Fixed Installment Method or Straight Line Method or
Original Cost Method of Depreciation:
Learning Objectives:
-
Define, explain and give
example of fixed installment or straight line or original cost method.
-
What are the advantages and
disadvantages of of using this method?
Fixed installment method
is also know as straight line method or original cost method.
Under this method the expected life of the asset or the period during which
a particular asset will render service is the calculated. The cost of the
asset less scrap value, if any, at the end f its expected life is divided by
the number of years of its expected life and each year a fixed amount is
charged in accounts as depreciation. The amount chargeable in respect of
depreciation under this method remains constant from year to year. This
method is also know as straight line method because if a graph of the
amounts of annual depreciation is drawn, it would be a straight line.
Formula:
The following formula or
equation is used to calculate depreciation under this method:
Annual
Depreciation = [(Cost of Assets - Scrap Value)/Estimated Life of Machinery]
Journal Entries:
The journal entries that will have to be
made under this method are very simple. The journal entries will be as
under:
| 1. |
Depreciation account |
| |
To Asset
account |
| |
(Being the depreciation of the
asset) |
| |
|
| 2. |
Profit and loss account |
| |
To
Depreciation account |
| |
(Being the amount of depreciation
charged to Profit and Loss account) |
These entries will be passed at the end of
each year so long as the asset lasts. In the last year, the scrap will be
sold and with the amount that realised by the sale the following entry will
be passed:
| 3. |
Cash account |
| |
To Asset
account |
| |
(Being the sale price of scrap
realised.) |
Advantages:
- Fixed installment method of
depreciation is simple and easy to work out
- The book value of the asset can be
reduced to zero.
Disadvantages:
- This method, in spit of its being
simplest is not very popular because of the fact that whereas each
year's depreciation charge is equal, the charge for repairs and renewals
goes on increasing as the asset becomes older. The result is that the
profit and loss account has to bear a light burden in the initial years
of the asset but later on this burden becomes heavier.
- Interest on money is locked up in the
asset is not taken into account as is done in some other methods.
- No provision for the replacement of
the asset is made.
- Difficulty is faced in calculation of
depreciation on additions made during the year.
Scope of Application:
On account of the above mentioned
advantages and disadvantages of fixed installment method, it is generally
applied in case of those assets which have small value or which do not
require many repairs and renewals for example copyright, patents, short
leases etc.
Example:
On 1st January 1991 X purchased a machinery
for $21,000. The estimated life of the machine is 10 years. After it its
break up value will be $1,000 only. Calculate the amount of annual
depreciation according to fixed installment method (straight line method or
original cost method) and prepare the machinery account for the first three
years.
Machinery Account
| |
Debit Side |
|
|
Credit Side |
|
| |
|
$ |
|
|
$ |
|
1991 Jan. 1 |
To Bank account |
21,000 |
1991 Dec. 31 |
By Depreciation account |
2,000 |
| |
|
|
1991 Dec. 31 |
By Balance c/d |
19,000 |
| |
|
|
|
|
|
| |
|
21,000 |
|
|
21,000 |
| |
|
|
|
|
|
|
1992 Jan. 1 |
To Balance b/d |
19,000 |
1991 Dec. 31 |
By Depreciation account |
2,000 |
| |
|
|
1991 Dec. 31 |
|
17,000 |
| |
|
|
|
|
|
| |
|
15,000 |
|
|
15,000 |
| |
|
|
|
|
|
|
1993 Jan. 1 |
To Balance b/d |
17,000 |
1991 Dec. 31 |
By Depreciation account |
2,000 |
| |
|
|
1991 Dec. 31 |
By Balance c/d |
15,000 |
| |
|
|
|
|
|
| |
|
17,000 |
|
|
17,000 |
|
