Depreciation and its Accounting
(Why Does Everything Lose Value Over Time?)
You bought a phone for ₹20,000. After 3 years, it’s worth ₹5,000. Where did the other ₹15,000 go? That loss in value = Depreciation. This chapter teaches you WHY it happens, HOW to calculate it (4 methods), and WHERE to record it in the books.
Banky’s New Bike is Already “Depreciating”! 🏍️
Banky bought a bike for ₹1,20,000. His friend said: “Bro, the moment you drove it out of the showroom, it lost ₹20,000 in value!” Banky was shocked. His mentor explains: “That’s depreciation — and as a banker, you need to know how to calculate and record it!”
Why Should You Learn Depreciation?
Because every loan you sanction has assets that depreciate!
Exam Marks
3–5 questions! SLM formula, WDV calculation, causes of depreciation, AS-10/Ind AS-16 methods. Very formula-based — easy marks if you practice!
Bank Work
Depreciation affects P&L (profit reduces), Balance Sheet (asset value reduces), and loan collateral valuation. Critical for credit appraisal.
Personal Life
Your car, laptop, phone — everything depreciates! Understanding this helps you make better buying & selling decisions.
Real Bank Scenario
What Will You Learn?
Key Words — Plain & Simple
In simplest words: You buy a car for ₹10 lakh. Every year, it loses some value — because of wear and tear, because it’s getting old, because newer models come out. After 10 years, it might be worth only ₹1 lakh (scrap value). That ₹9 lakh loss over 10 years is depreciation.
4 key facts: (1) It’s a PART of operating cost — not extra. (2) It’s a REDUCTION in asset value. (3) It happens because of USE, TIME, or BECOMING OUTDATED. (4) The decrease is GRADUAL and CONTINUOUS — not sudden.
Important: Depreciation is an EXPENSE — it goes to the debit of P&L Account. It reduces profit. But it’s a non-cash expense — you don’t pay cash to anyone. You just acknowledge that your asset is worth less than before.
(1) Wear & Tear: You USE the machine every day — parts wear out. Like tyres going bald after 40,000 km.
(2) Time (Efflux of Time): Even if you DON’T use an asset, it loses value just by sitting there. A car bought in 1972 is worth almost nothing in 2026, even if never driven! Time itself destroys value.
(3) Obsolescence: A new, better version comes out and makes the old one useless. Like how a DVD player became worthless when streaming started. A new invention kills the old one.
(4) Accidents: A machine gets damaged in a fire or flood. Sudden loss of value.
(5) Fall in Market Price: Market conditions change and the asset’s value drops.
Exception: LAND generally does NOT depreciate — it actually goes UP in value (appreciates). Old paintings too. But almost everything else depreciates.
How it works: Assume the asset loses the SAME amount of value every year. If a machine costs ₹1,00,000, scrap value is ₹10,000, and useful life is 10 years: Depreciation = (1,00,000 − 10,000) ÷ 10 = ₹9,000 per year. Every year, same ₹9,000. Simple!
Best for: Assets that give CONSISTENT performance throughout their life — like Plant & Machinery.
Advantages: Simplest method. Easy to understand. Same amount every year. Disadvantages: Doesn’t account for increasing repair costs in later years. Total P&L charge (depreciation + repairs) increases over time.
Note: If asset is bought MID-YEAR (e.g., 1st October), only charge depreciation for the months used. Oct to Mar = 6 months = half year’s depreciation.
How it works: Apply a fixed percentage on the REMAINING value (not original cost). Year 1: 10% of ₹4,00,000 = ₹40,000. Remaining = ₹3,60,000. Year 2: 10% of ₹3,60,000 = ₹36,000. Remaining = ₹3,24,000. Year 3: 10% of ₹3,24,000 = ₹32,400. See? The depreciation DECREASES every year because the base keeps shrinking.
Best for: Assets that need MORE repairs as they get older. In early years: high depreciation + low repairs = reasonable total cost. In later years: low depreciation + high repairs = still reasonable total cost. It balances out!
Recognised by: Ind AS-16, Income Tax Act, and Companies Act. This is the method RBI and tax authorities prefer.
Advantages: Balances depreciation with repairs over the years. Tax-approved. Disadvantages: Asset value never reaches zero. Harder to understand. Varying depreciation each year.
