Definition and
Explanation:
Under annuity method of depreciation the cost
of asset is regarded as investment and interest at
fixed rate is calculated thereon. Had the proprietor
invested outside the business, an amount equal to
the cost of asset, he would have earned some
interest. So as a result of buying the asset the
proprietor loses not only cost of asset by using it,
but also the above mentioned interest. Hence
depreciation is calculated in such a way as will
cover both the above mentioned losses. The amount of
annual depreciation is determined from annuity
table.
Annuity method is particularly applicable to those
assets whose cost is heavy and life is long and
fixed, e.g. leasehold property, land and building
etc.
Example:
A firm purchased a 5
years' lease for $40,000 on first January. It
decides to write off depreciation on the annuity
method. Presuming the rate of interest to be 5% per
annum.
Show the lease
account for the first 3 years. Calculations are to
be made to the nearest dollar.
Annuity Table
Amount required to
write off $1 by the annuity method.
|
Years |
3% |
3.5% |
4% |
4.5% |
5% |
|
3 |
0.353530 |
0.359634 |
0.360349 |
0.363773 |
0.367209 |
|
4 |
0.269027 |
0.272251 |
0.275490 |
0.278744 |
0.282012 |
|
5 |
0.218355 |
0.221418 |
0.224627 |
0.227792 |
0.230975 |
|
6 |
0.184598 |
0.187668 |
0.190762 |
0.193878 |
0.197017 |
|
7 |
0.160506 |
0.163544 |
0.166610 |
0.169701 |
0.172820 |
|
8 |
0.142456 |
0.145477 |
0.148528 |
0.151610 |
0.154722 |
Solution:
According to the
annuity table given above, the annual charge for
depreciation reckoning interest at 5 percent p.a.
would be:
230975 × 40,000 =
$9,239
Lease Account
| |
Debit Side |
|
|
Credit Side |
|
| Date |
|
$ |
Date |
|
$ |
| 1st Year |
|
|
1st Year |
|
|
| Jan. 1 |
To Cash |
40,000 |
Dec. 31 |
By Depreciation |
9,239 |
| Dec. 31 |
To Interest |
2,000 |
|
By Balance c/d |
32,761 |
| |
|
|
|
|
|
| |
|
42,000 |
|
|
42,000 |
| |
|
|
|
|
|
| 2nd Year |
|
|
2nd Year |
|
|
| Jan. 1 |
To Balance b/d |
32,761 |
Dec. 31 |
By Depreciation |
9,239 |
| Dec. 31 |
To Interest |
1,638 |
|
By Balance c/d |
25,160 |
| |
|
|
|
|
|
| |
|
34,399 |
|
|
34,399 |
| |
|
|
|
|
|
| 3rd Year |
|
|
|
|
|
| Jan. 1 |
To Balance b/d |
25,160 |
Dec. 31 |
By Depreciation |
9,239 |
| Dec. 31 |
To Interest |
1,258 |
|
By Balance c/d |
17,179 |
| |
|
|
|
|
|
| |
|
26,418 |
|
|
26,418 |
| |
|
|
|
|
|
| 3rd Year |
|
|
|
|
|
| Jan. 1 |
To Balance b/d |
17,170 |
|
|
|
|
