Module 06: Fixed Assets and Depreciation Accounting

Inventory is consumed within a short period, so it sits under current assets. Fixed assets are not consumed; they are used for several years to create value. The accounting problem therefore changes shape. Instead of asking "which price attaches to the unit that left the store", Module 6 asks two questions: what exactly goes into the cost of the asset, and how do we spread that cost across the years the asset serves us. Every rupee of that spread is a depreciation expense, and depreciation is a pure accounting estimate: no cash moves when it is charged.

6.1 Types of fixed assets and how each is written off

The classification table transcribed, because it is the spine of the whole module:

Memory hook: Three words, three asset families. Depreciation for tangibles, amortisation for intangibles, depletion for natural resources. Land and goodwill get none of the three.

Deferred charges deserve an example because the class is unfamiliar. A software company adopts AI, halves its manpower need, and pays Rs 500 crore over and above normal terminal benefits to lay off permanent staff. The benefit of that restructuring runs for several years, so the company charges Rs 100 crore a year for five years and carries the unwritten-off balance (Rs 400 crore at the end of year 1) as an asset called deferred charges. A major aircraft overhaul is treated the same way: capitalised, not expensed.

Goodwill arises only on purchase of another business. If a hospital's book asset value is Rs 500 crore, the buyer assesses goodwill at Rs 300 crore and pays Rs 800 crore, the buyer's entry is cash −800 crore, land / building / other assets +500 crore, goodwill +300 crore, all three on the asset side. Goodwill has infinite life, so it is not amortised; it is tested for impairment, a loss in value from external causes. In 1993 Coca-Cola bought Limca, Thums Up and Gold Spot for USD 600 million. Gold Spot is no longer sold, so the carrying value of that brand must be written down. A heavy new tax on soft drink producers would impair all three.

6.2 Two accounting concepts applied to fixed assets

Cost concept. Fixed assets are recorded at the cost of acquisition and carry that value for their whole life. Depreciation is accumulated separately in a contra-asset account and deducted from historical cost to show the net book value. The historical cost figure itself is never touched.

Materiality concept. Assets below a threshold the firm fixes (commonly Rs 5,000 or Rs 10,000) are expensed rather than capitalised, because tracking them as assets costs more than the information is worth.

Repairs and maintenance versus betterment.

Common trap: The line between the two is genuinely thin, and the answer can depend on how the asset is grouped. If electrical fittings sit inside the broader heading "Building", replacing a fitting is repairs and maintenance and hits the P&L. If "Electrical fittings" is a separate asset class, the replacement is an addition to fixed assets and never touches the P&L at all. Same cash, opposite profit effect.

Fair value and revaluation. IFRS prescribes fair value accounting for both monetary and non-monetary assets, but in practice accountants keep assets at cost and test for impairment. Land is the exception and is periodically revalued. If land bought 30 years ago for Rs 3 crore is now worth Rs 100 crore and the company decides to revalue:

6.3 Determining the cost of an asset

Formula: Cost = every expense incurred up to the point the asset is ready for its intended use.

Included in cost:

• Invoice price paid to the supplier, including GST and other taxes
• Transport cost to bring the asset in
• Erection, commissioning and trial run costs
• Cost of demolishing an existing building before constructing a new one, which goes into the cost of the new building
• Travel, boarding and lodging of foreign technicians who come to commission an imported machine (some companies expense these instead)

Self-constructed assets (common in process industries, where machines are fabricated on site) are valued at construction cost: material, labour, other direct expenses, an allocated share of overhead, and interest on the construction loan capitalised only until the asset is ready for use. Interest for any period after that is an expense.

Assets bought with securities rather than cash. The rule is a priority order:

1. First, find the fair value of the shares or bonds given up. That is the asset's cost.
2. Only if the fair value of the securities cannot be found, fall back on the fair value of the asset itself.

Given: a seller quotes Rs 60 crore for high-tech equipment and agrees to accept 1 crore shares of the buyer. The buyer's share price is Rs 58.