How it works: A pen-making machine costs ₹1,00,000. Scrap = ₹10,000. It can make 10,00,000 pens in its lifetime. This year it made 2,00,000 pens. Depreciation = (2,00,000/10,00,000) × 90,000 = ₹18,000.
Best for: Assets where value loss depends on USE, not time — like mining equipment, delivery vehicles (depreciate per km driven).
Tangible assets (machines, buildings) = Depreciation. Intangible assets (patents, trademarks, software) = Amortisation. Same concept, different name. A patent that lasts 20 years is amortised over 20 years — its value reduces every year, just like a machine’s. Governed by Ind AS-38.
Full Chapter — The Story
📖 Part 1 — Why Do We NEED Depreciation? (3 Reasons)
(1) To know CORRECT profit: If you use a machine to earn money, the machine is slowly being “used up.” This “using up” is a cost of doing business. Without recording depreciation, your profit would look HIGHER than it actually is. That’s cheating your shareholders!
(2) To show CORRECT financial position: If a machine costs ₹10 lakh and you’ve used it for 8 years, showing it at ₹10 lakh on the balance sheet is LYING. It’s worth much less. Depreciation ensures assets are shown at their TRUE (reduced) value.
(3) To save for REPLACEMENT: One day, the machine will die. If you haven’t been setting aside money for a new one, you’ll be stuck. Depreciation = gradually putting money aside (in the form of reduced profits) so you can REPLACE the asset when needed. Some companies even create a Sinking Fund — they invest the depreciation amount in securities, and when the asset needs replacement, they sell the securities to buy a new asset.
📋 Part 2 — The 4 Factors You Need to Calculate Depreciation
To calculate depreciation, you need exactly 4 things:
(1) Cost of the Asset: The FULL cost — purchase price + transport + installation + any expense to make it ready for use. If you bought a machine for ₹5 lakh, paid ₹20,000 for transport, and ₹30,000 for installation, the cost = ₹5,50,000 (not just ₹5 lakh).
(2) Scrap/Residual Value: What will the asset be worth at the END of its life? When a machine dies, you sell it as scrap metal — maybe ₹10,000. That’s the scrap value. Some assets have zero scrap value.
(3) Useful Life: How many years will the asset be USEFUL? Not how long it CAN physically last, but how long it will be economically useful. A machine might run for 15 years, but after 10 years a better machine comes out — so useful life = 10 years.
(4) Method: Which formula to use — SLM, WDV, Units of Production, or Sum of Years’ Digits.
📝 Part 3 — The Accounting Entry
How do you record depreciation in the books? Two methods:
Method 1 — Direct (reduce asset directly): Depreciation A/c Dr. (expense) | To Asset A/c Cr. (reduces asset value). Result: Asset appears at reduced value in Balance Sheet.
Method 2 — Provision (keep asset at original cost, show reduction separately): Depreciation A/c Dr. | To Provision for Depreciation A/c Cr. Result: Asset stays at ORIGINAL cost in Balance Sheet, but the provision account is shown as a DEDUCTION from it. Net value = Cost − Provision.
In both methods: Depreciation A/c is transferred to P&L Account at year-end (it’s a nominal account = expense). It REDUCES the profit.
📊 Part 4 — SLM vs WDV — Which Is Better?
SLM (Straight Line): Same depreciation every year. Simple. But in later years, repair costs increase while depreciation stays the same — so total P&L charge (depreciation + repairs) goes UP over time. Not ideal.
WDV (Written Down Value): High depreciation in early years, low in later years. In early years: high depreciation + low repairs = balanced. In later years: low depreciation + high repairs = still balanced. Total P&L charge stays roughly EVEN across years. More realistic. Recognised by Income Tax Act, Ind AS-16, and Companies Act. Tax authorities use this method.
Indian Accounting Standards (AS-10 and Ind AS-16) recognise 3 methods: (1) Straight Line, (2) Diminishing Balance (WDV), and (3) Units of Production. Sum of Years’ Digits is an additional method but less commonly used.
Exam-Ready Points
🎯 Must Remember!
- Depreciation = Gradual decrease in value of an asset due to use, time, obsolescence. It’s an operating cost. Non-cash expense.
