Provision for Depreciation and Asset Disposal Account

Depreciation refers to the decrease in the value of assets of the company over the time period due to use, wear and tear, and obsolescence. In others words, it is the method to allocate the cost of an asset over its useful life. Depreciation is always charged on the cost price of the asset and not on its market price. It is charged every year to the extent of the depreciable amount. Examples of assets that can be depreciated are Machines, Computers, Furniture, Vehicles, etc.

According to R.N. Carter, “Depreciation is the gradual and permanent decrease in the value of an asset from any cause.”

According to William Pickles, “Depreciation may be defined as the permanent and continuing diminution in the quality, quantity or the value of an asset.”

Accounting Treatment of Depreciation:

I. Charging to Asset Account:

Under this arrangement, the depreciation for an accounting period is to be deducted from the given fixed asset by crediting it to the respective asset account and then charged to the profit and loss account while preparing financial statements. In the Balance Sheet, such an asset is shown at its net value, which is obtained after deducting the amount of depreciation from the historical cost of such an asset. 

The following Journal entries are passed:

Illustration:

ABC Ltd. purchased a plant for ₹5,00,000 on April 01, 2022, and spent ₹1,00,000 for its installation. Record journal entries for the year 2022-23 given that the depreciation is charged @5% p.a. using the straight-line method if :
(i) The books of account close on March 31 every year; and
(ii) The firm charges depreciation to the asset account.

Solution:

Working Notes:

(i) Total cost of plant = Acquisition cost + Installation Charges

= 5,00,000 + 1,00,000

= ₹ 6,00,000

(ii) Amount of depreciation to be charged every year = @5% on ₹6,00,000 = ₹ 30,000

II. Creating Provision for Depreciation or Accumulated Depreciation Account:

As the name suggests, this method involves accumulating depreciation charges every year into an account rather than directly charging it to the cost of the given fixed asset. The account prepared for such purpose is called provision for depreciation account. A depreciation provision allows a company to account for the gradual decline in the value of its fixed assets over time, thus allowing the company’s financial statements to accurately reflect the current value of its investments in those assets.

The following Journal entries are passed:

Illustration:

GFG Ltd. acquired a machine for ₹1,80,000 on October 01, 2021, and spent ₹20,000 for its installation. The firm writes off depreciation at the rate of 10% on the original cost every year. Record necessary journal entries for the year 2021-22 and draw up necessary for the first three years given that:
(i) The book of accounts closes on March 31 every year; and
(ii) The firm maintains provision for depreciation account. 

Solution:

Asset Disposal Account:

Disposal of an asset means selling it off when it is not of any value to the business any longer. An asset fails to be of value to a business due to the following two reasons:

• at the end of its useful life
• loss due to any accident, fire, obsolescence, etc., during its useful life.

Asset Disposal Account and its Uses:

An asset disposal account is prepared in order to deal with transactions pertaining to the sale of a fixed asset in a business under one account head. The concerned variables are the original cost of the asset, depreciation accumulated on the asset up to date, sale price of the asset, value of the parts of the asset retained for use, if any, and the resultant profit or loss on disposal. The balance of the Asset Disposal Account is transferred to the Profit and Loss Account. The uses of an Asset Disposal Account are:

• It is generally prepared in cases where the business has created a provision for depreciation and only a part of the fixed asset has been disposed. 
• It gives a complete summary of all transactions relating to the sale of assets in one place.

Accounting Treatment of Asset Disposal Account (When Provision for Depreciation A/c is Maintained):

*Either of the two entries would be recorded, depending on whether it is profit or loss.

Illustration:

On January 01, 2022, Durga Ltd. purchased five trucks for ₹20,000 each. The business charges depreciation @10% p.a. every year and accumulates it in provision for depreciation account. On January 01, 2023, one truck was sold for ₹15,000. On July 01, 2024, another truck (purchased for ₹20,000 on Jan, 01,2021) was sold for ₹18,000. A new truck costing ₹30,000 was purchased on October 01, 2024. Prepare Trucks Account, Provision for depreciation account and Truck disposal account for the years ended on December 2022, 2023 and 2024 if the firm closes its accounts in December every year.

Solution:

Working Notes:

1. Calculation of amount of depreciation:

2. Loss on sale of the first truck:

3. Profit on sale of the second truck: