is shown by way of deduction from the original cost of the asset.
 
Sometimes, depreciation is given in the Trial Balance itself. This is possible only if the entry has been passed before preparation of the Trial Balance. In that case the Depreciation Account appears in the Trial Balance itself; and the concerned asset appears as its reduced value since the depreciation amount is credited to it. In such a situation no further adjustment is necessary; the Depreciation Account is transferred to the debit side of the Profit and Loss Account like other expenses.

 

Example 5- The following is the extract from a Trial Balance

TRIAL BALANCE AS AT.....

Particulars

Debit Rs.

Credit Rs.

Machinery A/c

2,00,000

 

Provision for Depreciation on Machinery A/c

 

80,000

Depreciation on Machinery

20,000

 

Furniture A/c

36,000

 

Depreciation on Furniture A/c

4,000

 
Show relevant extracts from the Profit and loss Account and the Balance Sheet.

 

Profit and Loss Account

Dr.     Cr.

Particulars

Rs.

Particulars

Rs.

To Depreciation:

On Machinery 20,000

On Furniture 4,000

                --------

 

 

 

 


24,000

 

 

 

 

 


Balance Sheet

Liabilities

Rs.

Assets

Rs.

   

Machinery         2,00,000

Less: Provision

For Depreciation   80,000

                       -----------

Furniture

 

 

 

 


1,20,000
36,000





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