Fixed Installment Method vs. Written Down Value Method
1. Introduction to the Two Core Methods
While various mathematical methods exist to compute depreciation (Annuity, Sinking Fund, Insurance Policy, Machine Hour Rate), the two universally recognized methods prescribed by the BBA DAVV syllabus, the Indian Companies Act 2013, and the Income Tax Act 1961 are:
- Fixed Installment Method (also known as the Straight Line Method - SLM)
- Written Down Value Method (also known as the Diminishing Balance Method - WDV or Reducing Balance Method)
2. Fixed Installment Method (Straight Line Method - SLM)
Core Concept:
Under this method, an equal fixed amount of depreciation is written off every year throughout the working life of the asset.
Because the annual depreciation figure remains constant year after year, if plotted on a graph against time, it forms a flat, straight horizontal line—hence the name Straight Line Method.
Mathematical Formulas for SLM:
Annual Depreciation (₹) = (Total Cost of Asset - Estimated Scrap Value / Estimated Useful Life in Years)
Rate of Depreciation (%) = (Annual Depreciation / Total Cost of Asset) × 100
Salient Features of SLM:
- Base Amount: Depreciation is always calculated on the Original Historical Cost of the asset every year.
- Final Book Value: At the end of its useful working life, the book value of the asset in the ledger is reduced exactly to its Scrap Value (or Zero)!
Example:
- Cost of Machine = ₹1,00,000; Scrap value = ₹10,000; Useful life = 5 years. Annual Depreciation = (₹1,00,000 - ₹10,000) / 5 = ₹18,000 per year Each year for 5 years, exactly ₹18,000 will be debited to the Profit & Loss Account.
3. Written Down Value Method (Diminishing Balance Method - WDV)
Core Concept:
Under this method, depreciation is charged at a fixed percentage, but not on original cost; it is calculated each year on the opening book balance (Written Down Value / Book Value) of the asset brought forward from the previous year.
Because the book value of the asset decreases with each passing year, the amount of annual depreciation charged also progressively decreases (diminishes) every year!
Key Characteristics of WDV:
- Base Amount: Depreciation is calculated on the Written Down Value (Cost minus accumulated depreciation) at the start of that year.
- Final Book Value: The book value never mathematically reaches absolute zero, because you are always calculating a percentage of a positive remaining balance!
Example:
- Cost of Machine = ₹1,00,000; Depreciation rate = 20% p.a. under WDV:
- Year 1: 20% of ₹1,00,000 = ₹20,000 → Closing Book Value = ₹80,000.
- Year 2: 20% of ₹80,000 = ₹16,000 → Closing Book Value = ₹64,000.
- Year 3: 20% of ₹64,000 = ₹12,800 → Closing Book Value = ₹51,200.
- Year 4: 20% of ₹51,200 = ₹10,240 → Closing Book Value = ₹40,960.
Notice how the annual depreciation amount automatically decreases: ₹20,000 → ₹16,000 → ₹12,800 → ₹10,240!
4. Why is WDV Preferred by Tax Authorities and Modern Businesses?
In real life, as a machine gets older, its maintenance and repair costs increase drastically.
Look at the total annual burden on the Profit & Loss Account under both methods:
| Year | SLM Depreciation | Repair Cost | Total P&L Charge (SLM) | WDV Depreciation | Repair Cost | Total P&L Charge (WDV) |
|---|---|---|---|---|---|---|
| Year 1 | ₹15,000 | ₹1,000 | ₹16,000 | ₹20,000 | ₹1,000 | ₹21,000 |
| Year 2 | ₹15,000 | ₹3,000 | ₹18,000 | ₹16,000 | ₹3,000 | ₹19,000 |
| Year 3 | ₹15,000 | ₹6,000 | ₹21,000 | ₹12,800 | ₹6,000 | ₹18,800 |
| Year 4 | ₹15,000 | ₹10,000 | ₹25,000 (Unfair!) | ₹10,240 | ₹10,000 | ₹20,240 (Even!) |
Key Financial Insight: Under WDV, as the machine ages, high depreciation is paired with low repairs in early years, and low depreciation is paired with high repairs in later years. This keeps the combined annual operational charge to the Profit & Loss Account almost uniform and balanced over the asset’s lifetime! For this exact reason, the Indian Income Tax Act (Section 32) officially recognizes only the WDV Method for business tax deductions!
