ICAI Notes- Depreciation and Amortisation | Principles and Practice of Accounting - CA Foundation PDF Download

 Page 1


LEARNING OUTCOMES 
DEPRECIATION AND  
 AMORTISATION 
 
 
 
After studying this chapter, you will be able to: 
? Understand the meaning and nature of depreciation. 
? Understand how to determine the amount of depreciation from the 
total value of Property, Plant and Equipment and its useful life. 
? Understand various methods of depreciation and learn advantages 
and disadvantages of such methods. 
? Understand how to calculate the amount of profit or loss resulting 
from the sale/disposal of Property, Plant and Equipment. 
? Familiarize with the accounting treatment for change in the method 
of depreciation from Straight Line Method to Reducing Balance 
method. 
? Familiarize with the accounting treatment for change in estimated 
useful life and residual value of property, plant and equipment. 
? Understand the meaning and nature of intangible assets and its 
amortisation. 
5
CHAPTER 
  
© The Institute of Chartered Accountants of India
Page 2


LEARNING OUTCOMES 
DEPRECIATION AND  
 AMORTISATION 
 
 
 
After studying this chapter, you will be able to: 
? Understand the meaning and nature of depreciation. 
? Understand how to determine the amount of depreciation from the 
total value of Property, Plant and Equipment and its useful life. 
? Understand various methods of depreciation and learn advantages 
and disadvantages of such methods. 
? Understand how to calculate the amount of profit or loss resulting 
from the sale/disposal of Property, Plant and Equipment. 
? Familiarize with the accounting treatment for change in the method 
of depreciation from Straight Line Method to Reducing Balance 
method. 
? Familiarize with the accounting treatment for change in estimated 
useful life and residual value of property, plant and equipment. 
? Understand the meaning and nature of intangible assets and its 
amortisation. 
5
CHAPTER 
  
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING 
1.2 
 5.2 
 
 
 1.  INTRODUCTION 
1.1  Concept of Depreciation 
Tangible Assets are assets that have a physical substance i.e., they can be seen and touched, held for 
use in the production or supply of goods or services, for rental to others, or for administrative 
purposes. Useful life of tangible asset is based on expected usage.  
Property, plant and equipment are tangible items that: 
(a) are held for use in the production or supply of goods or services, for rental to others, 
or for administrative purposes; and 
(b) are expected to be used during more than a period of twelve months. 
These are also called fixed assets in common parlance. When a fixed asset is purchased, it is 
recorded in books of account at its original or acquisition/purchase cost. However fixed assets 
are used to earn revenues or save costs for several accounting periods in future with the same 
acquisition cost until the concerned fixed asset is sold or discarded. For example, acquisition 
of a machinery expected to be in use for 10 years in the production of finished goods will earn 
revenues over the next 10 years. Similarly, an ATM machine installed by a bank will result in 
cost savings over the expected life of such ATM machines for the bank in terms of not 
requiring to employ personnel to dispense cash for customers. Since the life of such assets 
exceeds one year, it is therefore necessary that a part of the acquisition cost of such fixed 
Factors affecting the amount of 
depreciation
Cost of asset
Expected useful life and 
utility
Estimated residual 
value
Objectives of providing depreciation
To ascertain true 
results of 
operations 
To present true 
and fair view of 
the financial 
position
To accumulate 
funds for the 
replacement of 
assets
To ascertain true 
cost of production
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
Page 3


LEARNING OUTCOMES 
DEPRECIATION AND  
 AMORTISATION 
 
 
 
After studying this chapter, you will be able to: 
? Understand the meaning and nature of depreciation. 
? Understand how to determine the amount of depreciation from the 
total value of Property, Plant and Equipment and its useful life. 
? Understand various methods of depreciation and learn advantages 
and disadvantages of such methods. 
? Understand how to calculate the amount of profit or loss resulting 
from the sale/disposal of Property, Plant and Equipment. 
? Familiarize with the accounting treatment for change in the method 
of depreciation from Straight Line Method to Reducing Balance 
method. 
? Familiarize with the accounting treatment for change in estimated 
useful life and residual value of property, plant and equipment. 
? Understand the meaning and nature of intangible assets and its 
amortisation. 
5
CHAPTER 
  
