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Sunday, July 18, 2010

Concept And Meaning Of Annuity Method Of Depreciation, Its Advantages And Disadantages

Concept And Meaning Of Annuity Method Of Providing Depreciation

Under this method, it is assumed that the amount spent in the purchase of the assets is an investment which should earn interest. The amount spent in acquiring an asset is assumed as an investment and interest is charged at a certain rate on the diminishing balance of assets and is debited to assets account and credited to interest account which is transferred to profit and loss account. The asset is credited year by years with a fixed amount of depreciation. The amount of depreciation charged every year is such that in spite of asset being debited with interest every year, the asset is reduced to zero or its residual value. The amount of depreciation is calculated on the basis of annuity table.

When additions are made to asset account, calculations have to be revised. This method is used in the case of leases having large amount spread over a number of years.

Advantages Of Annuity Method Of Depreciation

The following are the advantages of annuity method:

i. Annuity method takes interest on capital invested in the asset into account.

ii. Annuity method is regarded as most exact and precise from the point of view of calculations. So it is a scientific method.

Disadvantages Of Annuity Method Of Depreciation

The following are the disadvantages of the annuity method:

i. The annuity method is difficult to understand.

ii. The burden on profit and loss account goes on increasing with the passage of time whereas the amount of depreciation charged each year remains constant. The amount of interest credited goes on diminishing as years pass by, the ultimate consequence being that the net burden on profit and loss account grows heavier each year.

iii. When the asset requires frequent addition and extensions, the calculation have to be changed frequently, which is very inconvenient.