06/10/2015depreciation,provisions and reserves1
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21/04/23 DEPRECIATION,PROVISIONS AND RESERVES 1
1 CONCEPT OF DEPRECIATION 2 CAUSES OF DEPRECIATION 3 NEED OF DEPRECIATION 4 BASIC FACTORS 5 METHODS OF DEPRECIATION6 PROVISION AND RESERVES
21/04/23 DEPRECIATION,PROVISIONS AND RESERVES 3
DEFINITIONDepreciation is the permanent decrease in the value of an asset due to use and /or the lapse of the time.
CLMA, LONDON
21/04/23 4DEPRECIATION,PROVISIONS AND RESERVES
CAUSES OF DEPRECIATIONPhysical depreciation Economic factors Time factors Depletion Accident
21/04/23 DEPRECIATION,PROVISIONS AND RESERVES 6
NEED FOR CHARGING DEPRECIATION
To calculation the profit .True and fair view in balance sheet. Replacement of asset .Saving in income tax.Accurate ascertainment of cost.
BASIC FACTORS AFFECTING DEPRECIATION
Cost of asset .Estimated working life.Salvage/Residual/Scrap value.Legal provisions Additions to assets
METHODS OF DEPRECIATION
CHANGEMACHINE HOUR RATE
DEPLETION
REVALUATION
INSURANCE POLICYDEPRECIATION FUND
ANNUITY
SUM OF THE DIGITS
DIMINISHING BALANCE
FIXED INSTALMENT
STRAIGHT LINE METHODUnder this method,a fixed asset in written off
annually so that,by the time asset is worn out ,its proportion cost of the value in the book is reduced to zero.
FORMULA FIXED ASSET- ESTIMATED SCRAP
VALUE ESTIMATED LIFE OF ASSET
21/04/23 DEPRECIATION,PROVISIONS AND RESERVES 9
MERITS AND DEMERITS
21/04/23 DEPRECIATION,PROVISIONS AND RESERVES 10
MERITS- 1. Simple . 2. Asset is fully written off . 3. Knowledge of total depreciation charged . 4. Suitable for fixed life assets. DEMERITS- 1. Interest on capital. 2. Reairs and maintenance 3. Income tax
QUESTION:- A trader bought machinery on 1st jan , 2001 for Rs . 125000 whose useful life has been estimated 5 years . After the expiry of
useful life , the scrap will realise Rs 25000. ANNUAL DEPRECIATION
125000-25000 =5000
5
MACHINERY ACCOUNTDATE
PARTICULARS
AMT DATE
PARTICULARS
AMT
2001 Jan 1
To bank a\c 125000
2001 Dec 31
By depreciation a\c
20000
Dec 31
By bal c\d 105000
125000
125000
2002Jan 1
To bal b\d 105000
2002Dec 31
By depreciation a\c
20000
Dec 31
By bal c\d 85000
105000
105000
2003Jan 1
To bal b\d 85000
2003Dec 31
By depreciation a\c
20000
Dec 31
By bal c\d 65000
85000
85000
2004 Jan 1
To bal b\d 65000
2004Dec 31
By depreciation a\c
20000
By bal c\d 45000
65000
65000
2005Jan 1
To bal b\d 45000
2005Dec 31
By depreciation a\c
20000
Dec 31
By bal c\d 25000
45000
45000
DIMINISHING BALANCE METHODDepreciation is calculated at a certain
percentage each year on the balance of the asset which is brought forward from the previous year. The amount of depreciation charged in each period is not fixed but it goes on decreasing gradually as the beginning balance of the asset in each year will reduce.
MERITS & DEMERITSMERITS
1. Fresh calculation of depreciation are not necessary as and when additions are made. 2. this method is recognized by the income tax authorities in India.
DEMERITS 1.Its difficult to determine the suitable rate of depreciation. 2. the original cost of the asset is altogether lost sight of in subsequent years and the asset can never be reduced to zero.
QUESTION:- A company bought machinery for Rs .400000, including a shaft Rs . 40000. The machinery is subject to dep at 10% by reducing instalment method . In the beginning of the fifth year , the shaft became obsolete and instalment method . In the beginning of the fifth year , the shaft become obsolete and was sold for Rs. 8000.Write up the
machinery account for five years .
MACHINERY ACCOUNTDATE
PARTICULARS
AMT DATE PARTICULARS
AMT
1ST Yr
To bank a\c 400000
1ST Yr.
By depreciation a\c
40000
By bal c\d 360000
400000
400000
2ND
YrTo bal b\d 36000
02ND
YrBy depreciation a\c @10% ON 360000
36000
By bal c\d 324000
360000
360000
3RD Yr.