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING 
1.2 
 5.2 
 
 
 1.  INTRODUCTION 
1.1  Concept of Depreciation 
Tangible Assets are assets that have a physical substance i.e., they can be seen and touched, held for 
use in the production or supply of goods or services, for rental to others, or for administrative 
purposes. Useful life of tangible asset is based on expected usage.  
Property, plant and equipment are tangible items that: 
(a) are held for use in the production or supply of goods or services, for rental to others, 
or for administrative purposes; and 
(b) are expected to be used during more than a period of twelve months. 
These are also called fixed assets in common parlance. When a fixed asset is purchased, it is 
recorded in books of account at its original or acquisition/purchase cost. However fixed assets 
are used to earn revenues or save costs for several accounting periods in future with the same 
acquisition cost until the concerned fixed asset is sold or discarded. For example, acquisition 
of a machinery expected to be in use for 10 years in the production of finished goods will earn 
revenues over the next 10 years. Similarly, an ATM machine installed by a bank will result in 
cost savings over the expected life of such ATM machines for the bank in terms of not 
requiring to employ personnel to dispense cash for customers. Since the life of such assets 
exceeds one year, it is therefore necessary that a part of the acquisition cost of such fixed 
Factors affecting the amount of 
depreciation
Cost of asset
Expected useful life and 
utility
Estimated residual 
value
Objectives of providing depreciation
To ascertain true 
results of 
operations 
To present true 
and fair view of 
the financial 
position
To accumulate 
funds for the 
replacement of 
assets
To ascertain true 
cost of production
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
    
 
 5.3 DEPRECIATION AND AMORTISATION 
assets be treated or allocated as an expense in each of the accounting period in which the 
asset is utilized. The amount or value of fixed assets allocated in such manner to respective 
accounting period is called depreciation. Value of such assets decreases with passage of time 
mainly due to following reasons. 
1. Wear and tear due to its use in business 
2. Efflux of time (even when it is not being used) 
3. Obsolescence due to technological or other changes 
4. Decrease in market value 
5. Depletion mainly in case of mines and other natural reserves 
It is important to account for value of portion of property, plant and equipment utilized for 
generating revenue during an accounting year to ascertain true income. In other words, 
against the income/cost savings generated during a period, it is essential to book a portion 
of the cost of the asset utilized in generating such income/cost savings. This portion of cost 
of Property, Plant & Equipment allocated to an accounting year is called depreciation.  
As per Schedule II under the Companies Act, 2013, Depreciation is the systematic 
allocation of the depreciable amount of an asset over its useful life. The depreciable 
amount of an asset is the cost of an asset or other amount substituted for cost (i.e., in 
case of revaluation of assets, such revalued amount), less its residual value. The useful 
life of an asset is the period over which an asset is expected to be available for use by 
an entity, or the number of production or similar units expected to be obtained from 
the asset by the entity. 
Thus, there are 3 important factors for computing depreciation: 
-  Estimated useful life of the asset 
-  Cost of the asset 
-  Residual value of the asset at the end of the of its estimated useful life 
Depreciation of an asset begins when it is available for use, i.e., when it is in the location and 
condition necessary for it to be capable of operating in the manner intended by management. 
Thus it is not necessary that an asset must be used to be depreciated. There is decrease in 
value of assets due to normal wear and tear or obsolescence even when these are not 
physically used. Accordingly, value of such wear and tear should be estimated and accounted 
for. 
Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each 
accounting period during the expected useful life of the asset.  Depreciation for a period  helps 
to charge that portion of the cost of the asset against the revenues earned, which is expired 
© The Institute of Chartered Accountants of India
Page 4