5. In-Depth Comparison: Fixed Installment (SLM) vs. Written Down Value (WDV)
| Feature | Fixed Installment Method (SLM) | Written Down Value Method (WDV) |
|---|---|---|
| 1. Basis of Calculation | Always calculated on the Original Historical Cost of the asset. | Calculated on the Written Down Value (opening book value) each year. |
| 2. Annual Depreciation Amount | Remains identical and constant every year. | Gradually decreases (diminishes) every year. |
| 3. Final Balance at End of Life | Asset’s book value can be reduced to zero or exact scrap value. | Asset’s book value never mathematically reaches absolute zero. |
| 4. Combined P&L Charge (Depreciation + Repairs) | Unequal and unfair; heavy burden on P&L in later years when repairs escalate. | Almost uniform and equitable throughout the asset’s working life. |
| 5. Income Tax Recognition | Not accepted by the Indian Income Tax Department (except for power generating units). | Universally accepted and mandated by Indian Income Tax authorities. |
| 6. Suitability | Suitable for simple assets with negligible repairs and fixed expiration (Leases, Patents, Copyrights, Furniture). | Highly suitable for complex plant, heavy industrial machinery, automobiles, computers, and electronic equipment. |
6. Syllabus Activity 2: Household Asset Depreciation Assignment
As prescribed in the DAVV BBA syllabus, let us conduct a practical study on an everyday household asset:
Step 1: Asset Selection & Life Estimation
- Selected Household Asset: Home Air Conditioner (1.5 Ton 5-Star Split AC).
- Purchase Price (Historical Cost): ₹40,000.
- Estimated Useful Life: 5 years.
Step 2: Determine Depreciation Percentage
As instructed in the syllabus guideline: Depreciation Percentage = 100 / Useful Life = 100 / 5 = 20% per year
Step 3: Multi-Year Depreciation Schedule (Diminishing Balance / WDV Method)
| Year | Opening Book Value (₹) | Depreciation at 20% on WDV (₹) | Closing Book Value (₹) |
|---|---|---|---|
| Year 1 | ₹40,000 | ₹40,000 × 20% = ₹8,000 | ₹40,000 - ₹8,000 = ₹32,000 |
| Year 2 | ₹32,000 | ₹32,000 × 20% = ₹6,400 | ₹32,000 - ₹6,400 = ₹25,600 |
| Year 3 | ₹25,600 | ₹25,600 × 20% = ₹5,120 | ₹25,600 - ₹5,120 = ₹20,480 |
| Year 4 | ₹20,480 | ₹20,480 × 20% = ₹4,096 | ₹20,480 - ₹4,096 = ₹16,384 |
| Year 5 | ₹16,384 | ₹16,384 × 20% = ₹3,277 | ₹16,384 - ₹3,277 = ₹13,107 |
- At the end of Year 5, the AC has an unexpired written down value of ₹13,107, which represents its fair second-hand market value if resold!
7. Solved Practical Numerical Problem: Machinery Account Preparation
Problem: On 1st April 2023, Goyal & Sons purchased a machine for ₹80,000 and spent ₹20,000 on its immediate carriage and installation (Total Cost = ₹1,00,000). The firm closes its accounts annually on 31st March and charges depreciation at 10% per annum.
