Methods of Calculating Depreciation Amount

Depreciation: The Core Question

Before you pick a method, you must understand what you are actually calculating. Depreciation is not a guess or a tax trick — it is the systematic allocation of an asset's depreciable amount over its useful life. The depreciable amount is the cost of the asset minus its estimated residual value (the scrap value you expect to recover at the end). The method you choose determines how much of that amount is charged to each accounting period.

The textbook makes clear that two methods are mandated by law and enforced by professional accounting practice in India: the Straight Line Method (SLM) and the Written Down Value Method (WDV). These are the only two you will use in most problems. Other methods — annuity method, depreciation fund method, insurance policy method, sum of years' digits method, double declining method — exist but are not part of the core syllabus for this chapter.

Factors That Determine the Choice of Method

You cannot pick a method arbitrarily. The selection depends on three things:

• Type of the asset — a building wears out differently from a machine or a vehicle.
• Nature of the use of such asset — is it used evenly every year, or does it lose efficiency quickly?
• Circumstances prevailing in the business — does the business prefer a constant charge each year, or a declining charge that matches falling repair costs?

The Consistency Rule (Accounting Standard-6)

This is a critical exam point. Once you select a depreciation method, you must apply it consistently from period to period. You cannot switch methods just to show a higher profit one year and a lower profit the next. A change in method is allowed only under specific circumstances — for example, if a new law requires it, or if the pattern of economic benefits from the asset has fundamentally changed. If a change is made, the effect of the change and the reason for it must be disclosed in the financial statements.

The Two Main Methods — A Quick Distinction

The Depreciation Formula (Plain Text)

Straight Line Method:

Depreciation per year = (Original Cost of Asset − Estimated Residual Value) ÷ Estimated Useful Life in Years

Alternatively, if a rate is given:

Depreciation per year = Original Cost × Rate of Depreciation (as a decimal)

Written Down Value Method:

Depreciation for the year = Book Value at the beginning of the year × Rate of Depreciation (as a decimal)

The book value at the beginning of year 1 is the original cost. At the beginning of year 2, it is original cost minus depreciation of year 1, and so on.

Accounting Treatment (Journal Entry)

Regardless of which method you use, the journal entry to record depreciation is the same:

Why this entry? Depreciation is an expense — it reduces the profit of the business. So you debit the Depreciation account (an expense account). At the same time, the asset's value is being consumed, so you credit the Asset account to reduce its book value. At the end of the accounting period, the Depreciation account is closed by transferring its balance to the Profit & Loss Account: