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Advantages of straight line method

 

Straight line method of providing depreciation has got the following advantages :

1. Simplicity. This is the simplest method of providing depreciation. This can be easily understood even by ordinary person. Calculation of depreciation according to this method is also very simple.

 

2. Assets can be completely written off. According to this method, assets can be written off to zero. The depreciation is calculated on the original cost of the asset at the specified rate, so the value of asset is fully split over the useful life of asset.

3. Knowledge of total depreciation charged. The amount of total depreciation charged can be easily known by multiplying the yearly amount of depreciation with number of years, the asset has been used.

 

4. Suitable for small firms. Straight line method is the most suitable method for small firms. These firms use this method, because it is easy, simple and suitable to the size of the firms.

 

5. Suitable for firms having large number of old and new machines. The weaknesses of this method are removed, if the firm has both old and new machines. More maintenance charges on old machines and lesser on the new machines balance each other.

 

6. Useful for assets having lesser value. This method is the most suitable for charging depreciation on assets of lesser value such as furniture, fixture and patents etc.

 

Disadvantages or limitations of straight line method

 

Straight line method suffers from the following weaknesses :

 

1. Undue pressure on final years. The final years of the life of the asset have to bear more repairs and maintenance charges and also the same amount of depreciation. whereas initial years have to suffer lesser repair charges.

 

2. No provision for replacement. The amount charged as depreciation is retained in the business and used in the routine affairs. The firm has to bother for making arrangement of funds for the replacement of assets although depreciation has been charged every year.

 

3. Loss of interest. The amount of depreciation charged every year is not invested outside the firm, so no interest is received. In certain methods of depreciation the amount of depreciation is invested outside the business in securities and interest is received.

 

4. Illogical method. It seems illogical to charge depreciation on the original cost of the asset every year when the balance of the asset is declining year after year.

 

5. Unsuitable for assets having long life and more value. This method is not suitable for those assets which are subject to additions and extension from time to time, such as land and building and plant and machinery. It is not suitable for assets having more value also.

 

Uses of straight line method

 

Straight line method is suitable for those assets, which require lesser expenses on repairs and maintenance. The method is also useful for assets of lesser value such as patents, furniture etc. This method is also useful for those big manufacturing concerns who have got a large number of machines. Some assets are very old and some of them are fresh. The combined result of the depreciation on both the old and new machines and also repairs and maintenance charges balance each other. In case of old machines, maintenance charges are more but in case of new machines charges are lesser. More maintenance charges on old machines and lesser repairs on new balance each other.

 

The method is very simple so most appropriate for small firms and assets of small value.

Its Accounting treatment is as under :

According to this method following journal entries are passed:

1. For purchase of assetsAssets A/c

To Bank or Cash A/c

 

2. For depreciation on assets

Depreciation A/c

To Assets A/c

 

3. For sale of assets

Bank or Cash A/c

To Assets A/c

Dr.

 

 

 

Dr.

 

 

 

Dr.

 

4. For loss on sale of assets

P/L A/c                                                            Dr.

To Assets A/c

The third and fourth entry regarding sale of asset or loss can be combined together :

Bank or Cash A/c                                                        Dr.

Loss on Sale of Assets A/c                                          Dr.

To Assets A/c

Loss on sale of assets account will be closed by transfer to profit and loss account :

 

5. For profit on sale of assets

Assets A/c                                                       Dr.

To P/L A/c

 

Illustration 1. (Straight Line Method: W1zen rate is given). The purchase of furniture amounted to $ 4,000 and it is decided to write off 5 per cent on the original cost as depreciation at the end of each year.

 

Show the ledger account as it will appear during the first four years. Pass journal entries also.

 

Solution.                                                                     Journal Entries

Amount

Date                                        Particulars                                          L.F.

Debit               Credit

$                        $

1st year

Jan. 1                           Furniture A/c                                                  Dr.      4,000

To Bank A/c                                                                                        4,000

(Being purchase of furniture)

 

Dec. 31                        Depreciation A/c                                             Dr.       200

To Furniture A/c                                                                                 200

(Being depreciation on furniture @ 5% on $ 4,000)

 

2nd year

Dec. 31                                    Depreciation A/c                                Dr.      200

To Furniture A/c                                                                     200

(Being depreciation charged on furniture @ 5% on $ 4,000)

 

3rd year

Dec. 31                        Depreciation A/c                                             Dr.       200

To Furniture A/c                                                                                 200

(Being depreciation charged on furniture @ 5% on $ 4,000)

 

4th year

Dec. 31                        Depreciation A/c                                             Dr.       200

To Furniture A/c                                                                                 200

(Being depreciation charged on furniture @ 5% on $ 4,000)

Explanation. As per the instructions of question, depreciation on furniture has to be charged@ 5% on original cost. The original cost of the furniture is $ 4.000, so depreciation on furniture will be charged every year on its original value, i.e., $ 4,000. This is why, every year $ 200 has been charged as depreciation.

Fixed Installment Method

Furniture Account

Dr.                                                                                                                                           Cr.

Illustration 2. (Straight line Method: Original cost, expected life and scrap value). On January 1, 2003 M/s Ram & Sons purchased a Machinery for $ 2,00,000. They spent $ 12,000 on its freight and $ 8,000 for its installation. The expected life of the machine is 10 years. It is expected that the machine will be sold for $ 20,000 after its useful life. Prepare machinery account and depreciation account for 3 years. Books of Accounts are closed on December 31, every year.

 

Solution.                                             Machine Account

Dr.                                                                              

 

Depredation Account

Dr.                                                                                                                                           Cr.

Working Note :

Calculation of Depreciation :

Cost of machine- Scrap value / Expected life of machinery = (2,20,000-20,000) / 10

= $ 20000.

Illustration 3. (Straight Line Method: Additions to assets). On 1st January, 2001 a Company bought Plant and Machinery costing $ 35,000. It is estimated that its working life is 10 years, at the end of which it will fetch $ 5,000. Additions are made on 1st January, 2002 to the value of $ 20,000 (Residual value $ 2,000). More additions are made on July 1, 2003 to the value of $ 10,000. (Breakup value $ 1,000). The working life of both the additional Plants and Machinery is 20 years.

 

Show the Plant and Machinery account for the first four years, if depreciation is written off according to Straight Line Method. The accounts are closed on 31st December every year.

 

Solution.                                             Plant and Machinery Account

Dr.                                                                                                                   Cr.

Notes 1. Calculation of Depreciation= (Cost of Plant and Machinery – Residual value) / Working life

2. The amount of depreciation on all the three machines will be ascertained separately as above.

 

Illustration 4. (Straight Line Method: Sale of assets). On 1st July 2003 Raj & Co. purchased machinery worth $ 40,000. On 1st July, 2005 it buys additional machinery worth $ 10,000. On 30th June, 2006 half of the machinery purchased on 1st July, 2003 is sold for $ 9,500. The company writes off 10% on the original cost. The accounts are closed every year on 31st December.

 

Show the machinery account for four years, Accounts are closed on December 31, every year.

 

Solution.                                             Machinery Account

Dr.                                                                                                                   Cr.

 

Notes. (i) Calculation of loss on sale of Machinery :

 

Book value of full machine (on July 1, 2003) = 40,000

 

Book value of half machinery (on July 1, 2003) =40,000* 1/2 =

 

Less : Depreciation on half machinery @ 10% on straight line method :

2003 (July 1-Dee. 31)          1,000

2004 (for full year)              2,000

2005 (for full year)                  2,000

2006 (Jan.1 – June 30)             1,000

 

Book value as on June 30, 2006

 

Less : Amount received from sale

 

Loss on sale of machinery

 

(ii) Journal entry for sale of machinery:

2006

June 30,                       Bank A/c                    Dr.

Profit and Loss A/c       Dr.

Depreciation A/c         Dr.                                 .

To Machinery A/c

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9,500

4,500

1,000

$

 

 

 

20,000

 

 

 

 

 

6,000

 

14,000

 

9,500

 

4,500

 

 

 

 

 

 

15,000

 

Calculation of Depreciation on Additions to Asset

 

Business is a continuing activity, so we may purchase additional assets or we may add to the existing assets. Addition to the fixed assets, such as land and building, plant and machinery, vehicles and furniture etc. are capital expenditure. It will increase the value of assets, so depreciation will also be charged on these additions. Depreciation on additions will be charged since the date of additions at the specified rate.

 

For example, if addition to machinery worth $ 20,000 on July l, 2005, will be depreciated at the rate of I 0% (specified) for six months together with the depreciation on the book value of old machinery, depreciation on the additions during the first year will be the same under straight line or written down value method.

 

Treatment of Sale of Asset

 

The firm may sell asset, if it is obsolete. It may also be sold when it is not in perfect order. The disposal of asset will take place, when purchase of fresh, up-to-date asset is made and the old asset becomes unwanted. In any case, the sale of asset has to be accounted for. The treatment of asset in case of sale will be made as under:

 

Treatment of Sale of Asset as

 

(i) If set is sold at the book value

Bank A/c                                                              Dr.

To Asset A/c

 

(ii) If the asset is sold at lesser than book value (loss)

Bank A/c                                                                Dr.

Profit and Loss A/c                                               Dr.

To Asset A/c

 

(iii) If the asset is sold for more than the book value

Bank A/c                                                                 Dr.

To Asset A/c

To Profit and Loss A/c