LEARNING OUTCOMES 
DEPRECIATION AND  
 AMORTISATION 
 
 
 
After studying this chapter, you will be able to: 
? Understand the meaning and nature of depreciation. 
? Understand how to determine the amount of depreciation from the 
total value of Property, Plant and Equipment and its useful life. 
? Understand various methods of depreciation and learn advantages 
and disadvantages of such methods. 
? Understand how to calculate the amount of profit or loss resulting 
from the sale/disposal of Property, Plant and Equipment. 
? Familiarize with the accounting treatment for change in the method 
of depreciation from Straight Line Method to Reducing Balance 
method. 
? Familiarize with the accounting treatment for change in estimated 
useful life and residual value of property, plant and equipment. 
? Understand the meaning and nature of intangible assets and its 
amortisation. 
5
CHAPTER 
  
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING 
1.2 
 5.2 
 
 
 1.  INTRODUCTION 
1.1  Concept of Depreciation 
Tangible Assets are assets that have a physical substance i.e., they can be seen and touched, held for 
use in the production or supply of goods or services, for rental to others, or for administrative 
purposes. Useful life of tangible asset is based on expected usage.  
Property, plant and equipment are tangible items that: 
(a) are held for use in the production or supply of goods or services, for rental to others, 
or for administrative purposes; and 
(b) are expected to be used during more than a period of twelve months. 
These are also called fixed assets in common parlance. When a fixed asset is purchased, it is 
recorded in books of account at its original or acquisition/purchase cost. However fixed assets 
are used to earn revenues or save costs for several accounting periods in future with the same 
acquisition cost until the concerned fixed asset is sold or discarded. For example, acquisition 
of a machinery expected to be in use for 10 years in the production of finished goods will earn 
revenues over the next 10 years. Similarly, an ATM machine installed by a bank will result in 
cost savings over the expected life of such ATM machines for the bank in terms of not 
requiring to employ personnel to dispense cash for customers. Since the life of such assets 
exceeds one year, it is therefore necessary that a part of the acquisition cost of such fixed 
Factors affecting the amount of 
depreciation
Cost of asset
Expected useful life and 
utility
Estimated residual 
value
Objectives of providing depreciation
To ascertain true 
results of 
operations 
To present true 
and fair view of 
the financial 
position
To accumulate 
funds for the 
replacement of 
assets
To ascertain true 
cost of production
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
    
