Machinery account in the books of a company was as follows:As per AS-6

"Depreciation is a measure of the wearing out, consumption or other loss of a

value of a depreciable asset arising from use, efflux of time or obsolescence
through technology and market changes. 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 includes amortisation
of assets whose useful life is predetermined.
The Institute of Cost and Management Accountants (ICMA), London:
"Depreciation is the diminution in intrinsic value of the asset due to use and/or
lapse of time."
According to International Accounting Standard Committee:
"Depreciation is the allocation of the depreciable amount of an asset over its
estimated useful life. Depreciation for the accounting period is charged to
income either directly or indirectly."
Causes of Depreciation
Following are the main causes of depreciation:
(1) Physical Deterioration. It is caused mainly from wear and tear when the
asset is in use and from erosion, rust, rot and decay from being exposed to wind,
rain, sun and other elements of nature.
(ii) Economic Factors. These may be said to be those that cause the asset to be
put out of use even though it is in good physical condition. These arise due to
obsolescence and inadequacy. Obsolescence means the process of becoming
obsolete or out of date. An old machinery though in good physical condition
may be rendered obsolete by the introduction of a new model which produces
more than the old machinery. Inadequacy refers to the termination of the use of
an asset because of growth and changes in the size of the firm. But obsolescence
and inadequacy do not necessarily mean that the asset is scrapped. It is merely
put out of use by the firm. Another firm will often buy it.
(iii) Time factors. There are certain assets with a fixed period of legal life such
as lease, patents, and copyrights. For instance, a lease can be entered into for
any period while a patent's legal life is for some years but on certain grounds
this can be extended. Provision for the consumption of these assets is called
amortisation rather than depreciation.
(iv) Depletion. Some assets are of a wasting character perhaps due to the
extraction of raw materials from them. These materials are then either used by
the firm to make something else or are sold in their raw state to other firms.
Natural resources such as mines, quarries and oil wells come under this heading.
To provide for the consumption of an asset of a wasting character is called
provision for depletion.
(e) Accident. An asset may reduce in value because of meeting of an accident.
S
1. A second hand machine was purchased on 1-1-90 for Rs. 30,000 and
repair charges amounted to Rs. 6,000. It was installed at a cost of Rs.
4,000. On 1st July 1991, another machine was purchased for Rs. 26,000.
On 1st July 1992 the first machine was sold for Rs. 30,000. On the same
day, one more machine was bought for Rs. 25,000. On 31-12-92, the
machine bought on 1st July 1991 was sold for Rs. 23,000. Accounts are
closed every year on 31st December. Depreciation is written off at 15%
per annum. Prepare the Machinery A/c for 3 years ending 31-12-92.

2. The following balances appear in the books of Mohan.

1.1.90 Machinery A/c 50,000
1.1.90 Provision for Depreciation A/c 20,000
On 1.1.90 they decided to sell a machine for Rs. 4,500. This machine was
purchased for Rs. 9,000 in January 1986. You are required to prepare
Machinery A/c and the Provision for Depreciation A/c on 31.12.90
assuming the firm has been charging depreciation at 10% p.a. on straight-
line method.
3. George Co. Ltd. purchased a machine on 1st January 1995 for Rs. 50,000.
On 1st July 1995 further machinery was purchased for Rs. 25,000. On 1st
July 1996, the machinery purchased on 1st January 1995 having become
obsolete, was sold off for Rs. 20,000. Depreciation has to be charged at
20% on the original cost assuming that the accounts are closed every year
on 31st December. You are required to prepare:
(a) Machinery A/c
(b) Provision for Depreciation A/c.
4. A company acquired a machine on 1.1.88 at a cost of Rs. 40,000 and spent
Rs. 1,000 on its installation. The firm writes off depreciation at 10% on the
diminishing balance. The books are closed on 31st December of each year.
Show the Machinery A/c for 3 year,
5. Messrs. Sarojini Balu & Co., purchased a machine for Rs. 22,000 on January
1. 1992. The estimated life of the machinery is 10 years, after which it's break-
up value will be Rs. 2,000. Depreciation has to be charged at 21% on the
diminishing balance. There was an addition to the original plant on January 1
1994 to the value of Rs. 4,000. You are required to prepare machinery A/c for
the first three years.

calendar year, purchased on 1-1-93 a machine for Rs. 40,000. It purchased

further machinery on 1st Oct. 1993 for Rs. 20,000 and on 1st July 1994 for Rs.
10,000. On 1-7-1995, 1/4th of the machinery installed on 1-1-1993 became
obsolete and was sold for Rs. 6,800.
Show how the machinery account would appear in the books of the company
for all the 3 years under Diminishing Balance method. Depreciation is to be
provided at 10% p.a.