Answer: the equipment is recorded at Rs 58 crore, not the Rs 60 crore quoted. If the buying company were unlisted so that no market price exists, the cost would be the Rs 60 crore quote.

6.4 Basket purchase

When a single price buys two or more assets that will have different lives, the lump sum must be split. Allocate in the ratio of independent appraised values.

Example 1: land and building. Paid Rs 210 lakh. Independent appraisal: land Rs 80 lakh, building Rs 160 lakh, total Rs 240 lakh. The ratio is 1 : 2.

Answer: land Rs 70 lakh, building Rs 140 lakh. The appraised total of 240 exceeding the 210 paid does not matter; only the ratio is used.

Example 2: computer and printer. Quoted separately at Rs 80,000 and Rs 20,000, sold together for Rs 90,000. Ratio 80 : 20.

Answer: computer Rs 72,000, printer Rs 18,000. The split matters because the two assets will carry different depreciation rates.

6.5 Why depreciation exists: the buy-versus-lease proof

Two identical factories stand next to each other. Company 1 buys a machine for Rs 10 lakh with a 10-year life. Company 2 leases an identical machine for Rs 1 lakh a year. Both earn revenue of Rs 6 lakh and incur operating expenses of Rs 4 lakh, excluding depreciation and lease rent.

Without depreciation, Company 1 looks twice as profitable as an identical business. Charging Rs 1 lakh a year makes the two comparable. Depreciation is the matching concept applied to a long-lived asset: the expense of using the asset must sit in the same period as the revenue it helped earn.

Physical life versus service life. A machine may run for 10 years, but if new technology is expected in 6 years the firm will not use it beyond 6. Depreciate over the service life, not the physical life.

Resale value versus salvage value. If the amount recoverable at the end of the service life is significant it is called resale value; if negligible, salvage value. Either way it is deducted before spreading.

6.6 Straight line method

Given: cost Rs 10 lakh, service life 6 years, resale value Rs 1 lakh.

Answer: Rs 1.5 lakh a year for six years. The method assumes the asset's productivity is equal in every year of its life.

6.7 Written down value method (accelerated / declining balance)

If productivity declines over the asset's life, or if servicing and fuel costs rise so that net revenue falls year on year, a higher charge in early years matches better. The WDV method applies a fixed percentage to the reducing net value.

Using the same asset (depreciable base Rs 9 lakh, rate 30%):

Shortcut: each year's charge equals the previous year's charge multiplied by (1 − rate). At 20%, multiply by 0.8; at 30%, by 0.7.

Common trap: The WDV net value never reaches zero. However long you run the asset, the charge is always a percentage of a positive balance. That is the method's defining weakness and the reason firms either switch to straight line partway or use sum of years' digits instead.

Double declining balance is simply WDV at twice the straight line rate. A 10-year asset has an SLM rate of 10%, so DDB uses 20%.

6.8 Sum of the years' digits (SYD)

SYD is a written down value method that borrows the straight line method's completeness: the rates sum to exactly 100%, so the asset writes off fully within its life.

Where: $N$ is the service life in years and $t$ is the year being charged, so the numerators count down from $N$ to 1.

For N = 5 the denominator is $\frac{5 \times 6}{2} = 15$ and the rates are 5/15, 4/15, 3/15, 2/15, 1/15.

Given an asset of Rs 1,50,000 with a 5-year life:

Answer: both methods write the asset down to zero; SYD front-loads the charge while SLM keeps it flat.

6.9 Comparing all four methods over 12 years (the Excel working)

Given: machine cost Rs 10 lakh, life 10 years, SLM rate 10%, WDV rate 20% (double declining), the asset is actually used for 12 years and then sold for Rs 50,000.

The switch trigger. At the start of year 5 the remaining net value is Rs 4,09,600. The WDV charge for year 5 would be 20% of that, Rs 81,920, which is below the straight line charge of Rs 1,00,000. That is the signal to switch. Spread the remaining 4,09,600 over the remaining 6 years:

Answer: the switch drives net book value to exactly zero at the end of year 10, so the Rs 50,000 sale is entirely profit, exactly as under SLM and SYD.