 
 5.3 DEPRECIATION AND AMORTISATION 
assets be treated or allocated as an expense in each of the accounting period in which the 
asset is utilized. The amount or value of fixed assets allocated in such manner to respective 
accounting period is called depreciation. Value of such assets decreases with passage of time 
mainly due to following reasons. 
1. Wear and tear due to its use in business 
2. Efflux of time (even when it is not being used) 
3. Obsolescence due to technological or other changes 
4. Decrease in market value 
5. Depletion mainly in case of mines and other natural reserves 
It is important to account for value of portion of property, plant and equipment utilized for 
generating revenue during an accounting year to ascertain true income. In other words, 
against the income/cost savings generated during a period, it is essential to book a portion 
of the cost of the asset utilized in generating such income/cost savings. This portion of cost 
of Property, Plant & Equipment allocated to an accounting year is called depreciation.  
As per Schedule II under the Companies Act, 2013, Depreciation is the systematic 
allocation of the depreciable amount of an asset over its useful life. The depreciable 
amount of an asset is the cost of an asset or other amount substituted for cost (i.e., in 
case of revaluation of assets, such revalued amount), less its residual value. The useful 
life of an asset is the period over which an asset is expected to be available for use by 
an entity, or the number of production or similar units expected to be obtained from 
the asset by the entity. 
Thus, there are 3 important factors for computing depreciation: 
-  Estimated useful life of the asset 
-  Cost of the asset 
-  Residual value of the asset at the end of the of its estimated useful life 
Depreciation of an asset begins when it is available for use, i.e., when it is in the location and 
condition necessary for it to be capable of operating in the manner intended by management. 
Thus it is not necessary that an asset must be used to be depreciated. There is decrease in 
value of assets due to normal wear and tear or obsolescence even when these are not 
physically used. Accordingly, value of such wear and tear should be estimated and accounted 
for. 
Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each 
accounting period during the expected useful life of the asset.  Depreciation for a period  helps 
to charge that portion of the cost of the asset against the revenues earned, which is expired 
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING 
1.4 
 5.4 
for that period and hence follows matching principle. In other words the total cost of the asset 
is reflected in form of a) Expired cost (depreciation) and b) Unexpired Cost which shall be the 
written down value of the asset being reflected in balance sheet. Also, charging depreciation 
every year reduces the distributable profits thereby ensuring the availability of funds whenever 
the replacement is required. 
The depreciation is a type of loss in the value of assets employed for carrying on a business. Being 
an essential element of business expenditure, it is necessary to calculate the amount of such loss 
and to make a provision, and therefore, arrive at the amount of profit or loss made by the business. 
Basically, the cost of an asset used for purpose of business has to be written off over its 
economic (not physical) life which must be estimated. A point to remember is that usually, at 
the end of the economic life, an asset has some value as scrap or otherwise. The amount to 
be written off in each year should be as such which will reduce the book value of the asset, at 
the end of its economic life, to its estimated scrap value. 
1.2  Depreciation on components of an assets 
It may be noted that Accounting Standards as well as the Companies Act, 2013 requires 
depreciation to be charged on a component basis.  Each part of an item of Property, Plant and 
Equipment with a cost that is significant in relation to the total cost of the item should be 
depreciated separately. An enterprise should allocate the amount initially recognised in 
respect of an item of property, plant and equipment to its significant parts/components and 
should depreciate each such part separately based on the useful life and residual value of 
each  particular component. For Example- Aircraft is a classic example of such an asset. The 
airframe (i.e. the body of the aircraft), the engines and the interiors have different individual 
useful lives. If the life of the airframe (being the longest of the individual lives of the three 
major types of components) is taken as the life of the aircraft, it is important that other two 
major components i.e. engine and interiors are depreciated over their respective useful life 
and not over the life of airframe. Other components (usually small and low value) which will 
require replacement very frequently may be depreciated over the useful life of airframe and 
their frequent replacement cost may be charged to expense as and when it is incurred.  
Here it is important to note that a part of  Property, Plant & Equipment to be identified as a 
separate component should have both  
(a) significant cost when compared to overall cost of item of property, plant and 
equipment and 
(b) an estimated useful life or depreciation method different from rest of the parts of the 
property plant and equipment. 
A significant part of an item of property, plant and equipment may have a useful life and a 
depreciation method that are the same as the useful life and the depreciation method of 
© The Institute of Chartered Accountants of India
Page 5


LEARNING OUTCOMES 
DEPRECIATION AND  
 AMORTISATION 
 
 
 
After studying this chapter, you will be able to: 
? Understand the meaning and nature of depreciation. 
? Understand how to determine the amount of depreciation from the 
total value of Property, Plant and Equipment and its useful life. 
? Understand various methods of depreciation and learn advantages 
and disadvantages of such methods. 
? Understand how to calculate the amount of profit or loss resulting 
from the sale/disposal of Property, Plant and Equipment. 
? Familiarize with the accounting treatment for change in the method 
of depreciation from Straight Line Method to Reducing Balance 
method. 
? Familiarize with the accounting treatment for change in estimated 
useful life and residual value of property, plant and equipment. 
? Understand the meaning and nature of intangible assets and its 
amortisation. 
5
CHAPTER 
  