To bal b\d
324000
3rd Yr.
By depreciation@10%ON Rs.324000
32400
By bal c\d 291600
324000
324000
4TH Yr.
To bal b\d
291600
4TH Yr.
By depreciation@10%ON Rs.291600
29160
By bal c\d 262440
291600
291600
5th Yr.
To bal b\d
262440
5TH Yr.
By bank a\c 8000
By profit & loss [Loss on sale of shaft]
18244
By depreciation@10%ON Rs 236196
23620
By bal c\d 212576
262440
262440
SUM OF THE DIGITS METHOD
This is a variant of the reducing instalment or diminishing balance method.
QUESTION:-Suppose machinery was purchased for Rs. 60000 on 1st jan,2003 and depreciation was charged following the sum of the digits method assuming its useful life to be 3 years. Depreciation for three years will be calculated as under:
DEPRECIATION FOR THE FIRST YEAR = 3 Rs.60000 =Rs.30000
3+2+1 SECOND YEAR = 2 Rs.60000=Rs.20000
6 THIRD YEAR = 1 Rs.60000 =Rs.10000
6
ANNUITY METHOD Under this ,amount spent on purchase of an
asset is regarded as an investment which is assumed to earn interest at a certain rate. The amount to be written off as depreciation is calculated from annuity table , an extract of which is given below :
Years 3% 3 1% 2
4% 4 1% 2
5%
3 0.353530
0.359634
0.360349
0.363773
0.367209
4 0.269027
0.272251
0.275490
0.278744
0.282012
5 0.218355
0.221481
0.224627
0.227792
0.230975
QUESTION:- A firm purchases a 5 yr lease for Rs.40,000 on 1st jan . It decides to write off depreciation on annuity method ,presuming the rate of interest to be 5% per annum . The annuity tables show that a sum of Rs. 9,239 should be written off every year. Show the lease account for five yr .calculation are to be made to the nearest – rupee.
DATE PARTICULARS
AMT DATE PARTICULARS
AMT
1st yrJan 1
To cash 40000 1st yr Dec 31
By depreciation a\c
9239
Dec 31
To interest 2000 Dec 31
By bal c\d 32761
42000 42000
2nd yr Jan 1
To bal b\d 32761 2nd yr Dec 31
By depreciation a\c
9239
Dec 31
To interest 1638 Dec 31
By bal c\d 25160
34399 34399
LEASE ACCOUNT
3rd yr Jan 1
To bal b\d 25160
3rd yr Dec 31
By depreciation a\c
9239
Dec 31
To interest 1258 Dec 31
By bal c\d 17179
26418
26418
4th yr Jan 1
To bal b\d 17179
4th yr Dec 31
By depreciation a\c
9239
Dec 31
To interest 859 Dec 31
By bal c\d 8799
18038
18038
5th yr Jan 1
To bal b\d 8799 5th yr Dec 31
By depreciation a\c
9239
Dec 31
To interest 440
9239 9239
DEPRECIATION FUND METHODThis method is implies that the amount
written off as depreciation should be kept aside and invested in readily saleable securities. The securities accumulate and when the life of asset expires, the securities are sold and with the sale proceeds a new asset is purchased. The rate of interest which is easily calculated from sinking fund tables , an extract of given below :
years 3% 3 1% 2
4% 4 1% 2
5%
3 0.323540
0.321934
0.320349
0.318773
0.317208
4 0.239027
0.237251
0.235490
0.233741
0.232012
5 0.188350
0.186481
0.184627
0.182792
0.180975
SINKING FUND TABLE
QUESTION:- A company purchased a 3 years lease on January 1,2007 for Rs. 25000. It is decided to provide for the replacement of lease at the end of 3 years by setting up a depreciation fund .It is expected that the investments will fetch interest at 5%. Sinking fund table show that to provide the requisite sum at 5% at the end of 3 years an investment of Rs 7932 is required every year. Investment are made to the nearest rupee. On 31st Dec,2009 the investments were sold for Rs. 15250. on 1st January,2010, the same lease was renewed for a further
period of 3 years by payment of Rs. 30000.
