Chapter 5: Accounting for Fixed Assets and Depreciation
5.1 Fixed Assets (Non-Current Assets)
5.1.1 Meaning and Classification
Fixed Assets (Property, Plant, and Equipment under NAS 16) are long-lived resources acquired by an enterprise for continuous use in producing or supplying goods and services over multiple accounting periods—not for resale in the ordinary course of business.
- Tangible Fixed Assets: Possess physical substance and can be seen and touched (e.g., Land, Buildings, Plant & Machinery, Vehicles, Furniture & Fixtures, Computers). Note: Land is a non-depreciable tangible asset because its useful life is unlimited.
- Intangible Fixed Assets: Lack physical substance but confer long-term legal or competitive rights (e.g., Goodwill, Patents, Copyrights, Trademarks, Computer Software Licenses). Their systematic write-off over useful life is called Amortization.
5.1.2 Acquisition Cost (Capitalized Cost) of a Fixed Asset
Under the Historical Cost Concept and NAS 16, the initial cost of a fixed asset includes all expenditures necessary to bring the asset to its working location and condition for intended use:
Total Cost of Asset = Purchase Price (net of Trade Discount) + Import Duty / Custom + Carriage / Freight / Transit Insurance + Installation & Erection Wages + Brokerage / Registration Fees (or Overhauling of Second-hand Asset)
5.2 Concept of Depreciation
5.2.1 Meaning and Definition
Depreciation is the gradual, continuous, and permanent decrease in the book value (service potential) of a depreciable tangible fixed asset due to physical wear and tear, passage of time, or obsolescence, allocated systematically as an operating expense over its estimated useful life.
- R.N. Carter: “Depreciation is the gradual and permanent decrease in the value of an asset from any cause.”
- NAS 16: “Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.”
5.2.2 Causes, Objectives, and Factors Affecting Depreciation
| Aspect | Detailed Breakdown |
|---|---|
| Causes of Depreciation | 1. Physical Wear and Tear: Friction, vibration, and strain from constant operational use. 2. Effluxion / Passage of Time: Weathering (rust, decay) or expiration of legal tenure (leases). 3. Obsolescence: Emergence of superior technology or shift in market demand rendering old machinery uneconomical. 4. Depletion / Exhaustion: Extraction of natural resources from mines, quarries, or oil wells. 5. Accidents: Sudden physical damage reducing working capacity. |
| Objectives / Need for Charging Depreciation | 1. Ascertainment of True Profit or Loss: Matches the cost of using fixed assets against revenues earned (Matching Principle). 2. True and Fair Financial Position: Shows fixed assets at realistic Written Down Value (WDV) on the Balance Sheet. 3. Accumulation of Funds for Asset Replacement: Since depreciation is a non-cash expense, it retains working capital inside the business to replace worn-out assets. 4. Accurate Cost of Production & Tax Compliance: Required to compute product cost and claim allowable tax deductions under Nepal Income Tax Act, 2058. |
| Three Factors Affecting Depreciation | 1. Total Cost of Asset (C): Purchase price plus all installation and freight charges. 2. Estimated Scrap / Salvage / Residual Value (S): Estimated net realizable value at the end of useful life. 3. Estimated Useful Life (N): Number of years (or machine hours) the asset is expected to remain productive. |
5.2.3 Overview of Depreciation under Nepal Income Tax Act, 2058
Under the Income Tax Act, 2058 (Schedule 2) of Nepal, depreciable assets are grouped into five pools (Block of Assets) and depreciated on a Diminishing Balance Basis (except Pool E):
- Pool A (Buildings & permanent structures): 5% p.a.
- Pool B (Computers, data handling equipment, furniture, office equipment): 25% p.a.
- Pool C (Automobiles, buses, minibuses, vehicles): 20% p.a.
- Pool D (Construction & earth-moving equipment, plant & machinery, uncategorized tangible assets): 15% p.a.
- Pool E (Intangible assets: patents, software, copyrights): Straight Line Method over useful life rounded down to nearest half-year.
(Note: Manufacturing/Special industries registered under Industrial Enterprises Act receive an additional one-third accelerated depreciation allowance on Pools A, B, C, and D).
5.3 Methods of Depreciation (NEB Syllabus)
5.3.1 Method 1: Straight Line Method (SLM / Fixed Installment / Original Cost Method)
Under the Straight Line Method, a fixed and equal amount of depreciation is charged every year throughout the useful life of the asset as a fixed percentage of its Original Cost. The book value can be reduced to zero (or scrap value).
