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Depreciation Methods: A Deeper Dive

This document expands on depreciation methods, including the straight-line method, written-down value (declining balance) method, sum-of-the-years' digits (SYD) method, and conventions for partial-year depreciation and multiple shifts.

Straight-Line Method

  • Assumption: Equal benefit/productivity from the asset throughout its useful life.
  • Formula: (Cost - Salvage Value) / Useful Life
  • Limitation: Doesn't account for declining productivity or increasing maintenance costs over time.

Written-Down Value (Declining Balance) Method

  • Concept: Higher depreciation expense in early years, gradually decreasing over time. Reflects declining productivity or increasing maintenance.
  • Calculation:

Screenshot (348)

  • Example:
    • Cost: ₹9 lakhs (₹10 lakhs - ₹1 lakh salvage value)
    • Depreciation Rate: 30%
    • Year 1 Depreciation: ₹9 lakhs * 30% = ₹2.7 lakhs
    • Year 1 Net Book Value: ₹9 lakhs - ₹2.7 lakhs = ₹6.3 lakhs
    • Year 2 Depreciation: ₹6.3 lakhs * 30% = ₹1.89 lakhs
    • And so on...
  • Key Feature: The asset's book value never reaches zero using this method, though it gets very close.
  • Switching to Straight-Line: To fully depreciate the asset, you can switch to the straight-line method in the later years.

Sum-of-the-Years' Digits (SYD) Method

  • Concept: Another accelerated depreciation method that combines elements of straight-line and declining balance.
  • Calculation:
    1. Calculate the sum of the years' digits: N * (N + 1) / 2, where N is the useful life.
    2. For each year, the depreciation rate is a fraction: (Remaining Useful Life) / (Sum of the Years' Digits)
  • Example:
    • Asset value = 150000
    • Useful Life (N): 5 years
    • Sum of Years' Digits: 5 * (5 + 1) / 2 = 15

Screenshot (350)

  • Key Feature: The asset's book value will reach zero at the end of its useful life.

Partial-Year Depreciation

When an asset is purchased or sold during the year, depreciation needs to be prorated. Common conventions include:

  1. Pro Rata: Calculate depreciation based on the number of months the asset was in service.

    • Example: Asset purchased in February, fiscal year ends in March. Depreciation rate is 12%. Two months' depreciation is (12%/12) * 2 = 2%.

  2. Half-Year/Full-Year Convention:

    • If the asset is in use for 180 days (6 months) or more, charge a full year's depreciation.
    • If the asset is in use for less than 180 days, charge half a year's depreciation.

  3. Half-Year Convention (US): Regardless of the purchase/sale date, 50% of the normal depreciation is charged in the first year and the remaining 50% when the asset is disposed of. This smooths out depreciation over time assuming consistent asset purchases.

Depreciation for Multiple Shifts

If an asset is used for multiple shifts, the depreciation rate is often increased to reflect the accelerated wear and tear. A common industry practice is to add 50% to the depreciation rate for each additional shift.

  • Example: 10% depreciation for one shift, 15% for two shifts, 20% for three shifts.

Example Comparison (Straight-Line vs. Declining Balance)

  • Asset Value: ₹10 lakhs
  • Useful Life: 10 years (Used for 12 years then sold for ₹50,000)
  • Straight-Line Depreciation Rate: 10%
  • Declining Balance Depreciation Rate: 20% (Double Declining Balance)
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