The compilation of these Depreciation, Provision and Reserves Notes makes students exam preparation simpler and organised.
Other Methods of Depreciation
Depreciation refers to the decline or decrease in the value of a depreciable fixed asset due to the normal wear and tear or efflux of time or obsolescence. There are various methods of depreciation that we can apply to accounts. We treat depreciation as an expense and thus, charge it to the Profit and Loss A/c. Besides the uniform charge method and declining charge method, there are also other methods of charging depreciation.
Other Methods of Depreciation
The following methods fall under this category:
- Group Depreciation Method
- Depletion Method
- Machine Hour Rate Method
- Inventory System (Valuation)
Group Depreciation Method
Under this method, we combine all the fixed assets of a similar nature into a pool with a common cost base in order to calculate depreciation. The basis underlying the pooling is that they are similar in the way they function or each asset is too small to consider it material individually.
This method is also known as the Composite depreciation method. For example, the trolleys that we use in the shopping malls are their assets but are too small to consider each of them as material. Thus, we can charge depreciation on them as per the group depreciation method.
Generally, this method is used for smaller items that have a low cost. It simplifies the calculation of the depreciation. Also, it saves time and costs incurred in accounting and auditing work. However, due to the various accounting software that easily records depreciation of the individual assets, the use of this method is less in use.
Depletion refers to the exhaustion of natural resources. Thus, we use this method where our assets are some natural resources. We pay a price to use natural resources. Examples of such assets can be the oil well, coal mines, mineral deposits, etc.
Under this method, we calculate depreciation on one unit of output. This is calculated by dividing the total cost of acquisition or the purchase price of the asset by the expected number of units that can be produced. This method is similar to the Units of Production Method.
Depreciation per unit of output = Cost of the asset/Estimated total units of output
Machine Hour Rate Method
Under this method, we calculate the hourly rate of depreciation. This is done by dividing the total cost of the asset by the estimated working hours. Thus, the useful life of the asset is the estimated number of machine-hours for which it can be used.
In this case, the actual depreciation depends on the working hours during the period. This method is useful in the case of textile and jute mills and also in the handloom industry.
Depreciation per hour = (Cost of the asset – Residual Value)/Estimated total machine hours
Amrit Ltd. purchases a machine on 1st April 2015 for ₹110000 and pays ₹20000 for its installation. At the end of its useful life, the machine may realize ₹30000. It’s expected life in machine hours is 200000 hours. The machine hours utilized in 2015 are 10000, in 2016 are 15000 and in 2017 are 25000. Calculate the amount of depreciation.
Hourly Rate of depreciation = (Cost of the Asset – Residual Value)/Estimated total machine hours
= (110000 + 20000 – 30000)/200000
= 0.50 paise per hour
Depreciation = Machine hours × rate per hour
2015: 10000 × 0.50 = ₹ 5000
2016: 15000 × 0.50 = ₹ 7500
2017: 25000 × 0.50 = ₹ 12500