ANNUITY METHOD OF DEPRECIATION - BACKGROUND
Depreciation under Annuity Method is usually adopted for fixed assets with long life and cost such as lease buildings. Imagine a situation, where a company chooses to invest its money in an investment which earns interest (like a fixed deposit, or any other investment), instead of buying a machinery. The company would earn fixed amount of income from such investments had it not invested on the machinery. Since, it has chosen to buy the machinery, the company is obviously losing the interest income.
ANNUITY METHOD OF DEPRECIATION - ADVANTAGES AND DISADVANTAGES
The annuity method of depreciation gives more significance to this lost income. However, the annuity method is not suitable for assets like plant and machineries. The method of calculating the annuity method is also quite complex. Hence it is not advisable to adopt this method unless, the nature of the company or nature of the asset warrants its adoption.
ANNUITY METHOD OF DEPRECIATION - WRITTEN DOWN VALUE
Annuity Method of depreciation seeks to bring in the interest factor and says, the interest must also be included in the cost of the machinery and the depreciation has to be calculated on the total amount (WDV + Lost Interest). Thus, unlike in other methods of depreciation, under annuity method, we not only take the written down value (WDV) of the machinery every year to calculate the depreciation for that year, but also take the lost interest, include it in the cost and calculate depreciation on the total amount.
HOW IS DEPRECIATION CALCULATED ON ANNUITY METHOD
Under annuity method, the depreciation is determined from the annuity tables. The annuity table provides the depreciation value based on the interest and the number of years. Under annuity method of depreciation, the value of depreciation remains the same and just the proportion of interest and WDV changes.
Thus under annuity method of depreciation, the depreciation amount usually consist of two elements.
STEPS IN DETERMINING THE DEPRECIATION AMOUNT UNDER ANNUITY METHOD OF DEPRECIATION
JOURNAL ENTRIES FOR ANNUITY METHOD OF DEPRECIATION
1) ON PURCHASE OF ASSET/ LEASE -
Lease Account Dr.
To Bank Account
2) INTEREST ON LEASE AT THE END OF THE YEAR -
Lease Account Dr.
To Interest Account
3) CHARGING DEPRECIATION AT THE END OF THE YEAR -
Depreciation Account Dr.
To Lease Account
4) TAKING INTEREST AND DEPRECIATION TO PROFIT AND LOSS ACCOUNT -
Profit and Loss Account Dr.
To Depreciation Account
5) Interest Account Dr.
To Profit and Loss Account
Examples and Practice Problems on Annuity Method of Depreciation
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