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING 
1.2 
 5.2 
 
 
 1.  INTRODUCTION 
1.1  Concept of Depreciation 
Tangible Assets are assets that have a physical substance i.e., they can be seen and touched, held for 
use in the production or supply of goods or services, for rental to others, or for administrative 
purposes. Useful life of tangible asset is based on expected usage.  
Property, plant and equipment are tangible items that: 
(a) are held for use in the production or supply of goods or services, for rental to others, 
or for administrative purposes; and 
(b) are expected to be used during more than a period of twelve months. 
These are also called fixed assets in common parlance. When a fixed asset is purchased, it is 
recorded in books of account at its original or acquisition/purchase cost. However fixed assets 
are used to earn revenues or save costs for several accounting periods in future with the same 
acquisition cost until the concerned fixed asset is sold or discarded. For example, acquisition 
of a machinery expected to be in use for 10 years in the production of finished goods will earn 
revenues over the next 10 years. Similarly, an ATM machine installed by a bank will result in 
cost savings over the expected life of such ATM machines for the bank in terms of not 
requiring to employ personnel to dispense cash for customers. Since the life of such assets 
exceeds one year, it is therefore necessary that a part of the acquisition cost of such fixed 
Factors affecting the amount of 
depreciation
Cost of asset
Expected useful life and 
utility
Estimated residual 
value
Objectives of providing depreciation
To ascertain true 
results of 
operations 
To present true 
and fair view of 
the financial 
position
To accumulate 
funds for the 
replacement of 
assets
To ascertain true 
cost of production
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
    
 
 5.3 DEPRECIATION AND AMORTISATION 
assets be treated or allocated as an expense in each of the accounting period in which the 
asset is utilized. The amount or value of fixed assets allocated in such manner to respective 
accounting period is called depreciation. Value of such assets decreases with passage of time 
mainly due to following reasons. 
1. Wear and tear due to its use in business 
2. Efflux of time (even when it is not being used) 
3. Obsolescence due to technological or other changes 
4. Decrease in market value 
5. Depletion mainly in case of mines and other natural reserves 
It is important to account for value of portion of property, plant and equipment utilized for 
generating revenue during an accounting year to ascertain true income. In other words, 
against the income/cost savings generated during a period, it is essential to book a portion 
of the cost of the asset utilized in generating such income/cost savings. This portion of cost 
of Property, Plant & Equipment allocated to an accounting year is called depreciation.  
As per Schedule II under the Companies Act, 2013, Depreciation is the systematic 
allocation of the depreciable amount of an asset over its useful life. The depreciable 
amount of an asset is the cost of an asset or other amount substituted for cost (i.e., in 
case of revaluation of assets, such revalued amount), less its residual value. The useful 
life of an asset is the period over which an asset is expected to be available for use by 
an entity, or the number of production or similar units expected to be obtained from 
the asset by the entity. 
Thus, there are 3 important factors for computing depreciation: 
-  Estimated useful life of the asset 
-  Cost of the asset 
-  Residual value of the asset at the end of the of its estimated useful life 
Depreciation of an asset begins when it is available for use, i.e., when it is in the location and 
condition necessary for it to be capable of operating in the manner intended by management. 
Thus it is not necessary that an asset must be used to be depreciated. There is decrease in 
value of assets due to normal wear and tear or obsolescence even when these are not 
physically used. Accordingly, value of such wear and tear should be estimated and accounted 
for. 
Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each 
accounting period during the expected useful life of the asset.  Depreciation for a period  helps 
to charge that portion of the cost of the asset against the revenues earned, which is expired 
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING 
1.4 
 5.4 
for that period and hence follows matching principle. In other words the total cost of the asset 
is reflected in form of a) Expired cost (depreciation) and b) Unexpired Cost which shall be the 
written down value of the asset being reflected in balance sheet. Also, charging depreciation 
every year reduces the distributable profits thereby ensuring the availability of funds whenever 
the replacement is required. 
The depreciation is a type of loss in the value of assets employed for carrying on a business. Being 
an essential element of business expenditure, it is necessary to calculate the amount of such loss 
and to make a provision, and therefore, arrive at the amount of profit or loss made by the business. 
Basically, the cost of an asset used for purpose of business has to be written off over its 
economic (not physical) life which must be estimated. A point to remember is that usually, at 
the end of the economic life, an asset has some value as scrap or otherwise. The amount to 
be written off in each year should be as such which will reduce the book value of the asset, at 
the end of its economic life, to its estimated scrap value. 
1.2  Depreciation on components of an assets 
It may be noted that Accounting Standards as well as the Companies Act, 2013 requires 
depreciation to be charged on a component basis.  Each part of an item of Property, Plant and 
Equipment with a cost that is significant in relation to the total cost of the item should be 
depreciated separately. An enterprise should allocate the amount initially recognised in 
respect of an item of property, plant and equipment to its significant parts/components and 
should depreciate each such part separately based on the useful life and residual value of 
each  particular component. For Example- Aircraft is a classic example of such an asset. The 
airframe (i.e. the body of the aircraft), the engines and the interiors have different individual 
useful lives. If the life of the airframe (being the longest of the individual lives of the three 
major types of components) is taken as the life of the aircraft, it is important that other two 
major components i.e. engine and interiors are depreciated over their respective useful life 
and not over the life of airframe. Other components (usually small and low value) which will 
require replacement very frequently may be depreciated over the useful life of airframe and 
their frequent replacement cost may be charged to expense as and when it is incurred.  
Here it is important to note that a part of  Property, Plant & Equipment to be identified as a 
separate component should have both  
(a) significant cost when compared to overall cost of item of property, plant and 
equipment and 
(b) an estimated useful life or depreciation method different from rest of the parts of the 
property plant and equipment. 
A significant part of an item of property, plant and equipment may have a useful life and a 
depreciation method that are the same as the useful life and the depreciation method of 
© The Institute of Chartered Accountants of India
 
