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ACCOUNTING AND AUDITING

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ACCOUNTING AND AUDITING

Property, plant and equipment are tangible items that:
(a) are held for use in the production or supply of goods or services, for rental to others, or for administrative
purposes; and
(b) are expected to be used during more than a period of twelve months.
These are also called fixed assets in common parlance.

DEPRECIATION
Depreciation may be described as a permanent, continuing and gradual shrinkage in the book value of fixed
assets. It is based on the cost of assets consumed in a business and not on its market value.

REASONS OF DEPRECIATION
Value of such assets decreases with passage of time mainly due to following reasons.
1.Wear and tear due to its use in business
2. Efflux of time even when it is not being used
3. Obsolescence due to technological or other changes
Obsolescence is another factor leading to depreciation of fixed assets. In ordinary language, obsolescence means
the fact of being ―out-of-date”. Obsolescence implies to an existing asset becoming out-of-date on account of
the availability of better type of asset. It arises from such factors as:
• Technological changes;
• Improvements in production methods;
• Change in market demand for the product or service output of the asset;
• Legal or other description.
4. Decrease in market value
5. Depletion mainly in case of mines and other natural reserves
Depletion is the allocation of the cost of wasting natural resources such as oil, gas, timber, and minerals to the
production process. This method is used in case of mines, quarries etc. containing only a certain quantity of
product.
SUBSTANCE OVER FORM – ACTUALLITY OVER LEGALLITY
NOTE
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Decline in the usefulness of the asset may be caused by abnormal factors such as accidents due to fire,
earthquake, floods, etc. Accidental loss is permanent but not continuing or gradual. For example, a car which has
been repaired after an accident will not fetch the same price in the market even if it has not been used.
As per Schedule II under the Companies Act, 2013, Depreciation is the systematic allocation of the depreciable
amount of an asset over its useful life. The depreciable amount of an asset is the cost of an asset or other amount
substituted for cost, less its residual value. The useful life of an asset is the period over which an asset is expected
to be available for use by an entity, or the number of production or similar units expected to be obtained from the
asset by the entity.
OBJECTIVE OF DEPRECIATION
Matching of Costs and Revenue
The rationale of the acquisition of fixed assets in business operations is that these are used in the earning of
revenue. Every asset is bound to undergo some wear and tear, and hence lose value, once it is put to use in
business.
Therefore, depreciation is as much the cost as any other expense incurred in the normal course of business like
salary, carriage, postage and stationary, etc. It is a charge against the revenue of the corresponding period and
must be deducted before arriving at net profit according to ̳Generally Accepted Accounting Principles‟.
Prime objectives for providing depreciation are:
(1) Correct income measurement: Depreciation should be charged for proper estimation of periodic profit or loss.
In case an enterprise does not account for depreciation on Property, Plant & Equipment, it will not be considering
loss in value of property, plant & equipment due to their use in production or operations of the enterprise and will
not result in true profit or loss for the period.
(2) True position statement: Value of the Property, Plant & Equipment should be adjusted for depreciation charged
in order to depict the actual financial position. In case depreciation is not accounted for appropriately, the
property, plant and equipment would be disclosed in financial statements at a value higher than their true value.
Whereas we should always present the same at its unexpired cost which is after charging the expired cost as
depreciation.
(3) Funds for replacement: Generation of adequate funds in the hands of the business for replacement of the asset
at the end of its useful life. Depreciation is a good indication of the amount an enterprise should set aside to replace
a fixed asset after its economic useful life is over. However, the replacement cost of a fixed asset may be impacted
by inflation or other technological changes.
(4) Ascertainment of true cost of production: For ascertaining the cost of the production, it is necessary to charge
depreciation as an item of cost of production.
FACTORS IN THE MEASUREMENT OF DEPRECIATION
Estimation of exact amount of depreciation is not easy as it involves lot of estimation. Generally following
factors are taken into consideration for calculation of depreciation.
1.Cost of asset including expenses for installation, commissioning, trial run etc.
2. Estimated useful life of the asset (both in terms of time & also utility/units).
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3. Estimated scrap value (if any) at the end of useful life of the asset.
Cost of Property, Plant and Equipment comprises:
(a) its purchase price, including non-refundable import duties and purchase taxes, after deducting trade discounts
and rebates.
(b) any cost directly attributable to bring the asset to the location and condition necessary for it to be capable of
operating in a manner intended by the enterprise.
(c) the initial estimate of the costs of dismantling, removing, the item and restoring the site on which an asset is
located.
Examples of costs directly attributable costs are:
(a) cost of employee benefits arising directly from acquisition or construction of an item of property,
plant and equipment.
(b) cost of site preparation
(c) initial delivery and handling costs
(d) installation and assembly costs
(e) cost of testing whether the asset is functioning properly, after deducting the net proceeds from
selling the items produced while testing (such as samples produced while testing)
(f) professional fees e.g. engineers hired for helping in installation of a machine
Thus all the expenses which are necessary for asset to bring it in condition and location of desired used will
become part of cost of the asset.
However, following expenses should not become part of cost of asset:
(a) costs of opening new facility or business, such as inauguration costs;
(b) cost of introducing new product or service (for example cost of advertisement or promotional
activities).
(c) cost of conducting business in a new location or with a new class of customer (including cost of staff training);
and
(d) administration and other general overhead costs.
Once an asset has been brought to its intended condition and location of use, no cost should recognized as part of
cost of the asset unless there is major repair or addition which increases the useful life of the asset or improves
the production capacity of the asset. Accordingly, cost incurred while and item is capable of operating in intended
manner but it is not yet put to use or is used at less than full capacity should not be capitalized as part of cost of
the asset. Similarly, cost of relocation of an asset should not be capitalized.
Any additions made to a particular item of property, plant and equipment after it is initially put to use are
depreciated over the remaining useful life of the asset. Any addition or extension which has a separate identity
and is capable of being used after the existing asset is disposed of, is accounted for separately. Therefore, it is
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important to maintain an asset register capturing asset wise details of cost, rate of depreciation, date of
capitalization etc. All these details need to be captured for any additions to existing assets as well. In the absence
of the adequate information, it will be very difficult to compute depreciation expense year on year. Also, at the
time of disposal or discard of a particular asset, it will not be possible to compute gain or loss on such
disposal/discard.
METHODS OF DEPRECIATION
1. Straight line method
2. Reducing balance method
3. Sum of years of digits method
4. Machine hour method
5. Production units’ method
6. Depletion method
7. Annuity Method

PROFIT AND LOSS ON SALE OF FIXED ASSETS

The resulting profit or loss on sale of the tangible asset is ultimately transferred to profit and loss account