Methods of depreciation and accounting under AS-10

Depreciation is the systematic allocation of the depreciable amount of an asset (its cost less residual value) over its useful life. It is a process of cost allocation that matches the cost of the asset with the revenue it helps to earn, not a process of valuation.

Methods of calculating depreciation

The main methods are:

1. Straight line (fixed instalment) method: a fixed amount every year: (cost − estimated scrap value) ÷ estimated life, or a fixed percentage of original cost. Simple, gives a constant charge, and suits assets that give equal benefit each year (furniture, buildings). It ignores the rising repairs of later years. Example: cost ₹60,000, scrap nil, 10 years: ₹6,000 a year.
2. Diminishing (written-down) balance method: a fixed percentage of the opening book value each year, so the charge falls year by year; the heavier early charge balances the lighter early repairs. Suits plant and machinery. The asset never reaches zero. Example: ₹60,000 at 20%: ₹12,000, then ₹9,600, then ₹7,680.
3. Annuity method: depreciation includes interest on the capital locked up in the asset; suited to long leases.
4. Depreciation (sinking) fund method: the depreciation is invested outside the business so that funds accumulate to replace the asset.
5. Insurance policy method: an endowment policy provides the replacement sum.
6. Machine hour rate / units of production: depreciation in proportion to hours worked or output.
7. Depletion method: for mines and quarries, in proportion to the quantity extracted.
8. Revaluation method: for small items such as loose tools, the fall in value is the depreciation.

When an asset is used for part of a year, depreciation is charged only for that part; an asset discarded early has its realised value credited to the asset account and the balance written off as a loss.

Accounting as per AS-10 (Property, Plant and Equipment)

1. Choice of method. A variety of methods may be used to allocate the depreciable amount on a systematic basis over the useful life: the straight-line, diminishing balance and units of production methods. The enterprise selects the method that most closely reflects the expected pattern of consumption of the asset's future economic benefits and applies it consistently.
2. Revenue-based depreciation is not appropriate, because revenue reflects factors other than the consumption of the asset.
3. Depreciable amount and useful life: cost less residual value is allocated over the useful life; the residual value and useful life are reviewed at least at each financial year end, and changes are accounted for as a change in accounting estimate (prospectively).
4. Change of method: the method is reviewed at least at each year end and changed if the expected pattern of consumption has changed; the change is a change in accounting estimate, applied prospectively, with nothing restated.
5. Component approach: each part of an item with a cost significant to the total is depreciated separately.
6. Start and end: depreciation begins when the asset is available for use and ceases at the earlier of the date it is retired from active use and held for disposal and the date it is derecognised (not merely because it is idle); land (apart from quarries and landfill sites) is not depreciated.
7. Recording: Depreciation A/c Dr, To Asset A/c (or Provision for Depreciation / Accumulated Depreciation A/c); the depreciation is closed to the Profit and Loss Account, and the asset is shown at cost (or revalued amount) less accumulated depreciation, with the method, useful lives or rates disclosed.