Memory hook: Only pure WDV produces a loss here, and only because it left Rs 68,719 of unwritten-off value on a machine that fetched Rs 50,000. Every method that finishes at zero turns the sale proceeds straight into profit.

Practice note. Straight line is used for the financial accounts; written down value is used for income tax. Charging more depreciation early defers tax rather than saving it permanently, because total depreciation can never exceed the asset's cost. The difference between the book charge and the tax charge is what creates the deferred tax liability discussed in Module 7.

6.10 Part-year conventions and shift loading

Three conventions, and the exam question is usually which one the problem tells you to use.

The pro rata rule ignores whether you bought on 3 February or 23 February. The half-year convention's logic is that if purchases are spread evenly through the year and the annual spend is stable, taking half a year on everything evens out.

Multi-shift loading. A stated asset life assumes one shift of eight hours. Industry practice adds 50% more depreciation per additional shift:

6.11 Disposal of assets

Accumulated depreciation is a contra asset: it sits on the asset side of the accounting equation carrying a negative value, always shown next to its parent asset. On disposal you must clear both accounts and let the gain or loss fall out as the balancing figure.

The four steps:

1. Reverse the asset at cost
2. Reverse the accumulated depreciation
3. Record the cash received
4. The balance is the profit (income) or loss (expense) on sale

Given: machine cost Rs 10 lakh, SLM at 10%, held six years, so accumulated depreciation is Rs 6 lakh and net book value is Rs 4 lakh.

Answer: a profit of Rs 1 lakh in the first case and a loss of Rs 1.5 lakh in the second, because book value was Rs 4 lakh either way.

6.12 Exchange of assets: similar versus dissimilar

This is the rule most likely to be examined, and this course frames it strictly as similar versus dissimilar.

Worked example, similar. Old drilling machine cost Rs 20 lakh, accumulated depreciation Rs 15 lakh, net book value Rs 5 lakh. The new drilling machine lists at Rs 32 lakh, but the seller will take the old machine plus Rs 25 lakh cash.

Answer: the new machine goes on the books at Rs 30 lakh and no gain or loss is recognised. The Rs 32 lakh list price is never used.

Worked example, dissimilar. Same old drilling machine (cost 20, accumulated 15, NBV 5). It is exchanged for a packing machine whose independently assessed fair value is Rs 50 lakh, plus Rs 42 lakh cash.

Answer: profit of Rs 3 lakh. The logic: the seller takes Rs 42 lakh for a Rs 50 lakh asset, so he is crediting Rs 8 lakh for the old machine whose book value is only Rs 5 lakh.

6.13 Exercise: Jam Transport (both exchange cases, and the priority rule)

Given: a luxury bus operator buys four new buses at Rs 90 lakh each.

Buses 1 and 2 (similar exchange). It gives two old buses (cost Rs 140 lakh, accumulated depreciation Rs 100 lakh, net book value Rs 40 lakh) and pays Rs 120 lakh cash.

Answer: Rs 160 lakh, and no profit or loss. The buses are genuinely worth Rs 180 lakh (2 × 90), but that fair value is deliberately ignored because the exchange is of similar assets.

Buses 3 and 4 (dissimilar exchange). It gives a piece of land (cost Rs 20 lakh, no depreciation, current market value Rs 70 lakh) and pays Rs 100 lakh cash.

Answer: profit of Rs 60 lakh.

Common trap: The instinctive answer is Rs 50 lakh (market value 70 less cost 20). That is wrong when the fair value of the asset acquired is reliably measurable, because the acquired asset's fair value takes priority and the gain becomes the balancing figure. The Rs 70 lakh market value of the land is then irrelevant.

The variant. If the fair value of the buses cannot be reliably assessed, invert the priority: recognise the gain on the land first at 70 − 20 = Rs 50 lakh, and let the new bus value become the balancing figure of 100 + 70 = Rs 170 lakh.

6.14 Group depreciation

A software company with 80,000 desktops and laptops cannot maintain a separate asset account and accumulated depreciation for each machine. Under group depreciation all such assets are treated as one asset.

