As we all know that depreciation is the decrease in the value of assets. In other words, it can be said that it is a method of allocating the cost of the asset over its useful life. However, at the end of the accounting year, depreciation is charged to the Profit and Loss A/c. Annuity method of depreciation is also another method of depreciation apart from other methods like the straight-line method, written down value method, etc.
Annuity Method
This method of depreciation considers the cost of the asset and also the amount of interest lost on the capital expenditure. Thus, it is based on the assumption that if the amount that is spent on the purchase of the asset was invested elsewhere, it would have earned a certain amount of interest.
Therefore, not only the cost of the asset should be allocated but also the amount of interest on it should be allocated over the useful life of the asset. In other words, this method determines the internal rate of return (IRR) on the cash flows of the asset.
Thus, the amount of depreciation is calculated using the Annuity Tables. The capital expenditure and interest accruing thereof are written off during the life of the asset. The amount of depreciation every year is constant. But, the interest charged in the initial years is more and that in later years is less. Hence, the amount of capital expenditure charged is less in the initial years and it is more in later years.
This method is suitable in case of long-term leases. On the contrary, it is not suitable where there are frequent additions or deductions in the asset because then the calculation of depreciation becomes difficult.
Source:budgeting.thenest.com
Browse more Topics under Concept And Accounting Of Depreciation
- Concept and Meaning of Depreciation
- Cost of Asset for Calculating Depreciation
- Straight Line Method
- Diminishing Balance Method
- Units of Production Method
- Sinking Fund Method
- Profit or Loss on Disposal of Asset
- Change in Method of Depreciation
Journal Entries for Annuity Method:
Date | Particulars | Amount (Dr.) | Amount (Cr.) | |
1. Charging interest on asset | Asset A/c | Dr. | xx | |
To Interest A/c | xx | |||
(Being interest charged on asset) | ||||
2. Charging depreciation on asset | Depreciation A/c | Dr. | xx | |
To Asset / Provision for Depreciation A/c | xx | |||
(Being depreciation charged on asset) | ||||
3. Transferring depreciation to Profit & Loss A/c | Profit &Loss A/c | Dr. | xx | |
To Depreciation A/c | xx | |||
(Being depreciation on asset transferred to Profit & Loss A/c) | ||||
4. Transferring interest to Profit & Loss A/c | Interest A/c | Dr. | xx | |
To Profit &Loss A/c | xx | |||
(Being interest on capital expenditure on asset transferred to Profit & Loss A/c) |
Solved Example for You
Q. A Ltd. purchased a 5 years lease on 1 April 2013 for ₹500000. It is decided to write off depreciation on lease using the Annuity Method. The rate of interest is presumed to be 6% p.a. The annuity for ₹1 for 5 years at 6% interest is 0.237396. Prepare the Lease A/c and the Profit & Loss A/c for 5 years.
Ans: Amount of depreciation to be written off every year = 0.237396 x 500000 = ₹118698
Lease A/c
Date | Particulars | Amount | Date | Particulars | Amount | |
2013-14 | 2013-14 | |||||
1 Apr | To Bank A/c | 500000 | 31 Mar | By Depreciation A/c | 118698 | |
31 Mar | To Interest A/c | 30000 | 31 Mar | By balance c/d | 411302 | |
(6% on 500000) | ||||||
530000 | 530000 | |||||
2014-15 | 2014-15 | |||||
1 Apr | To Balance b/d | 411302 | 31 Mar | By Depreciation A/c | 118698 | |
31 Mar | To Interest A/c | 24678 | 31 Mar | By balance c/d | 317282 | |
(6% on 411302) | ||||||
435980 | 435980 | |||||
2015-16 | 2015-16 | |||||
1 Apr | To Balance b/d | 317282 | 31 Mar | By Depreciation A/c | 118698 | |
31 Mar | To Interest A/c | 19037 | 31 Mar | By balance c/d | 217621 | |
(6% on 317282) | ||||||
336319 | 336319 | |||||
2016-17 | 2016-17 | |||||
1 Apr | To Balance b/d | 217621 | 31 Mar | By Depreciation A/c | 118698 | |
31 Mar | To Interest A/c | 13057 | 31 Mar | By balance c/d | 111980 | |
(6% on 217621) | ||||||
230678 | 230678 | |||||
2017-18 | 2017-18 | |||||
1 Apr | To Balance b/d | 111980 | 31 Mar | By Depreciation A/c | 118698 | |
31 Mar | To Interest A/c | 6718 | ||||
(6% on 111980) | ||||||
118698 | 118698 |
Profit & Loss A/c
Date | Particulars | Amount | Date | Particulars | Amount | |
2013-14 | 2013-14 | |||||
31 Mar | To Depreciation A/c | 118698 | 31 Mar | By Interest A/c | 30000 | |
2014-15 | 2014-15 | |||||
31 Mar | To Depreciation A/c | 118698 | 31 Mar | By Interest A/c | 24678 | |
2015-16 | 2015-16 | |||||
31 Mar | To Depreciation A/c | 118698 | 31 Mar | By Interest A/c | 19037 | |
2016-17 | 2016-17 | |||||
31 Mar | To Depreciation A/c | 118698 | 31 Mar | By Interest A/c | 13057 | |
2017-18 | 2017-18 | |||||
31 Mar | To Depreciation A/c | 118698 | 31 Mar | By Interest A/c | 6718 | |
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