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# 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

A D V E R T I S E M E N T

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

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