- When Scrap Value and Useful Life are given:
Annual Depreciation = (Total Cost of Asset (C) - Scrap Value (S)) ÷ Estimated Useful Life in Years (N)
Rate of Depreciation (%) = Annual Depreciation ÷ Total Cost of Asset (C) × 100 - When Rate of Depreciation (R%) is given:
Annual Depreciation = Original Cost of Asset × R ÷ 100 × Months Used in That Year ÷ 12
5.3.2 Method 2: Diminishing Balance Method (DBM / Written Down Value - WDV / Reducing Installment Method)
Under the Diminishing Balance Method, depreciation is charged at a fixed percentage on the opening book value (Written Down Value) of the asset at the beginning of each year (Original Cost minus accumulated depreciation of prior years). Thus, the annual depreciation amount decreases every year, and the book value of the asset never reaches zero.
Annual Depreciation = Opening Book Value (WDV) × R ÷ 100 × Months Used ÷ 12
5.3.3 Difference Between Straight Line Method (SLM) and Diminishing Balance Method (DBM)
| Basis of Comparison | Straight Line Method (SLM) | Diminishing Balance Method (DBM / WDV) |
|---|---|---|
| 1. Basis of Calculation | Calculated on the Original Cost of the asset every year. | Calculated on the Opening Book Value (Written Down Value) of each year. |
| 2. Amount of Annual Depreciation | Remains constant (equal) for every full year of use. | Decreases progressively year after year. |
| 3. Book Value at End of Life | Can be reduced to zero (or exact scrap value). | Never becomes zero, even after many years. |
| 4. Combined Charge on P&L (Depreciation + Repairs) | Unequal burden on P&L (higher in later years when repairs increase while depreciation stays fixed). | Balanced/uniform burden on P&L (higher depreciation in early years offsets higher repair costs in later years). |
| 5. Legal Recognition in Nepal | Recognized for Intangible Assets (Pool E) and general financial reporting. | Recognized by Nepal Income Tax Act, 2058 for tangible asset pools (Pools A, B, C, D). |
5.4 Accounting Treatment: Purchase, Sale, and Change of Method
5.4.1 Standard Journal Entries and Machinery Account Posting
| Transaction | Journal Entry | Posting in Machinery (Fixed Asset) Account |
|---|---|---|
| 1. Purchase of Asset (including installation) | Machinery A/c ………………….. Dr. To Bank A/c | Dr. side: To Bank A/c |
| 2. Charging Annual Depreciation | Depreciation A/c ………………. Dr. To Machinery A/c | Cr. side: By Depreciation A/c |
| 3. Sale of Asset During the Year | Bank A/c ………………………….. Dr. To Machinery A/c | Cr. side: By Bank A/c (Sale Proceeds) |
| 4A. If Sale Price < Book Value on Date of Sale (Loss on Sale) | Profit & Loss A/c (Loss) ……. Dr. To Machinery A/c | Cr. side: By Profit & Loss A/c (Balancing Loss) |
| 4B. If Sale Price > Book Value on Date of Sale (Profit on Sale) | Machinery A/c ………………….. Dr. To Profit & Loss A/c (Profit) | Dr. side: To Profit & Loss A/c (Balancing Profit) |
Golden Formula for Profit or Loss on Sale of Fixed Asset:
Book Value on Date of Sale = Original Cost of Sold Part - Total Depreciation Charged on Sold Part from Purchase Date up to Sale Date
- If Selling Price > Book Value ⇒ Profit on Sale (Debited to Asset A/c: To P&L A/c)
- If Selling Price < Book Value ⇒ Loss on Sale (Credited to Asset A/c: By P&L A/c)
5.4.2 Change in Method of Depreciation (Prospective vs. Retrospective Effect)
- Change with Prospective Effect (from the current year onward):
- Simply take the Opening Balance (To Balance b/d) of the year in which the change takes place and apply the New Method from that year onward. No past adjustment is required.
- Change with Retrospective Effect (from the original date of purchase):
- Step 1: Calculate the Total Depreciation Already Charged in past years under the Old Method.
- Step 2: Re-calculate what the Total Depreciation Should Have Been for those same past years under the New Method.
- Step 3: Compare the two totals in the year of change:
- If New Method Past Depr. > Old Method Past Depr. (Deficiency / Under-charged): Credit the Asset Account with By Profit & Loss A/c (Additional Depr.).