7. Machinery account in the books of a company was as follows:

Balance as at 1.1.86 Rs. 14900
Purchase of machinery on 1:7.86 Rs. 4400
Sale of machinery on 1.10.86 Rs. 1000
The original cost of machinery sold was Rs. 6,000 on 1.7.83Machinery is being
depreciated at 10% p.a. on diminishing balance of the asset. Show the
machinery A/c in the books of the company for the year 1986. The books are
closed on 31st Dec. each year.

8. Active Company Ltd. purchased on 1st January 1993 a machine for 1,00,000.
On 1st July 1993, it purchased another machine costing Rs. 50,000. 1st July
1994, the machine purchased on 1st January 1993 having become obsolete, was
sold off for Rs. 40,000. On 1st July 1995, a new machine was purchased for Rs.
1,20,000 and the machine purchased on 1st July 1993, was sold at Rs. 42,000 on
the same date. Depreciation is to be provided at 10% p.a. Under Diminishing
Balance Method every year assuming that the accounts are closed on 31st
December every year.
You are required to prepare
(i) Machinery A/c
(ii) Machinery Disposal A/c

9. A second-hand machine was purchased on 1.1.90 for 40,000. Overhauling

and installation expenses for the same machine amounted to Rs. 10,000.
Another 17 machine was purchased on 1.7.90 for Rs. 20,000

On 1.7.92, the machine installed on 1.1.90 was sold for Rs. 25,000. Dismantling
charges for the machine sold on 1.7.92 were Rs. 1,000. On the same date
another machine was purchased for Rs. 80,000 and commissioned on 30.9.92.
The company has adopted calendar year as its financial year. Under the existing
practice, the company provides depreciation @ 10% p.a. on original cost. In
1993, it has been decided that depreciation will be charged on the diminishing
balance @ 15% p.a The change is not to be made with retrospective effect.
Show Machinery A/c from 1990 to 1994.

INSURANCE POLICY METHOD:

Under this method, a policy is taken for the amount of the asset to be replaced.
At the end of the policy period, a definite amount is received from insurance
company which is used for purchasing new asset. Premium is paid every year
and this premium is equal to the amount of depreciation of each year. In the
beginning of each year premium is paid.

10. X Co. Ltd. purchased a lease of Rs. 50,000 on 1-1-90 to be replaced at the
end of five years. For this purpose, one insurance policy is taken out for which
the annual premium is Rs. 9,400. At the end of the period the lease is renewed
for Rs. 45,000. Show the various ledger accounts in the books of the company.

11. On 1 January 2007, Z Co. Ltd. purchased a lease of ₹2,00,000. It is decided

to replace the lease at the end of five years. For this purpose, an insurance
policy was taken out for which the annual premium is ₹37,600. On 1st January
2012, the lease is renewed for ₹1,80,000.
Prepare:
(a) Depreciation Reserve Account
(b) Depreciation Insurance Policy Account9
(c) Lease Account

12. Ahmed Co. Ltd. purchased a lease of ₹7,00,000 on 1st January 2012. It has
decided to replace the lease at the end of five years. An insurance policy is taken
by the company and pays an annual premium of ₹1,31,600. The lease is
renewed for ₹6,30,000 at the end of the period. Prepare Depreciation Reserve
Account, Depreciation Insurance Policy Account and Lease Account.

