How To Solve For Time In Continuous Compound Interest Formula Characteristics of Depreciation, Basic Factors of Determination of Depreciation

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Characteristics of Depreciation, Basic Factors of Determination of Depreciation

Characteristics of depreciation

Depreciation has the following characteristics:

(1) Depreciation is calculated only for fixed assets, e.g. building, equipment and machines, furniture, etc. In the case of current assets – such as stocks, debtors, accounts receivable, etc. – there is no depreciation.

(2) Depreciation causes a permanent, gradual and continuous decrease in the value of the property

(3) Depreciation takes place until the last day of the expected useful life of the asset

(4) Depreciation occurs due to the use of the asset In certain cases, however, depreciation may occur even when the asset is not used, e.g. rental property, patent right, copyright, etc.

(5) Depreciation is an expense from the income of the reporting period.

(6) Depreciation does not depend on fluctuations in the market value of the asset

(7) It is not possible to determine the amount of depreciation for the accounting year – it must be estimated. However, in certain cases it can be precisely determined, e.g. leasehold, patent, copyright, etc.

(8) The total depreciation of the asset must not exceed its depreciable value (cost minus scrap value).

Basic factors for determining wear

(1) the original cost of the fixed asset, i.e. the purchase price plus transportation and installation costs;

(2) the estimated amount of repair costs over the useful life;

(3) the estimated useful life of the asset, after which it will be retired;

4) estimated residual or residual value;

(5) investment interest – the amount invested when purchasing property, if it had been invested in another investment, interest would have been earned;

(6) possibility of expiration.

Fixed installment or original cost or straight line method, reducing/declining balance method

Under this method, depreciation is not calculated on the basis of the asset’s acquisition cost. It is calculated based on the book value. of assets. The asset’s book value is obtained by deducting depreciation from its acquisition cost. The book value of the asset gradually decreases due to depreciation expense. Because the depreciation percentage is applied when reducing the asset balance. this method is called the reducing balance or diminishing installment method or the discounted value method.

Advantages and disadvantages.

The declining balance method not only matches depreciation expense fairly with related income, but also fairly allocates. the incidence of depreciation and repair (ie higher depreciation but heavier repairs in later years) on the income statement over the life of the assets. Eliminating most of the costs in the early years also reduces the effects of aging. This is equally beneficial to management, as accelerated depreciation means lower taxable profits and taxes, hence less cash outflow.

Accelerated depreciation methods

Sum of Year Digits (SYD). This depreciation method accelerates depreciation expense so that the amount recognized in earlier periods of the asset’s useful life is greater than the amount recognized in later periods. SYD is found by estimating the asset’s useful life in years, then assigning consecutive numbers to each year and adding them together. n years,

SYD = 1 + 2 + 3 + 4 + … +n

Annuity method

The method reflects the time value of money (interest) and thus takes into account the actual cost of using a long-lived asset, which is equal to the amount actually invested in it plus the interest lost when the asset was acquired. Under this method, enough depreciation is written off each year that, after debiting the asset’s depreciation interest, the asset reduces to zero at the end of its life. Thus, the amount written off as depreciation is the same every year, but the interest decreases every year.

The amount of annual depreciation written off using the annuity method can be found in the annuity tables

Sinking fund method or sinking fund method

Under this method, a fixed amount is calculated as depreciation each year. Its purpose is to ensure the required lump sum of money at the retirement of a long-lived asset by setting aside and investing a fixed amount in easily realizable securities every year. These securities earn interest at a fixed rate and the same amount is reinvested with successive fixed amortization payments that are allowed to accumulate at compound interest. Thus, the sinking fund method takes into account this probable interest income by fixing the annual depreciation and investing it, together with compound interest, in the depreciable cost of the asset at the end of its useful life. Obviously, the fixed installment of annual depreciation is lower here than with the straight-line method. However, its amount depends on the life of the asset and the interest rate. The longer the period and the higher the rate, the lower the annual depreciation per rupee of depreciable cost.