The three rules:

1. Depreciation is applied to the gross cost of the whole group at the start of the year, not to individual assets
2. No accumulated depreciation is tracked per asset
3. No profit or loss is recognised on disposing of an individual asset

Worked example. 20% straight line, all purchases on day one of the year.

In year 4 the accumulated depreciation on the 50 computers given up is never even calculated. The entry is simply cash −170 lakh and computers +170 lakh.

The cash-sale variant. A computer costing Rs 50,000 is sold for Rs 3,000. We do not know when it was bought or what depreciation it carried.

Answer: accumulated depreciation absorbs Rs 47,000 as a balancing figure and no gain or loss is recognised.

6.15 Exercise: Allen & Go (group depreciation over four years)

Given: a garment manufacturer starts on 1 April 2020 with 200 sewing machines at Rs 6,000 each. In year 2 it adds 300 machines at Rs 8,000; in year 3, 500 machines at Rs 10,000. At the start of year 4 it exchanges 100 old machines for 500 new machines and pays Rs 35 lakh. Life 5 years, so the group rate is 20% straight line. All purchases fall on the first day of the accounting year.

Answer: depreciation of Rs 2.4 lakh, Rs 7.2 lakh, Rs 17.2 lakh and Rs 24.2 lakh across the four years.

Notice what the group treatment removes. We never ask whether the 100 machines exchanged came from the first, second or third purchase, so no FIFO or LIFO assumption is needed. We never compute their accumulated depreciation, and we never record a gain or loss. Had they been accounted individually, we would have had to reverse both the cost and the accumulated depreciation of those 100 machines, though (being similar assets) still no gain or loss would be recognised.

6.16 Exercise: Regal Paints (part-year conventions and disposal)

The company follows an April to March year and the 180-day rule: an asset purchased before 1 October gets a full year's depreciation and one purchased on or after 1 October gets half; on sale the logic reverses (sold before 1 October, half a year; sold on or after 1 October, a full year).

Machine 101. Purchased 1 January 2016 for Rs 5,00,000, straight line 10%, sold 31 May 2024 for Rs 1,50,000.

Answer: profit on sale Rs 1,00,000.

Machine 502. Purchased 1 May 2018 for Rs 6,00,000, written down value at 20%, sold in November 2023 for Rs 3,00,000.

Answer: profit on sale Rs 1,42,714.

Common trap: Under the 180-day rule the sale in November falls in the second half, so a full year of depreciation is charged in the year of disposal. Charging only half would leave book value at 1,77,000 and understate the profit by Rs 19,661.

6.17 Exercise: Jupiter Industries and the ranking of the four methods

This is the exercise behind the single line the student kept, and it is the interpretive key to the whole comparison:

Preference of different methods in terms of UoP: UoP > SL > SOYD > WDV

Given: a machine costs Rs 60 lakh, has a 10-year life and no salvage value, and is expected to produce 3,000 units in total: 100 units a year in years 1 and 2, 200 in years 3 and 4, 300 in years 5 and 6, 400 in years 7 and 8, and 500 in years 9 and 10.

Units of production. Rate $= \frac{60{,}00{,}000}{3{,}000} = 2{,}000$, that is Rs 2,000 per unit.

Straight line. $\frac{60{,}00{,}000}{10} = 6{,}00{,}000$, that is Rs 6,00,000 a year.

Written down value at 20%. Each year's charge is 80% of the previous year's.

Sum of years' digits. N = 10, so the denominator is $\frac{10 \times 11}{2} = 55$, and the numerators run 10, 9, 8 down to 1.

Now convert to depreciation per unit, which is the number that actually reaches the cost of a product:

Answer: ranked by the standard deviation of depreciation per unit, the preference order is UoP (0) > SL (1,834) > SOYD (3,849) > WDV (4,125).