- If New Method Past Depr. < Old Method Past Depr. (Surplus / Over-charged): Debit the Asset Account with To Profit & Loss A/c (Excess Depr. Written Back).
- Step 4: Charge current year’s depreciation according to the New Method.
5.5 Worked Numerical Examples (NEB 8-Mark Standard)
Illustration 5.1: Diminishing Balance Method with Additional Purchase & Sale
On 1st Baishakh 2080, Butwal Textile Mills purchased a machine for Rs. 1,80,000 and spent Rs. 20,000 on its installation. On 1st Kartik 2081, it purchased another machine for Rs. 1,00,000.
On 30th Chaitra 2082, the first machine purchased on 1st Baishakh 2080 became obsolete and was sold for Rs. 1,15,000.
Depreciation is charged @ 10% per annum under the Diminishing Balance Method (WDV), and the accounts are closed on 30th Chaitra every year.
Required: Prepare the Machinery Account for three years (2080, 2081, and 2082).
Solution:
Working Notes (Calculation of Depreciation & Profit/Loss on Sale of Machine I):
- Machine I (Purchased on 2080-01-01): Total Cost = Rs. 1,80,000 + Rs. 20,000 = Rs. 2,00,000.
- Year 2080 Depr. (12 mos @ 10%): 10% of 2,00,000 = Rs. 20,000 ⇒ WDV on 2081-01-01 = Rs. 1,80,000.
- Year 2081 Depr. (12 mos @ 10%): 10% of 1,80,000 = Rs. 18,000 ⇒ WDV on 2082-01-01 = Rs. 1,62,000.
- Year 2082 Depr. up to Sale Date (2082-12-30, 12 mos @ 10%): 10% of 1,62,000 = Rs. 16,200.
- Book Value of Machine I on Sale Date (2082-12-30): Rs. 1,62,000 - Rs. 16,200 = Rs. 1,45,800.
- Selling Price: Rs. 1,15,000.
- Loss on Sale of Machine I: Rs. 1,45,800 - Rs. 1,15,000 = Rs. 30,800 (Credited as By Profit & Loss A/c).
- Machine II (Purchased on 2081-07-01 for Rs. 1,00,000):
- Year 2081 Depr. (Kartik to Chaitra = 6 months @ 10%): 1,00,000 × 10% × 6 ÷ 12 = Rs. 5,000 ⇒ WDV on 2082-01-01 = Rs. 95,000.
- Year 2082 Depr. (Full 12 months @ 10%): 10% of 95,000 = Rs. 9,500 ⇒ Closing WDV on 2082-12-30 = Rs. 85,500.
In the Books of Butwal Textile Mills
Machinery Account
| Dr. Date | Particulars | J.F. | Amount (Rs.) | Cr. Date | Particulars | J.F. | Amount (Rs.) |
|---|---|---|---|---|---|---|---|
| 2080-01-01 | To Bank A/c (M-I: 1,80,000 + 20,000) | 2,00,000 | 2080-12-30 | By Depreciation A/c (M-I) | 20,000 | ||
| 2080-12-30 | By Balance c/d | 1,80,000 | |||||
| Total | 2,00,000 | Total | 2,00,000 | ||||
| 2081-01-01 | To Balance b/d (M-I) | 1,80,000 | 2081-12-30 | By Depreciation A/c (M-I: 18,000 + M-II: 5,000) | 23,000 | ||
| 2081-07-01 | To Bank A/c (M-II) | 1,00,000 | 2081-12-30 | By Balance c/d (M-I: 1,62,000 + M-II: 95,000) | 2,57,000 | ||
| Total | 2,80,000 | Total | 2,80,000 | ||||
| 2082-01-01 | To Balance b/d (M-I: 1,62,000 + M-II: 95,000) | 2,57,000 | 2082-12-30 | By Depreciation A/c (M-I sold) | 16,200 | ||
| 2082-12-30 | By Bank A/c (Sale of M-I) | 1,15,000 | |||||
| 2082-12-30 | By Profit & Loss A/c (Loss on M-I) | 30,800 | |||||
| 2082-12-30 | By Depreciation A/c (M-II) | 9,500 | |||||
| 2082-12-30 | By Balance c/d (M-II) | 85,500 | |||||
| Total | 2,57,000 | Total | 2,57,000 | ||||
| 2083-01-01 | To Balance b/d (M-II) | 85,500 |
Illustration 5.2: Change in Method of Depreciation (Retrospective Effect)
A company purchased a plant on 1st January 2023 for Rs. 1,00,000. It charged depreciation @ 10% p.a. under the Straight Line Method for 2023 and 2024. In 2025, the company decided to change the method to Diminishing Balance Method @ 15% p.a. with retrospective effect from 1st January 2023.