DEPRECIATION FUND ACCOUNT2007 Jan 1
To bal c\d 7932
2007 Dec 31
By depreciation a\c
7932
2008Dec 31
To bal c\d 16261
2008 Jan 1
By bal b\d 7932
Dec 31
By bank 397
Dec 31
By depreciation a\c
7932
16261
16261
2009 Dec 31
To depreciation Fund investment a\c
1011
2009 Jan 1
By bal b\d 16261
Dec 31
To lease a\c 25000
Dec 31
By bank [interest] 813
Dec 31
By depreciation a\c
7932
Dec 31
By profit & loss a\c
1005
26011
26011
DEPRECIATION FUND INVESTMENT ACCOUNT
2007 Dec 31
To bank 7932 2007 Dec 31
By bal c\d 7932
2008 jan 1
To bal b\d 7932 2008 Dec 31
By bal c\d 16261
Dec 31
To bank 8329
16261
16261
2009 jan 1
To bal b\d 16261
2009 Dec 31
By bank 15250
Dec 31
By depreciation fund a\c [loss transferred]
1011
16261
16261
INSURANCE POLICY METHODThis method is similar to the
depreciation fund method but instead of making investment , arrangement are made with an insurance company which will receive premiums annually and pay at the end of the fixed period the required amount . Premiums have to be paid at the beginning of each year.
QUESTION:-On 1st jan. 2006,a lease of premises is purchased for four years for Rs.50000 and it is decided to make provision for the replacement of the lease by means of an insurance policy purchased for an annual premium of Rs.12000. show the necessary ledger account for four years assuming that the renewal of the lease costs Rs.50000 on 1-1 2010.
LEASE ACCOUNT 2006 Jan 1
To bank a\c 50000
2006 dec31
By bal c\d 50000
2007 jan 1
To bal b\d 50000
2007dec31
By bal c\d 50000
2008 jan 1
To bal b\d 50000
2008dec31
By bal c\d 50000
2009 jan 1
To bal b\d 50000
2009dec31
By bal c\d 50000
DEPRECIATION RESERVE ACCOUNT
2006 Dec 31
To bal c\d 12000
2006 Dec 31
By profit and loss a\c
12000
2007 Dec 31
To bal c\d 24000
2007 Jan 1
By bal b\d 12000
Dec 31
By profit and loss a\c
12000
24000
24000
2008 Dec 31
To bal c\d 36000
2008 Jan 1
By bal b\d 24000
Dec 31
By profit and loss a\c
12000
36000
36000
2009 Dec 31
To lease a\c 50000
2009 jan 1
By bal b\d 36000
Dec 31
By profit and loss a\c
12000
Dec 31
By depreciation insurance policy a\c [profit on the realisation of policy]
2000
50000
50000
REVALUATION METHOD Under this , the asset is revalued at the end of the accounting year and this value is compared with the value of the asset at the beginning of the year . The difference is treated as depreciation .this method is used in case of bottles, corks, crates or etc
QUSETION:- A company manufactures loose tools for its own use .At the end of each year, depreciation is charged on revaluation method. From the following particulars show the loose tools account :Year ended 31-12-2006-loose tools manufactured Rs .5000[revalued on 31-12-2006:Rs.4100]
Year ended 31-12-2007-loose tools manufactured :Rs. 2700 [revalued on 31-12-2007:Rs5700]Year ended 31-12-2008-loose tools manufactured :Rs.1000 [revalued on 31-12-2009:Rs.6000] Year ended 31-12-2009-loose tools manufactured :Rs.1500[revalued on 31-12-2009: Rs.5100]
LOOSE TOOLS ACCOUNT 2006 TO COST OF
PRODUCTION A\C
5000
2006
BY DEP A\C [Bal .fig.]
900
BY BAL C\D 4100
5000
5000
2007 TO BAL B\D 4100
2007
BY DEP A\C [Bal .fig.]
1100
TO COST OF PRODUCTION A\C
2700
BY BAL C\D 5700
6800 6800
2008 To bal b\d 5700 2008 By depreciation a\c
700
To cost of production a\c
1000 By bal c\d 6000
6700 6700
950
250
1200
DEPLETION METHODThis method is mostly used in case of mine,
quarries; etc. from which certain quantity of output is expected to be obtained . The value of mine depends only upon quantity of minerals that can be obtained .when the whole quantity is taken ,the mine loses its value .the rate of depreciation is worked out only so much per tonne. It is simply dividing the cost of the mine by the total quantity of the minerals expected to be available.
QUESTION:-A mine was acquired at a cost of Rs.20,00,000 on 1st July 2007. It was expected it would yield 2,00,000 tons of minerals in all. The actual output was 2007-10,000 tons ,2008-40,000 tons and 2009-32,000 tons. Write up the mine account for the above years using depletion method of
charging depreciation. Rate of depreciation =Rs.10 per ton
MINE ACCOUNT 2007 July 1
To bank a\c 2000000
2007 Dec 31
By depreciation a\c
100000
Dec31
By bal c\d 1900000
2000000
2000000
2008 Jan 1
To bal b\d 1900000
2008 Dec31
By depreciation a\c
400000
Dec31
By bal c\d 15000000
1900000
1900000
2009 Jan 1
To bal b\d 1500000
2009 Dec 31
By depreciation a\c
320000
Dec 31
By bal c\d 1180000
1500000
1500000
2010 Jan 1
To bal b\d 1180000
MACHINE HOUR RATE METHODThis method is useful in case of
machines .The life of machine is fixed in terms of hours . Hourly rate of depreciation is worked out by dividing the cost of the machine by the total number of hours for which the machine is expected to be used .depreciation to be written off in a year will be ascertained by multiplying the hourly rate of depreciation by the number of hours that the machine actually runs in the year.
