Page 234 - DMGT104_FINANCIAL_ACCOUNTING

Financial Accounting

Notes compulsion, requirement of the Accounting Standard, etc. the management can change the
method of providing the depreciation on assets from diminishing balance method to fixed
installment method or vice versa. When the management decides to change the method of
depreciation, there can be the following two methods of such a change:
1. The method of charging the depreciation can be changed from the current year onwards.
It is called a prospective change. In such a situation new method of charging the depreciation
is applied from the current year over the remaining economic life of the assets.
2. When the method of charging the depreciation is changed from the back date or retrospective
year, it poses some problem. In such situation, first of all the depreciation is computed on
the assets by the new method from the back date. Similarly depreciation on the assets is find
by the old method (which is already shown in the books). Then the amount of these two
depreciation are compared. If the amount of depreciation calculated by new method exceeds,
excess of the amount is credited to the assets account in the current year and also shown in
the debit side of P&L A/c. If the amount of depreciation calculated by new method is less
than the amount of depreciation calculated by old method, this shortage is debited to the
assets account in the current year and also in the credit side of the P&L A/c.

10.3.3 Annuity Method

Under this method depreciation on assets is calculated keeping into account the cost of assets
along with interest thereon. The annuity method is a compounded interest method whereby the
depreciation is calculated based on the assumption that depreciation plus the normal cost of
capital to finance the assets are constant over the life of the assets. Interest along with cost of
assets is taken into account under this method while calculating the amount of depreciation.
Amount of interest is debited to assets account every year and then amount of depreciation is
credited to assets account. Calculation of interest is based on the opening balance of the asset. So
it (interest) decreases every year but the amount of depreciation remains constant which is taken
from the annuity tables for depreciation. This amount of depreciation is that much by which the
value of asset becomes zero.
In other words, if a firm purchases a plant of 50,000 and it only provides depreciation of
10,000 every year, after five years it will collect fund of 50,000 to replace the new plant. In this
case one point is ignored that interest means if this firm invested this amount of 50,000 in some
other form of securities in the place of buying assets, it would get return some interest along
with the principal amount of 50,000. In this method the amount of depreciation is determined
by adding the depreciation and interest thereon. The amount of depreciation is computed with
the help of annuity table. Under this method the following journal entries are passed for
depreciation and interest thereon.
1. When depreciation is charged on Assets
Depreciation Account Dr.
To Assets Account
2. When interest on cost of assets is calculated and showed
Assets Account Dr.

In Assets Account
3. When interest is transferred to P&L A/c
Interest Account Dr.
To P&L Account

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