by Fixed Installment Method is one of the simplest and most widely used depreciation methods. Under this method, a fixed and equal amount of depreciation is charged each year over the useful life of the asset. This amount is calculated by deducting the residual value (also called salvage value) from the original cost, and dividing the result by the number of useful years.
Formula
Annual Depreciation = (Cost of Asset − Residual Value) / Useful Life
Example
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Asset Cost: ₹5,00,000
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Residual Value: ₹50,000
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Useful Life: 5 years
- Equal Depreciation Each Year
Under the Fixed Installment Method, the same amount of depreciation is charged every year throughout the asset’s useful life. This creates a consistent expense, simplifying accounting and forecasting. The method assumes that the asset provides equal benefits annually and depreciates evenly. As a result, businesses can easily plan for the depreciation expense in their financial statements, and the profit or loss for each year is not significantly affected by changing depreciation amounts.
- Simplicity in Calculation and Application
One of the main features of the Fixed Installment Method is its simplicity. The depreciation amount is calculated once at the beginning of the asset’s life using a straightforward formula. This makes it easy to implement and understand, even for non-accountants. Its simplicity reduces the chances of errors, which makes it highly suitable for small businesses or organizations that do not have complex accounting systems or need an uncomplicated depreciation policy.
- Uniform Reduction in Asset Value
The book value of the asset reduces uniformly over the years, as the same depreciation amount is deducted annually. This straight-line reduction ensures that the balance sheet reflects a consistent decrease in the asset’s value over time. Unlike other methods that reduce the asset’s value sharply in the early years, the fixed installment method presents a more balanced and steady decline, which can be beneficial for reporting to stakeholders and investors.
- Not Based on Usage or Performance
This method does not consider the actual usage of the asset or how intensely it is used in any given year. Whether the asset is used heavily or sparingly, the depreciation amount remains the same. This can be a limitation for businesses where usage varies greatly year to year. It assumes that the asset wears out equally every year, which may not be accurate for assets that experience accelerated wear and tear.
- Suitable for Uniform Benefit Assets
The Fixed Installment Method is best suited for assets that provide equal utility or service throughout their useful life. For example, buildings, office furniture, or long-life equipment that operate under consistent conditions are ideal for this method. It aligns well with assets that do not experience drastic fluctuations in performance or maintenance costs, making it a reliable method for straightforward assets with predictable lifespans.
- Asset Value May Not Reflect Market Value
While this method ensures a consistent reduction in book value, the book value may not reflect the real market value of the asset over time. The asset may depreciate faster in reality due to technological advancements, market trends, or heavy use, which isn’t accounted for under this method. Therefore, the asset’s book value in the financial statements may appear inflated compared to its fair or resale value.
- No Provision for Increasing Maintenance Costs
As assets age, repair and maintenance costs generally rise, but this method does not accommodate that. Depreciation remains constant even though actual expenses associated with the asset may increase. This could result in underestimation of total operating costs in later years, affecting decision-making. Hence, for assets that deteriorate rapidly or need significant maintenance over time, this method may not present the most accurate financial picture.
- Widely Accepted for Financial Reporting
The Fixed Installment Method is widely recognized and accepted under various accounting frameworks, including GAAP and IFRS. Due to its clarity, uniformity, and ease of implementation, it is preferred for financial reporting and tax purposes, especially for small and medium enterprises. It also supports better comparability of financial statements over time, making it easier for auditors, investors, and regulators to analyze asset performance and depreciation trends.
- Simplicity in Calculation
The Fixed Installment Method is easy to understand and apply. It involves straightforward calculations where the same depreciation amount is deducted annually. This eliminates complex computations and reduces the risk of accounting errors. The method is especially suitable for small businesses or non-technical staff, as it does not require advanced accounting knowledge or software. Its simplicity makes it a commonly used method in manual accounting systems and early learning environments.
- Uniform Expense Allocation
This method ensures that the depreciation expense is consistent every year throughout the asset’s useful life. Such uniform allocation provides a steady expense figure in the profit and loss account, simplifying budgeting and forecasting. It leads to consistent financial reporting, making it easier for management to compare year-on-year financial performance without variations caused by fluctuating depreciation values. Investors and stakeholders also benefit from this predictability in expense recognition.
- Facilitates Stable Profit Measurement
Since depreciation remains constant annually, the impact on net profit also remains stable, allowing for consistent profit measurement. This is helpful for companies seeking a clear understanding of their financial performance across multiple years. The stable profit trend it offers is useful for performance analysis, internal decision-making, and reporting to stakeholders like shareholders, financial institutions, and regulatory authorities. It also supports dividend planning by avoiding large fluctuations in net income.