ANNUITY METHOD:
Under this method, interest at a fixed rate is calculated on the capital investment
involved in the purchase of the asset, on the assumption that, if the same amount
of capital was employed in some other investment, it would have earned a
certain rate of interest. The owner of the business, therefore, during the period
that he utilises any asset not only loses the original cost of that asset in the shape
of depreciation, but also loses the interest thereon. Under the annuity method,
the cost of the asset as also the interest thereon are written down annually by
equal instalments until the book value of the asset in question is reduced either
to zero or its residual value at the end of its usefulness to the business. The
amount of depreciation is found out from 'Annuity Tables'. It should be noted
that the amount of depreciation includes some portion of the asset and some
portion of this expected amount of interest also.

13. A firm purchases a 5 years' lease for Rs. 80,000 on 1st January. It decides to
write off depreciation on the Annuity method, presuming the rate of interest to
be 5%. per annum. The annuity tables show that a sum of Rs. 18,478 should be
written off every year. Show the lease account for five years. Calculations are to
be made to the nearest rupee.

14. On 1ª January 2010, a firm purchased a five-year lease for ₹1,60,000. It

decides to write off depreciation under annuity method. The rate of interest to be
charged at 5% per annum. The annuity tables show that a sum of ₹36,956
should be written off every year. Prepare the Lease Account for five years.
Calculations are to be made to the nearest rupee.

SINKING FUND METHOD.

Under this method, the amount of depreciation is calculated with reference to

sinking fund tables. It is debited to depreciation account and credited to sinking
fund account. At the end of the year, the depreciation is charged to Profit &
Loss a/c. This amount is invested in outside securities in order to earn
compound interest on the investment. This process continues in all the years of
the life of the asset. In the last year, the investments are sold and whatever
amount that is realised from the sale of securities is utilised for the replacement
of the asset. But the value of securities, when these are to be sold, may reduce
and may not provide full amount for the replacement of the asset.
15. A company purchased a 3-year, lease on 1-1-1990 for Rs. 50,000. It is
decided to provide for the replacement of lease at the end of three years by
setting up a sinking fund. It is expected that the investment will fetch interest at
5%. Sinking Fund tables show that to provide the requisite sum at 5% at the end
of three years, an investment at Rs. 15,864 is required every year. Investments
are made to the nearest rupee.
On 31st December 1992, the investments were sold for Rs. 30,500. On 1.1.93,
the same lease was renewed for a further period of 3 years by payment of Rs.
60,000. Show the journal entries and give the lease a/c, sinking fund a/c and
sinking fund investments a/c. Calculations are to be made to the nearest rupee.

16. On 1 January 2010. Alpha Company purchased a three-year lease for

1,00,000. It is decided to provide for the replacement of lease at the end of three
years by setting up a sinking fund. It is expected that the investment will fetch
interest at 5%. Sinking fund tables show that to provide the requisite sum at 5%
at the end of three years, an investment of ₹31,728 is required every year.
Investments are made to the nearest rupee.
On 31 December 2012, the investments were sold for ₹62,000. On 1* January
2013, the same lease was renewed for a further period of three years by
payment of ₹1,20,000.
Show the journal entries and prepare the Lease Account, Sinking Fund Account
and Sinking Fund Investments Account. Calculations are to be made to the
nearest rupee.

Depletion Method

Depletion method of depreciation will be calculated on wasting assets Natural

resources like mines, fuel oil, gas and wood are exhausted with usage. The rate
of production is measured by the rate of exhaustion of the asset. Under this
method, the total value of assets will be estimated. After ascertaining this, the
rate of depreciation per unit will be calculated by dividing the estimated life in
term of production units. The asset is reduced to zero at the end of the total
exhaustion. The formula to calculate depreciation under depletion method is as
follows:

Amount of Depreciation = Original cost – Scrap value

––––––––––––––––––––––––––––––––––
Estimated Life in terms of production Units
Machine Hour Rate Method
Under this method, hourly rate of depreciation is calculated. The cost of the
asset (less residual value, if any) is divided by the estimated working hours. The
actual depreciation depends upon the working hours during that year. This
method is useful for textiles, jute mills, etc.

Hourly Depreciation Rate= Original cost – Scrap value

––––––––––––––––––––––––––––––––––
Total Working Hours

Annual Depreciation = Working Hours of Machine in a Year x Hourly

depreciation rate