Depreciation Accounting
Depreciation is the systematic allocation of the cost of a fixed asset over its useful life. Assets like machinery, vehicles, and buildings lose value due to wear and tear, obsolescence, and passage of time. Depreciation matches the cost of the asset with the revenue it helps generate (matching concept).
Need for Depreciation
Without depreciation: profits would be overstated (asset cost not matched with revenue), assets would be overstated on the balance sheet, and tax calculations would be incorrect (depreciation is tax-deductible in Nepal). Depreciation ensures true and fair financial statements.
Factors Determining Depreciation
Cost of asset: purchase price plus installation, transport, and costs to bring it to working condition. Estimated useful life: how long the asset will be productive. Residual/scrap value: estimated value at end of useful life. Depreciable amount = Cost − Residual Value.
Straight Line Method (SLM)
Annual depreciation = (Cost − Residual Value) / Useful Life. Same amount charged every year. Example: Machine Rs 500,000, residual Rs 50,000, life 10 years. Annual depreciation = (500,000 − 50,000)/10 = Rs 45,000/year. Rate = 9%. Advantages: simple, consistent. Used for: buildings, furniture, patents.
Reducing Balance Method (WDV)
Annual depreciation = Rate × Written Down Value. Higher depreciation in early years, lower later. Example: Rs 500,000 at 20%. Year 1: 20% × 500,000 = Rs 100,000. Year 2: 20% × 400,000 = Rs 80,000. Year 3: 20% × 320,000 = Rs 64,000. Advantages: matches higher productivity and lower maintenance in early years. Used for: machinery, vehicles, computers.
Accounting Treatment
Journal: Depreciation A/c Dr, To Asset A/c (or To Provision for Depreciation A/c). Depreciation is P&L expense. Asset shown at cost less accumulated depreciation (net book value) in Balance Sheet. Provision for Depreciation Account keeps original cost visible.
Disposal of Assets
Compare sale price with book value. Sale > book value: profit on disposal (credit P&L). Sale < book value: loss on disposal (debit P&L). Journal: Bank Dr, Accumulated Dep Dr, To Asset, To/From Profit/Loss on Disposal.
Summary
Depreciation allocates asset cost over useful life. SLM provides equal annual charges; reducing balance provides higher early charges. Proper accounting treatment and disposal entries are essential skills.
SLM vs WDV Comparison Table
Machine cost Rs 200,000, residual Rs 20,000, life 5 years. SLM rate: (200,000−20,000)/5 = Rs 36,000/year. WDV rate: 37% (approximately).
| Year | SLM Depreciation | SLM Book Value | WDV Depreciation | WDV Book Value |
|---|---|---|---|---|
| 0 | — | 200,000 | — | 200,000 |
| 1 | 36,000 | 164,000 | 74,000 | 126,000 |
| 2 | 36,000 | 128,000 | 46,620 | 79,380 |
| 3 | 36,000 | 92,000 | 29,371 | 50,009 |
| 4 | 36,000 | 56,000 | 18,503 | 31,506 |
| 5 | 36,000 | 20,000 | 11,506 | 20,000 |
| Total | 180,000 | 180,000 |
Key observations: Both methods depreciate the same total amount (Rs 180,000). SLM charges equal amounts each year. WDV charges more in early years (Rs 74,000 in Year 1 vs Rs 11,506 in Year 5). WDV better matches the actual pattern of asset usage — most assets are more productive when new.
Worked Example: Asset Disposal
On 1 Shrawan 2079, a company bought a vehicle for Rs 800,000. Depreciation at 20% SLM. The vehicle was sold on 1 Magh 2081 (after 2.5 years) for Rs 450,000.
Solution:
Total depreciation = 20% × 800,000 × 2.5 years = Rs 400,000
Book value at sale = 800,000 − 400,000 = Rs 400,000
Sale price = Rs 450,000
Profit on disposal = 450,000 − 400,000 = Rs 50,000 (credited to P&L)
Journal entry:
Bank A/c Dr 450,000
Accumulated Depreciation A/c Dr 400,000
To Vehicle A/c 800,000
To Profit on Sale of Vehicle A/c 50,000
Nepal Tax Context
Nepal’s Income Tax Act 2058 allows depreciation as a tax-deductible expense. Rates are specified by the Inland Revenue Department (IRD): buildings 5%, furniture/fixtures 15%, vehicles 20%, computers 25%, plant and machinery varies by type. Companies must use the rates specified by IRD for tax purposes, even if different rates are used for accounting purposes.
Exam Tips
Tip 1: Clearly show the depreciation schedule year by year — examiners give marks for the table. Tip 2: For disposal, always compute book value first (cost − accumulated depreciation), then compare with sale price. Tip 3: If the question says depreciation from date of purchase, calculate months precisely. Tip 4: SLM and WDV give the same total depreciation over the asset’s life — only the timing differs. Tip 5: Remember Provision for Depreciation Account is a credit balance — it accumulates on the credit side year after year.