Why the ranking matters. Under WDV the firm charges Rs 12 lakh of depreciation in year 1, when it produces only 100 units and revenue is at its lowest, so it will probably report a loss. By year 10 it charges only Rs 1.61 lakh against 500 units of revenue and reports a large profit. Nothing about the business has changed, yet reported profitability swings violently. Units of production keeps the per-unit charge dead flat at Rs 2,000, so at a fixed selling price profit per unit is also flat.

The practical caveat. Units of production needs a measurable output attributable to the specific machine. Where a machine is an intermediate step whose output feeds another machine, output cannot be measured and UoP is infeasible. Then straight line is the best of the remaining three, which is exactly why most companies use SLM for their financial accounts and reserve WDV or SYD for income tax, where the aim is to postpone (not permanently save) tax.

Two further contrasts visible in this table:

• WDV never fully writes off the asset. Total charged is Rs 53,55,755 against a cost of Rs 60 lakh, so Rs 6.44 lakh of value remains after 10 years. SYD charges exactly Rs 60 lakh because its rates sum to 100%.
• WDV and SYD have the same shape (high early, low late); SYD simply guarantees a clean finish.

6.18 Natural resources and depletion

For a fully developed resource bought outright, the cost is the amount paid and it is spread on an output basis.

Given: a mine bought for Rs 100 crore with an estimated 100 lakh tons of mineral; 10 lakh tons extracted in year 1.

Answer: Rs 10 crore of depletion in year 1.

Exploration: full cost versus successful efforts. A company drills at 10 locations at Rs 30 crore each, total Rs 300 crore, and finds economically extractable oil at only 2 locations holding an estimated 10 crore barrels.

Answer: Rs 30 per barrel under full cost, Rs 6 per barrel under successful efforts. The choice moves Rs 240 crore between the balance sheet and the current year's P&L.

Biological assets. In a teakwood farm or poultry operation, value increases through natural growth. The increase is generally not recognised, but the amount spent on the asset each year is capitalised.

6.19 Intangible assets

Leasehold improvement worked. Land is leased for 20 years and must be handed back at the end. Levelling plus a building costs Rs 50 crore; the building would last 50 years.

Answer: Rs 2.5 crore a year over 20 years, not over the building's 50-year physical life, because the right of use ends with the lease.

Common trap: In-house R&D is expensed because there is no assurance of success, and even a successful output may not be commercially usable. Regulation permits capitalising a patent purchased from another entity but not the in-house spend that could have produced the same patent. Indian companies used to capitalise and amortise R&D; current regulation requires expensing.

6.20 Summary

• Fixed assets are tangible (land, building, plant) or intangible (patent, brand, goodwill), plus natural resources and deferred charges.
• Assets are carried at historical cost, being everything spent until the asset is ready for its intended use. Low-value items are expensed under the materiality concept.
• Repairs are expensed; betterments are capitalised. How the asset is grouped can decide which side of that line a cost falls on.
• A basket purchase is split in the ratio of independent appraised values.
• Depreciation exists to satisfy the matching concept, as the buy-versus-lease proof shows. Spread over the service life, net of resale or salvage value.
• Four methods: straight line (flat), written down value (front-loaded, never reaches zero), sum of years' digits (front-loaded, sums to 100%), units of production (constant charge per unit).
• Ranked by stability of depreciation per unit: UoP > SL > SOYD > WDV. SLM for the books, WDV for tax, and the gap creates deferred tax.
• Part-year: pro rata, 180-day rule, or US half-year convention. Extra shifts add 50% to the rate each.
• On disposal, reverse cost and accumulated depreciation, record cash, and the balance is the gain or loss.
• On exchange: similar assets, no gain or loss and the new asset is the balancing figure; dissimilar assets, gain or loss recognised and the new asset goes in at its independently assessed fair value.
• Group depreciation applies the rate to the gross cost of the group, keeps no per-asset accumulated depreciation and recognises no gain or loss on individual disposals.
• Depletion spreads a resource's cost on quantity extracted; exploration is accounted under full cost or successful efforts.
• Acquired intangibles are capitalised and amortised over the shorter of legal and useful life; goodwill and infinite-life intangibles are impairment-tested instead.