Disadvantages of the sinking fund method

The sinking fund method assumes a constant rate of return for each periodic investment in identical securities. This is hardly true in this dynamic world where interest rates vary from time to time. Any fluctuation in the rate of return will disturb the previous periodic amortization allocation and lead to its recognition. In addition, the amount realized from the sale of a security rarely matches its acquisition cost because fluctuations can be both uncertain and significant. They can create a large gap between the cash required and the cash supplied.

Insurance policy method

With this method, an attempt is made to provide the necessary funds for the retirement of a certain asset for a periodic payment (reward). Under this, the trader takes out a “principal return insurance policy” from the insurance company, which commits to paying a certain amount on a certain date if the trader pays a certain number of premiums at regular intervals. The merchant treats the periodic payment as depreciation and charges it to the income statement. In this case, the depreciation is calculated at the end of the year, while the bonus is calculated at the beginning of the year. At the end of the term, the insurance company will pay the policy money, which is usually enough to replace the retired set. Usually the amount received is more than the total premium paid as the policy gives interest.

Revaluation method

Within the framework of the system, the value of the property is assessed every year and compared to the value at the beginning of the year. The decline is treated as depreciation. Suppose the value of the tools at the beginning of the year was Rs. 8,000, during the year tools worth Rs. 6,000 were purchased and at the end of the year they were estimated at Rs. 11,000. The amount of depreciation for the year is: 8,000 + 6,000-11,000 = Rs. 3000. This method is useful for accounting for depreciation of livestock and loose implements.

Discharge method

Natural resources include physical assets such as mineral resources, oil and gas resources, and timber resources. These natural resources are depleted by exploitation. In some cases, the decline in physical deposits is offset by the growth or development of additional deposits.

The cost of a natural resource is the price paid to acquire it, plus the price paid to develop such an asset to bring it into a condition suitable for production.

It is better not to calculate periodic depletion on an annual basis. Rather, it is better to calculate the unit cost and then multiply the unit cost by the units produced in that particular year.

Machine hourly rate

In this method, the total number of operating hours of the machine over its actual life is estimated, and then the cost of the machine is divided by the number of hours of expected useful life, which gives an hourly rate. The annual depreciation is calculated by multiplying this rate by the number of hours, the machine actually works in a year.

Drive-through method

This method is only used for assets whose useful life depends on the number of kilometers driven, such as buses, cars, trucks and rolling stock, etc.

Global method

In this method, the value of the assets, regardless of their nature, is added up and depreciated at an average rate from the total value.

Choice of method

The depreciation methods mentioned above show that none of them is absolutely the best or the worst, as each method has its own advantages and disadvantages. The suitability of each method is relative and depends on various factors. The most important of these are the type of asset and the purpose of depreciation.

The straight line method is suitable for buildings and rentals etc. diminishing installment method is suitable for machinery etc and depletion method for wasting assets like mines. careers etc. However, the main objective is the main determinants of the appropriateness of the depreciation method. An important objective is true accounting reporting, tax benefits, comparable product costs, financial flexibility, replacement and expansion, etc. For example. the sinking fund method provides that the amount set aside for depreciation is invested in specific securities outside of business operations. Similar to the insurance policy method, the set aside amount is transferred to the insurance company. If the company has problems with working capital, the practicality of these methods is questionable.

Among the methods mentioned above, the most commonly used are (1) fixed installment and (2) reducing installment.

Difference Between Fixed Installment Method and Diminishing Installment Method

Fixed installment method

1. The rate and amount of depreciation remain the same every year.

2. The depreciation rate in percent is calculated every year from the acquisition cost of fixed assets.

3. At the end of its life, the value of the asset is reduced to zero or scrap value.

4. The older the property, the higher the cost of repairing it. But the amount of depreciation remains the same every year. Thus, the total amount of depreciation and repair increases every year. This gradually reduces the annual profit.

5. Relatively simple and easy calculation of depreciation.

Installment payment reduction

1. The rate remains the same, but the amount of depreciation gradually decreases.

2. The percentage of the depreciation rate is calculated based on the book value of the asset.

3. The value of the asset is never reduced to zero at the end of its life.

4. Depreciation amount gradually decreases while repair costs increase.

Thus, the total amount of depreciation and repair remains more or less the same each year. Hence, it results in little or no change in annual profit/loss.

5. Depreciation can be calculated without difficulty, but it is not so simple and easy.

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