SLM Methods

15/04/2020 2 By indiafreenotes

Depreciation means the decrease in the value of fixed assets due to normal wear and tear, efflux of time or obsolescence due to technology. Thus, it is important to measure the decrease in value of an asset and also account for it. There are various methods of providing depreciation. The most common method is the Straight line method (SLM).

According to the Straight line method, the cost of the asset is written off equally during its useful life. Therefore, an equal amount of depreciation is charged every year throughout the useful life of an asset. After the useful life of the asset, its value becomes nil or equal to its residual value. Thus, this method is also called Fixed Installment Method or Fixed percentage on original cost method.

When the amount of depreciation and the corresponding period are plotted on a graph it results in a straight line. Hence, it is known as the Straight line method (SLM).

This method is more suitable in case of leases and where the useful life and the residual value of the asset can be calculated accurately. However, where the repairs are low in the initial years and increase in subsequent years, this method will increase the charge on profit.

Also, while applying this method, the period of use of the asset should be considered. If an asset is used only for 3 months in a year then depreciation will be charged only for 3 months. However, for the Income Tax purposes, if an asset is used for more than 180 days full years’ depreciation will be charged.

Formulae:

Amount of Depreciation = (Cost of Asset – Net Residual Value) / Useful Life

The rate of Depreciation = (Annual Depreciation x 100) / Cost of Asset

Journal Entries for Straight Line Method of Depreciation

Date                                            Particulars Amount (Dr.) Amount(Cr.)
1. Purchase of asset Asset A/c Dr.  xx
To Cash/ Bank/ Creditor’s A/c  xx
(Being asset purchased)
2. Charge Depreciation Depreciation on Asset A/c Dr.  xx
To Asset A/c  xx
(Being depreciation charged on asset)
3. Transfer Depreciation Profit & Loss A/c Dr.  xx
To Depreciation on Asset A/c  xx
(Being depreciation on asset transferred to profit and loss account)

How to Calculate Straight Line Depreciation

The straight line calculation steps are:

  1. Determine the cost of the asset.
  2. Subtract the estimated salvage value of the asset from the cost of the asset to get the total depreciable amount.
  3. Determine the useful life of the asset.
  4. Divide the sum of step (2) by the number arrived at in step (3) to get the annual depreciation amount.

Benefits/Need of charging depreciation

  1. Tax Benefit: Depreciation is allowed as an expense under Income tax and therefore it is important to consider it to save income tax.
  2. Mandatory under companies act: It is compulsory to charge depreciation in profit and loss account in companies act 2013.
  3. Real Profit: If it is not considered then expenditure on behalf of fixed assets is not considered and the profit may be shown as a high number especially in industries required large plant and machinery. Also, this may lead to high distribution of earnings to shareholders and thus non-availability of funds when business is in need to replace the asset.
CategoryManagement Notes
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