    
 
 5.5 DEPRECIATION AND AMORTISATION 
another significant part of that same item. Such parts may be grouped in determining the 
depreciation charge.  
1.3  Objectives for Providing Depreciation 
Prime objectives for providing depreciation are: 
(1) Correct income measurement: Depreciation should be charged for proper estimation 
of periodic profit or loss. In case an enterprise does not account for depreciation on 
Property, Plant & Equipment, it will not be considering loss in value of property, plant 
& equipment due to their use in production or operations of the enterprise and will 
not result in true profit or loss for the period. 
(2) True position statement: Value of the Property, Plant & Equipment should be adjusted 
for depreciation charged in order to depict the actual financial position. In case 
depreciation is not accounted for appropriately, the property, plant and equipment 
would be disclosed in financial statements at a value higher than their true value. We 
should always present the same at its unexpired cost which is after charging the 
expired cost as depreciation. 
(3) Funds for replacement: Generation of adequate funds in the hands of the business for 
replacement of the asset at the end of its useful life. Depreciation is a good indication 
of the amount an enterprise should set aside to replace a fixed asset after its economic 
useful life is over. However, the replacement cost of a fixed asset may additionally be 
impacted by inflation or other technological changes. 
(4) Ascertainment of true cost of production: For ascertaining the cost of the production, it 
is necessary to charge depreciation as an item of cost of production. 
Further depreciation is a non-cash expense and unlike other normal expenditure (e.g. wages, 
rent, etc.) does not result in any cash outflow. Further depreciation by itself does not create 
funds it merely draws attention to the fact that out of gross revenue receipts, a certain amount 
should be retained for replacement of assets used for carrying on operation which is achieved 
by charging depreciation that reduces the distributable profits. 
 2.  FACTORS IN THE MEASUREMENT OF 
DEPRECIATION 
Estimation of exact amount of depreciation is not easy as it involves lot of estimation. 
Generally following factors are taken into consideration for calculation of depreciation.  
1. Cost of asset including expenses for installation, commissioning, trial run etc. 
2. Estimated useful life of the asset (both in terms of time & also utility/units). 
© The Institute of Chartered Accountants of India