Depreciation of Plant and Machinery
Depreciation implies decrease in the value of an asset due to lapse of time, wear and tear and other contributory causes. In order to find out the exact cost of manufacture of an article the charge for depreciation must be brought into the cost accounts. It will be better to maintain a separate Plant and Machinery Register in order to secure a greater accuracy in calculating the amount of depreciation and providing detailed particulars about each machine at one plane.
(a) Fixed installment method: In case of this method a fixed amount by way of depreciation is charged year after year. The amount of depreciation to be charged is determined by taking into consideration the original cost of the asset, its estimated scrap value and its expected life. For example, if a machine purchased for $ 10,000 will have a normal life of 10 years and realize $ 2,000 as scrap value, the annual charge for depreciation will be $ 800 calculated on the basis of following formula:
Depreciation = (Original cost – Estimated Scrap Value)/Normal Life of the Asset
It is to be noted that the normal risk of obsolescence of the asset should also be considered while calculating the amount of depreciation. For example, if in the above case it is expected that only after 8 years the machine will become obsolete the normal life should be taken as 8 years though the machine can be used for 10 years. Thus, technological life is more relevant.
(b) Machine-hour rate method: This method is similar to the first method with the only difference that in case of this method the life of the asset is estimated in terms of hours. The total cost minus the estimated scrap value is divided by the number of hours and the hourly-rate of depreciation is obtained. If in the above example the total number of hours for all ten years are expected to be $ 15,000, the hourly rate of depreciation will be
= 8,000/15,000 or 53 cent per hour
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