# Annuity Method of Charging Depreciation.

Why we have to charge interest in annuity method? & Why we have to follow this method? Please explain me,sir in simple sentence.

asked Jul 4, 2015 1,320 views

Annuity Method:

Every method of charging depreciation is different in the sense that it has some uniqueness to it as compared to other method.  This method recognises that the money we invest in an asset has interest value.  In all other methods we charge interest on the cost price of the asset.  In this method we add interest at some given rate to the cost of the asset and then charge depreciation.  Let us understand this with the help of an example:

Example: ABC Ltd purchased a lease on 1.4.2012 for three years at a cost of Rs.50000.  It is proposed to depreciate the lease by annuity method charging interest at 10% p.a.   Prepare Lease A/c for three years assuming that the company follows final year as the accounting year.

(Reference to the Annuity Table shows that to depreciate Rs. 1 by annuity method over 3 years periods by charging interest at 10% p.a. we need to write off a sum of Rs.0.4021148 every year).

Sol.:  Annual Depreciation = Re.0.4021148 X 100000 = Rs.40211.48

Dr.                                                            Lease Account                                                                    Cr.

 Date Particulars Rs. Date Particulars Rs. 01.4.2012 31.3.2013   01.4.2013 31.3.2014   01.4.2014 31.3.2015 To Bank A/c To Interest A/c   To Balance b/f To Interest   To Balance b/f To Interest A/c 10000.00 10000.00 31.32013 31.3.2013   31.3.2014 31.3.2014   31.3.2015 By Depreciation A/c By Balance c/f   By Depreciation A/c By Balance c/f   By Depreciation A/c 40211.48 69788.52 110000.00 110000.00 69788.52 6978.52 40211.48 36555.89 76767.37 76767.37 36555.89 3655.59 40211.48 40211.48 40211.48

Notes:

1. If you notice that this lease has been fully depreciated up to last paisa.  This does not happen in case of Written Down Value Method.

2. Asset A/c is being debited with Interest because this method recognises that the money spent on this asset has some opportunity cost. This simply means if this money was invested elsewhere it would have given us an interest of 10% p.a. so it must be added to the cost of asset and should form part of depreciation.

3. Since we are not paying this interest to any outside party, it is just a recognition of its opportunity cost, that is why we are crediting our own interest account.

answered Jul 5, 2015 by (3,971 points)