Depreciation is the reduction in the value of assets due to wear and tear. It is a method of allocation of cost of the asset over its useful life.
Every asset is subject to wear and tear in the normal course of its use and also with passage of time. The cost of the asset is allocated over time and considered as cost. Depreciation is also allowed as a deduction from profits as per income tax act and also as per companies act.
Common Methods or Types of Depreciation
- Written Down Value (WDV)WDV method of depreciation is the most common used method of depreciation. In income tax act, depreciation is allowed as per WDV method only.
In this method depreciation is charged on the book value of asset and book value is decreased each year by the depreciation.For eg- Asset is purchased at rs. 1,00,000 and depreciation rate is 10% then first year depreciation is rs. 10,000(10% of rs. 1,00,000), second year depreciation is rs. 9,000 ( 10% of 90,000 [1,00,000 – 10,000]) and third year depreciation is rs. 8,100 ( 10% of rs. 81,000 [90,000 – 9,000]).
This method is also called reducing balance method. This is considered as most logical method of depreciation.
- Straight Line Method (SLM)In this method equal amount of depreciation is charged on asset over its useful life. For eg asset is purchased for rs. 1,00,000 and useful life is 10 years with salvage value of rs. 10,000 then depreciation is charged at rs. 9,000 for each of the 10 years. (1,00,000 – 10,000)/10.There are also other methods of depreciation but they are not oftenly used such as depreciation on basis of units of production.