- Easy to Implement in Accounting Software
Most accounting software and ERP systems come with built-in support for the Straight Line or Fixed Installment Method. Its compatibility with digital tools ensures easy automation of depreciation calculations, posting of journal entries, and preparation of fixed asset registers. This reduces manual work and administrative burden, saving time and improving accuracy. For organizations using digital accounting solutions, this method offers seamless integration and operational efficiency.
- Transparency in Asset Valuation
The method offers clear and transparent asset valuation, as the depreciation amount and remaining book value are easy to determine. Every year, the asset’s value decreases by the same amount, making it simple for users of financial statements to understand and verify calculations. This transparency enhances the credibility of financial reporting and facilitates audits, as external auditors can easily trace and validate the depreciation records against accounting principles.
- Ideal for Assets with Constant Utility
This method is particularly suitable for assets that provide uniform benefits over time, such as furniture, fixtures, and office buildings. These assets depreciate gradually and predictably, making the Fixed Installment Method appropriate for representing their decline in value. The consistency in depreciation charges aligns well with the actual economic use of such assets, thus accurately reflecting their cost in the income statement over their useful lives.
- Supports Budgeting and Financial Planning
With depreciation being consistent year to year, the method aids in effective budgeting and financial forecasting. Management can predict depreciation expenses with certainty, helping in setting accurate budgets for future periods. It also simplifies long-term planning for asset replacement, cost management, and profitability projections. This level of predictability is advantageous for businesses focused on tight financial control and sustainable growth strategies.
- Widely Accepted in Accounting Standards
The Fixed Installment Method is recognized and accepted under most accounting frameworks, including Indian Accounting Standards, GAAP, and IFRS. Due to its clarity and standardization, it is often preferred for financial reporting and disclosure. Regulators and tax authorities are familiar with this method, and it is widely used in education, making it one of the most trusted and standardized depreciation practices in global accounting.
Disadvantages of Fixed Installment:
- Ignores Actual Asset Usage
The Fixed Installment Method charges equal depreciation each year regardless of how much the asset is used. This means even if the asset operates heavily in one year and lightly in another, the depreciation expense remains the same. It fails to reflect the true consumption or productivity of the asset, leading to a misrepresentation of actual wear and tear, especially in businesses where usage varies significantly from year to year.
- Does Not Consider Increasing Maintenance Costs
As an asset ages, its maintenance and repair costs usually increase. However, the Fixed Installment Method does not factor in this rising expense. Depreciation remains constant, which may understate total operational costs in later years. This can lead to inaccurate financial analysis and planning, especially when assets require substantial upkeep over time. As a result, the method may distort the actual cost burden associated with aging assets.
- Book Value May Differ from Market Value
One major limitation is that it does not align the asset’s book value with its actual market value. Depreciation is calculated on a predetermined schedule, regardless of fluctuations in the asset’s resale or fair value. If the asset becomes obsolete or its market value drops significantly, the balance sheet may overstate its worth. This creates a discrepancy between reported and real asset values, which can mislead investors and creditors.
- Unsuitable for Rapidly Depreciating Assets
The method is inappropriate for assets that lose a large portion of their value early in their life, such as technology or vehicles. These types of assets typically depreciate faster in the initial years. Using a uniform depreciation rate under this method fails to capture this early decline, making it an ineffective option. The asset’s value might appear overstated in the early years, misguiding stakeholders regarding its actual worth.
- Misstates Profitability in Early Years
Because it does not match higher asset efficiency or productivity in early years with a higher depreciation charge, this method can overstate profits initially. Assets usually perform better when new, and their higher output contributes more to revenue. By spreading depreciation evenly, the method does not fully account for this economic reality, leading to higher reported profits in the early years and potentially misleading conclusions about a company’s performance.
- No Incentive for Asset Replacement Planning
Since depreciation is charged evenly, businesses might delay asset replacement planning, assuming fixed costs throughout the asset’s life. In reality, as assets age, performance drops and costs rise. This method doesn’t encourage setting aside additional funds for unforeseen expenses or early replacement. It may leave companies financially unprepared for large capital investments when the asset reaches the end of its useful life, disrupting continuity in operations.
- Lacks Flexibility
The Fixed Installment Method offers no flexibility to adapt to changes in business conditions, asset usage patterns, or economic factors. Once depreciation is calculated, it remains fixed year after year. In contrast, other methods like the Written Down Value (WDV) or Units of Production offer better alignment with real-world usage or declining efficiency. The rigid structure of this method may not suit dynamic industries with fluctuating asset utilization.
- Not Accepted for Tax Purposes in Some Jurisdictions
While this method is widely used in financial accounting, it may not be accepted under certain tax regulations, particularly in countries where accelerated depreciation is encouraged. Tax authorities often favor methods like WDV that result in higher depreciation charges in early years, reducing taxable income. Companies using the Fixed Installment Method for accounting might need to maintain a separate depreciation schedule for tax purposes, increasing administrative complexity.
