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Home Depreciation, Provisions and Reserves Annuity Method of Depreciation
 
 

Annuity Method of Depreciation:

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      
 

More study material from this topic:

Definition, explanation and causes of depreciation
Depreciation is not a matter of valuation but a means of cost allocation
Activity method of depreciation
Straight line method of depreciation
Sum of the years' digits method of depreciation
Reducing balance method
Annuity method
Depreciation fund method or sinking fund method
Insurance policy method
Revaluation method
Depletion method
Machine hour rate, mileage, and global method
Methods of recording depreciation
Reserves
Difference between general reserve and specific reserve
Difference between capital reserve and general reserve
Difference between reserve and reserve fund
Difference between provision and reserve

 

 
 

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Financial Accounting Topics


  Introduction to Accounting
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  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
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  Special Journals
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  Cash Book
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Bank Reconciliation Statement
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  Final Accounts
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  Work Sheet
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  Capital and Revenue Items
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  Valuation of Inventories
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  Accounts of Non-profit Making Organizations
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  Statement of Cash Flows
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  Accounting Ratios Analysis
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  Depreciation, Provisions and Reserves
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  Accounting Dictionary
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  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
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  Variable Costing System
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  Materials and Inventory Cost Control
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  Activity Based Costing System
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  Standard Costing and Variance Analysis
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  Balanced Scorecard
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  Capital Investment Analysis/Capital Budgeting
 
 

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