Depreciation | Meaning | Methods | Examples

There are three types of decreases in the value of an asset, which refers to a different category of fixed assets shown as follows.

1. Depreciation
2. Depletion
3. Amortization

1. Depreciation is used for the Tangible fixed asset. Such as Building, Plant, Machinery, Furniture, fixtures, vehicles, Computers, etc.

2. Depletion is used in referring to the physical exhaustion of natural resources. Such as oil wells, Coal mines, etc.

3. Amortization is used for the Intangible fixed asset. Such as Goodwill, Patents, trademarks, leaseholds, etc.

1. Why do we need to calculate depreciation?

We will explain this topic with help of the following points :

1. To know the actual net profit of the business we have to record all the expenses related to earn that profit. We had to use our fixed assets to produce and store our product, So we have to record the diminished value of these assets in our books to find out an actual net profit of the business
2. Show the actual value of assets in the books of the accounts this is called the book value of an asset.
3. We have to purchase new assets against old when it becomes scrap, so to arrange the funds for replacement of assets we have to contribute some value of assets year by year from the profit.
4. The Indian Companies Act, 1956 has made it the statutory requirement for joint stock companies under section 205.

2. Journal entries for Depreciation:

We can treat Depreciation in two ways as follows:

1. When the net book value of assets is shown on the Balance sheet after deducting an amount of depreciation from the opening book value of an asset.

Example: 
Depreciation charged on building @ 10% on Rs 10,00,000/-.

Solution: -

We will treat two account

1. Depreciation Account -> is Expenses -> N/A -> All Expenses -> Debited
2. Building Account -> is an Assets -> R/A -> Goes out -> Credited

Date    Depreciation A/c    Dr.      1,00,000

                        To Building A/c                        1,00,000

(Being Dep charge on the building)

"After that, at the end of the year, we will transfer all income and expenses to Profit and loss account or income statement to get the actual profit or loss of the business for this we post this following transaction."

2. Depreciation transferred to Profit and Loss account or income statement

1. Depreciation Account -> is Expenses -> closing this account has a debit balance so now credited it.
2. Profit and Loss Account -> is Statement -> getting balances of  Expenses so now Debited it

Date    Profit and Loss A/c    Dr.      1,00,000

                   To Depreciation A/c                        1,00,000

(Being amount of dep transferred to Profit or loss account)

 2. When the original book value of assets shown on the Balance sheet and Accumulated depreciation/Provision for depreciation account opened and shown on the liability side of the balance sheet. 

Example: Depreciation charged on building @ 10% on Rs 10,00,000/-.

Solution: -will treat two account

1. Depreciation Account -> is Expenses -> N/A -> All Expenses -> Debited
2. Provision for Depreciation on Building Account -> it will also be treated as an Assets -> R/A -> Goes out -> Credited

The account of Provision has a credit balance so it will be shown on the liability side of the Balance Sheet.

Date    Depreciation A/c    Dr.      1,00,000           

                   To Provision for Dep on Building A/c                 1,00,000

(Being Dep charged and provision account opened )

Date    Profit and Loss A/c    Dr.      1,00,000

                        To Depreciation A/c                        1,00,000

(Being Depreciation transferred to Profit and Loss account or income statement)

3. Methods of Depreciation: