Depreciation Accounting – How to fix Depreciation Amount

FIXATION OF DEPRECIATION AMOUNT

Following are the three important factors which should be considered for determining the amount of depreciation to be charged to the Profit and Loss Account in respect of a particular asset.

1. Cost of the asset The cost of the asset includes the invoice price of the asset, less any trade discount pius all costs essential to bring the asset to a useahie condition. It should be noted that financial charges, such as interest on money borrowed for the purchase of the asset, should not be included in the cost of the asset.

2. Estimated scrap value. The term scrap value means the residual or the salvage value which is estimated to be realised on account of the sale of the asset at the end of its useful life. In determining the scrap value, the cost to be incurred in the disposal or removing of the asset should be deducted out of the total realisable value.

3. Estimated useful life. This is also termed as economic lift of the asset. This may be calculated in terms of years, months, hours, units of output of other operating measures such as kilometers in case of a taxi or a truck.

 

Realisation Principles in Accounting

Recognition proportionately over the performance of the contract According to this basis, revenue is recognised even in those cases where the work has not been completed in all respects. This is particularly true in case of long-term contracts which may take few years to complete. In case of such contracts, revenue is recognised on the basis of the work which has becn completed and approved by the contractee (technically known as work certified). This is done on the basis of certain accepted norms which are given below:

(i) When less than one-fourth ofthe contract is completed, no profit should be taken to the Profit and Loss Account,

(ii) When one-fourth or more but less than one-half of the contract is completed. one-third of the profit made to date should be taken to the Profit and Loss Account. This may, further, be reduced on the basis of cash received by the contractor from the coniractee. This is technically known as reducing profit on cash basis.

(iii) If half or more of the contract has been completed, two-third of the profit as reduced on cash basis maybe taken 10 the Profit and Loss account.

 

Realisation Principles – when the production is completed

Recognition when the production is completed. It is generally recognised that income accrues only at the time of sale and gain should not be anticipated by reflecting assets at their current market prices. However, in case of certain industries where products have an immediate marketability at more or less fixed prices, the revenue may be recognised as soon as the production is completed, The amount of income earned is the excess of the estimated sale prices of the products completed over the costs oftheir production or extraction. However, any expenditure incurred in the disposal of these products should be charged to such income and should be disclosed fully in the financial statements. This is particularly true in case of precious metals such as gold and silver and extractive industries (e.g. oil) and agriculture. In case of these industries, the inventories are staled at sales prices.

 

Realisation Concept – Recognition at the time when sales value is collected

Recognition at the time when sales value is collected. Many concerns use the cash basis for reeognising revenue rather than the accrual basis. In case of accrual basis, as explained above, revenue is taken to be realised when the payment for goods or services becomes due to the business. For example, in case of trading business, revenue will be taken to have been realised when the goods have been sold though the payment might be received later on. This is because as the goods have been sold away, the business becomes entitled to receive payment for thetn. In case, cash basis is followed, the revenue will be taken to have been realised only when payment for goods or services has been actually received. This basis for recognising revenue is generally followed in case of-sale of goods on instalment system (i.e., a system where sales value is to be collected in agreed number of instalments). The basis is not very satisfactory because it fails to match cost with the revenue in those case cases where there is a considerable time Jag between sale of goods or rendering of services and receiving payment for them.