Required: Show the Plant Account for 2023, 2024, and 2025.
Solution:
- Step 1 (Past Depr. Charged under SLM @ 10% for 2023 & 2024): Rs. 10,000 + Rs. 10,000 = Rs. 20,000 (WDV on 1st Jan 2025 = Rs. 80,000).
- Step 2 (Past Depr. Required under DBM @ 15% for 2023 & 2024):
- 2023: 15% of 1,00,000 = Rs. 15,000 (WDV = Rs. 85,000).
- 2024: 15% of 85,000 = Rs. 12,750 (WDV = Rs. 72,250).
- Total Required Past Depr. = Rs. 15,000 + Rs. 12,750 = Rs. 27,750.
- Step 3 (Deficiency / Additional Depr. charged to P&L A/c in 2025): Rs. 27,750 - Rs. 20,000 = Rs. 7,750 (Credited as By P&L A/c).
- Step 4 (2025 Current Year Depr. @ 15% on Revised WDV Rs. 72,250): 15% of 72,250 = Rs. 10,837.50 (Closing Balance = Rs. 72,250 - Rs. 10,837.50 = Rs. 61,412.50).
Plant Account
| Dr. Date | Particulars | Amount (Rs.) | Cr. Date | Particulars | Amount (Rs.) |
|---|---|---|---|---|---|
| 2023 Jan 1 | To Bank A/c | 1,00,000 | 2023 Dec 31 | By Depreciation A/c (SLM 10%) | 10,000 |
| 2023 Dec 31 | By Balance c/d | 90,000 | |||
| Total | 1,00,000 | Total | 1,00,000 | ||
| 2024 Jan 1 | To Balance b/d | 90,000 | 2024 Dec 31 | By Depreciation A/c (SLM 10%) | 10,000 |
| 2024 Dec 31 | By Balance c/d | 80,000 | |||
| Total | 90,000 | Total | 90,000 | ||
| 2025 Jan 1 | To Balance b/d | 80,000 | 2025 Jan 1 | By Profit & Loss A/c (additional depreciation for 2023 and 2024) | 7,750 |
| 2025 Dec 31 | By Depreciation A/c (DBM 15% of 72,250) | 10,837.50 | |||
| 2025 Dec 31 | By Balance c/d | 61,412.50 | |||
| Total | 80,000 | Total | 80,000 | ||
| 2026 Jan 1 | To Balance b/d | 61,412.50 |
5.6 NEB Board Exam Practice Questions
Group A: Very Short Answer Questions (1 Mark Each)
- Define depreciation.
- Mention any four causes of depreciation.
- State the formula for calculating annual depreciation under the Straight Line Method.
- Distinguish between Tangible and Intangible Fixed Assets with two examples of each.
- What is meant by Scrap Value (Residual Value) of an asset?
Group B & C: Short and Long Numerical Questions (5 / 8 Marks)
- Distinguish between the Straight Line Method and Diminishing Balance Method of charging depreciation on any five bases.
- Numerical Problem (8 Marks): On 1st Shrawan 2079, Hetauda Cement Co. purchased a machine for Rs. 4,00,000. On 1st Magh 2080, another machine was purchased for Rs. 2,00,000. On 1st Shrawan 2081, half of the machine purchased on 1st Shrawan 2079 was sold for Rs. 1,35,000, and a new machine costing Rs. 1,50,000 was purchased on the same date. Depreciation is charged @ 10% p.a. on the Straight Line Method, and accounts are closed on the last day of Ashadh each year. Prepare the Machinery Account from 2079/80 to 2081/82. (Ans: Loss on sale of half of M-I on 2081-04-01 = Book Value Rs. 1,60,000 [Cost 2,00,000 - 2 yrs depr. 40,000] - Sale Rs. 1,35,000 = Rs. 25,000 Loss; Total Depr. in 2081/82 = Remaining half of M-I Rs. 20,000 + M-II Rs. 20,000 + M-III Rs. 15,000 = Rs. 55,000; Closing Balance at the end of 2081/82 = Rs. 4,45,000)
Worked answers to these exercises are in Chapter 5 Solutions.