- 5 Causes (WTOAF): Wear & Tear, Time (efflux), Obsolescence, Accidents, Fall in market price
- LAND does NOT depreciate — it generally appreciates. Exception!
- 3 Needs: Correct profit, correct financial position (Balance Sheet), provision for replacement
- 4 Factors: Cost (including transport/installation), Scrap value, Useful life, Method
- SLM Formula: (Cost − Scrap) ÷ Useful Life = Annual Depreciation (SAME every year)
- WDV: Fixed % on REDUCING balance. Higher in early years, lower later. Asset never reaches zero.
- Units of Production: (Actual units ÷ Total expected units) × (Cost − Scrap). Based on USAGE, not time.
- Sum of Years’ Digits: Higher depreciation in early years. Sum digits of life years (e.g., 3 years = 3+2+1 = 6).
- AS-10 & Ind AS-16 recognise 3 methods: SLM, WDV (Diminishing Balance), Units of Production — ALL of the above!
- Ind AS-38: Deals with intangible assets. Amortisation = depreciation for intangible assets.
- Sinking Fund: Invest depreciation amount in securities → sell when asset needs replacement → use proceeds to buy new asset.
- Accounting entry: Depreciation A/c Dr. | To Asset A/c Cr. (direct method) OR To Provision for Depreciation A/c Cr.
- Depreciation → P&L Account (debit). Reduces profit. It’s a nominal account expense.
- Mid-year purchase: Charge depreciation only for months used. Oct purchase + Mar closing = 6 months depreciation.
- WDV is preferred by: Income Tax Act, Ind AS-16, Companies Act
- SLM advantage: Simple, easy, same every year. Disadvantage: Ignores increasing repair costs.
- WDV advantage: Balances depreciation + repairs. Disadvantage: Asset never reaches zero. Complex.
- Depreciation shrinks the: BOOK VALUE of the asset (not scrap, not market, not residual)
📝 Past Exam Questions
Memory Tricks
🧠 Trick 1 — 5 Causes
W = Wear & Tear
T = Time (efflux)
O = Obsolescence
A = Accidents
F = Fall in market price
🧠 Trick 2 — SLM Formula
“CSL = Cut Slice for Life!”
Same slice every year! 🍰
🧠 Trick 3 — SLM vs WDV
WDV = Hare 🐇 (fast start, slows down)
Both finish the race!
🧠 Trick 4 — 3 Recognised Methods
S = Straight Line
W = Written Down Value
U = Units of Production
🧠 Trick 5 — 4 Factors
(Same as CSL formula + Method!)
🧠 Trick 6 — Depreciation vs Amortisation
(you can TOUCH them)
Amortisation = 🏋️ GYM MEMBERSHIP expiring
(you CANNOT touch it)
🧠 Trick 7 — WDV Special Feature
It keeps reducing but NEVER dies!”
Asset value → ₹1, ₹0.50, ₹0.25… never ₹0!
🧠 Trick 8 — Sinking Fund
Put money aside every year →
Invest in securities →
Sell when machine dies → Buy new one!
The Whole Chapter in One Picture
Last-Minute Flash Cards
⚡ Chapter 6 Done! Everything in 7 Lines:
- Depreciation: Gradual loss in value of assets. Non-cash expense. Goes to P&L debit. Reduces profit.
- 5 Causes (WTOAF): Wear & Tear, Time, Obsolescence, Accidents, Fall in price. LAND = exception.
- 3 Needs: Correct profit, correct Balance Sheet, provision for replacement.
- 4 Factors (CSLM): Cost, Scrap, Life, Method — all 4 needed for calculation.
- SLM: (Cost−Scrap)÷Life = same every year 🐢. WDV: Fixed % on reducing balance = decreasing 🐇.
- AS-10/Ind AS-16: Recognise SLM + WDV + Units of Production (all three). Ind AS-38 = amortisation (intangibles).
- Sinking Fund: Save depreciation amount → invest → sell later → replace old asset. Piggy bank system!
Banky says: “SLM = cut the cake equally 🐢. WDV = snowball rolling downhill 🐇. Units = pay per ride 🛺. And my bike IS depreciating as we speak! 😅” 🎉📉
You now understand why assets lose value and how to calculate & record it. Next: Chapter 7 — Capital vs Revenue Expenditure! 💪