While maintaining accounts, one has to make sure of the correct values of any increment/decrement. When depreciation happens, that is, the value of fixed assets drops down, it is important to record this decrement carefully. There are various methods by which this can be accounted for, and one of the approaches is 'uniform charge method.' In this method, the value of depreciation is charged in a uniform manner year after year in the form of a fixed instalment method and many more. However, this method is best applicable to productive assets. There are some sub-methods that fall under this. Listed below are their names and a small explanation for each one of them.
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Depreciation Formula
Amount of Depreciation = \[\frac{\text{Cost of an asset – Net residual value}}{\text{useful life}}\]
Various Methods included in Uniform Charge Method
There are four sub-methods that come under this major method.
Fixed Instalment Method
In the fixed instalment method, a particular cost of depreciation is noted down with respect to the utility of the asset's life. When the utility of the asset’s life ends, this depreciation value either lowers down to zero or is changed to its residual value.
Annuity Method
In this method, the depreciation value is derived from the cost of the asset and the interest loss in the capital’s expenditure. This method prevails on the assumption that there might have been a better outcome if the investment was made in some other place. That is why we calculate interest loss, too, to keep a clean record of depreciation value.
Depreciation Fund Method
This method is used when the cost of depreciation is too high, and the new asset can not be bought with the remaining sources. Even though the depreciation cost is noted every year with proper terms and conditions, sometimes the company may lack resources to further buy the next asset. During such times, this method comes in use.
Insurance Policy Method
In this method, the company does not purchase securities; instead, it buys an insurance policy. This insurance policy is equal to the cost of the asset, which needs to be replaced. Every year, in the beginning, the company will have to pay some money, known as premium. In exchange for the premium, the insurance company agrees to pay a specific sum of money to them.
These are the various sub-methods that come under the Uniform Charge Method. All of these have their own advantages and disadvantages. While applying any of these, the company should look upon its resources and capability, and make the correct approach.
The relevance of Uniform Charge Method
In the sector of accounting, this method is very brief, and it is easy to keep a record of this. For a company, the correct cost of depreciation to be noted down is very important, as it adversely affects the economic growth of the company. Any error in this often results because of the use of poor methods. Thus, the Uniform Charge Method is a neat process, which, if applied, yields out correct results, thus being of great help to the company.
Did You Know?
This method is also known as Straight Line Method or Fixed Percentage on the Original Cost Method because this method changes the depreciation cost every year uniformly, thus avoiding any hindrance and abnormalities in the outcome. The original cost plays a vital role while using this method; its other names go along completely with the process.
FAQs on Uniform Charge Method for Depreciation
Q1. Are there major disadvantages of the Fixed Instalment Method?
Ans: There are a few disadvantages to the fixed instalment method. They are:
This method works on the assumption that the asset is in utility uniformly every year, thus not keeping a check if the asset is actually being used or not.
In the starting years, the repair is low and increases gradually later on. This leads to an increase in the charge applied to the profit.
The Uniform Charge Method provides us with alternatives, which makes it easy to record all the disadvantages of various methods and then come to a conclusion. The Final Instalment Method has more advantages than disadvantages, but this does not mean that the cons should be avoided. Even a small risk may lead to a huge loss for the company.
Q2. What causes the obsolescence of a Depreciable Asset?
Ans: Obsolescence simply refers to being outdated. When a better asset is available, the old asset becomes out of date and is not given much preference. This may happen due to the following factors:
Technological issues
Gradual improvements in the methods of production
Fluctuations or changes in the demands and aspirations of the market
Adverse restrictions, usually related to law
This leads to depreciation, whose value is calculated by different methods, one of them being the Uniform Charge Method as per the productivity level of the company.
Q3. Company A purchases a machine for $100,000 with an estimated salvage value of $20,000 and a useful life of 5 years. How to calculate the straight-line depreciation?
Ans: The straight-line depreciation for the machine would be calculated as follows:
Cost of the asset: $100,000
Cost of the asset - Estimated salvage value: $100,000 - $20,000 = $80,000 total depreciable cost
The useful life of the asset: 5 years
Divide step (2) by step (3): $80,000/5 years = $16,000 annual depreciation amount
Therefore, Company A would depreciate the machine at the amount of $16,000 annually for 5 years.
The depreciation rate can also be calculated if the annual depreciation amount is known. The depreciation rate is the annual depreciation amount / total depreciable cost. In this case, the machine has a straight-line depreciation rate of $16,000 / $80,000 = 20%.