Prepare the Machinery Account for 3 years (2023-24, 2024-25, 2025-26) under:
- Case A: Fixed Installment Method (SLM)
- Case B: Written Down Value Method (WDV)
Case A: Machinery Account under Fixed Installment Method (SLM)
- Total Original Cost = ₹80,000 + ₹20,000 = ₹1,00,000.
- Annual Depreciation = 10% of ₹1,00,000 = ₹10,000 every year.
Dr. Machinery Account (SLM) Cr.
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| Date | Particulars | J.F | Amount (₹) | Date | Particulars | J.F | Amount (₹) |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| 2023 | | | | 2024 | | | |
| Apr 1 | To Bank A/c | | 80,000 | Mar 31 | By Depreciation | | 10,000 |
| Apr 1 | To Bank (Inst)| | 20,000 | Mar 31 | By Balance c/d | | 90,000 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| | TOTAL | | ₹1,00,000 | | TOTAL | | ₹1,00,000 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| 2024 | | | | 2025 | | | |
| Apr 1 | To Balance b/d| | 90,000 | Mar 31 | By Depreciation | | 10,000 |
| | | | | Mar 31 | By Balance c/d | | 80,000 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| | TOTAL | | ₹90,000 | | TOTAL | | ₹90,000 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| 2025 | | | | 2026 | | | |
| Apr 1 | To Balance b/d| | 80,000 | Mar 31 | By Depreciation | | 10,000 |
| | | | | Mar 31 | By Balance c/d | | 70,000 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| | TOTAL | | ₹80,000 | | TOTAL | | ₹80,000 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| 2026 | | | | | | | |
| Apr 1 | To Balance b/d| | 70,000 | | | | |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+Case B: Machinery Account under Written Down Value Method (WDV)
- Year 1 Depreciation = 10% on ₹1,00,000 = ₹10,000.
- Year 2 Depreciation = 10% on ₹90,000 = ₹9,000.
- Year 3 Depreciation = 10% on ₹81,000 = ₹8,100.
Dr. Machinery Account (WDV) Cr.
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| Date | Particulars | J.F | Amount (₹) | Date | Particulars | J.F | Amount (₹) |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| 2023 | | | | 2024 | | | |
| Apr 1 | To Bank A/c | | 80,000 | Mar 31 | By Depreciation | | 10,000 |
| Apr 1 | To Bank (Inst)| | 20,000 | Mar 31 | By Balance c/d | | 90,000 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| | TOTAL | | ₹1,00,000 | | TOTAL | | ₹1,00,000 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| 2024 | | | | 2025 | | | |
| Apr 1 | To Balance b/d| | 90,000 | Mar 31 | By Depreciation | | 9,000 |
| | | | | Mar 31 | By Balance c/d | | 81,000 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| | TOTAL | | ₹90,000 | | TOTAL | | ₹90,000 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| 2025 | | | | 2026 | | | |
| Apr 1 | To Balance b/d| | 81,000 | Mar 31 | By Depreciation | | 8,100 |
| | | | | Mar 31 | By Balance c/d | | 72,900 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| | TOTAL | | ₹81,000 | | TOTAL | | ₹81,000 |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+
| 2026 | | | | | | | |
| Apr 1 | To Balance b/d| | 72,900 | | | | |
+------------+---------------+-----+------------+------------+-------------------+-----+------------+Final Balance as on 1st April 2026: Under SLM = ₹70,000 | Under WDV = ₹72,900
8. Summary & Quick Revision Checklist
- SLM (Fixed Installment): Constant depreciation calculated on Original Cost every year; book value can reach zero.
- WDV (Diminishing Balance): Decreasing annual depreciation calculated on Opening Book Value; book value never reaches zero.
- WDV equalizes total annual P&L charge (high depreciation + low repairs in Year 1 vs low depreciation + high repairs in Year 5).
- Income Tax Recognition: Only WDV is recognized under Section 32 of the Income Tax Act 1961.
- Installation and freight charges are capitalized by adding them directly to the asset’s acquisition cost.