QUESTION:- A machine was acquired on 1st April,2008 at a cost of Rs 90,000, the cost of installation being Rs. 10000. It is expected that its total life will be 20,000 hours. During 2008 it worked for 5,000 hours and during 2009 for 8,000 hours. Write up the machinery account for 2008 & 2009. Machine hour rate= Rs 5 per hour
MACHINERY ACCOUNT 2007Ap 1
To bank a\c [cost and installation charges]
100000
Dec 31
By depreciation a\c
25000
Dec31
By bal c\d 75000
100000
100000
2009 Jan 1
To bal b\d 75000 2009Dec31
By depreciation a\c
40000
Dec31
By bal c\d 35000
75000 75000
2010 Jan 1
To bal b\d 35000
CHANGE OF METHODSometimes the method is changed either
from straight line method to diminishing balance method or from diminishing balance method to straight line method with effect from the current year or with retrospective effect .if the change is from current year then there will be no problem but simply to change the method of depreciation .
QUESTION:- Plant and machinery account of a company had a debit balance of Rs. 1,47,390 on 1st jan ,2009.The company was incorporated in 2006 and has been following the practice of charging full year, depreciation every year on diminishing balance system @15%. In 2009 it was, however decided to change the method from reducing system to straight line with retrospection effect from 2006 and to give effect of the change while preparing the final accounts for the year ended 31st dec,2009, the rate of depreciation remaining same as before. In 2009, new machineries were purchased at a cost of Rs.50,000. All the other machineries were acquired in 2006.
Show Plant and machinery account from 2006 to 2009.
PLANT AND MACHINERY ACCOUNT
2006 Jan 1
TO BANK A\C
240000
2006 Dec31
BY DEP A\C [15% on Rs 240000]
36000
Dec31
BY BALC\D 204000
240000
240000
2007 Jan 1
TO BAL B\D 204000
2007 Dec31
BY DEP A\C [15% on Rs204000
30600
Dec31
BY BAL C\D 173400
204000
204000
2008 Jan 1
To bal b\d 173400
2008 Dec 31
By depreciation a\c [15% on Rs173400
26010
Dec 31
By bal c\d 147390
173400
173400
2009 Jan 1
To bal b\d 147390
2009 Dec 31
By profit and loss a\c [additional dep] 2
15390
Jan 1
To bank a\c [Additions]
50000 Dec31
By depreciation a\c [15%on 240000+50000]
43500
Dec 31
By bal c\d 138500
197390
197390
PROVISIONS AND RESERVESMEANING OF PROVISIONS
The term “provision” means any amount written off or retained by way of providing depreciation ,renewals or diminution in the value of assets or retained by way of providing for any know liability the amount of which may not be determined with substantial accuracy
Question:- A firm desires to debit its profit and loss account with a uniform figure every year in respect of repairs and renewals. It expects that considering the life of the asset in question Rs.10,000 will be the average amount to spent per year. Actual repairs are Rs.1,000 in the first year, Rs.2,300 in the second year and Rs.3,700 in the third year. Show the provision for repairs and renewals account.
FOR REPAIRS AND RENEWALS ACCOUNTYEAR 1
To bank [Repairs] 1000 YEAR 1
By profit and loss a\c
10000
To bal c\d 9000
10000 10000
2 To bank [Repairs] 2300 2 By bal b\d 9000
To bal c\d 16700 By profit and loss a\c
10000
19000 19000
3 To bank [Repairs] 3700 3 By bal b\d 16700
To bal c\d
23000
By profit and loss a\c
10000
26700
26700
MEANING OF RESERVE
Any sum which is appropriated out of profit and loss
appropriation account and is not meant to cover up
liability,contingency,commitment,or reduction in the value of an
asset is a reserve.
QUESTION:- Show the distinction between sinking fund to repay a liability and sinking fund to replace a wasting asset by the operation of ledger account at the end of five years in the following cases: 1. sinking fund to replace leasehold property valued Rs. 900000 at the end of five years . 2. sinking fund to repay Rs. 900000 debentures at the end of five years .
To old lease a\c [transfer]
900000 By bal b\d 900000
1. Sinking fund [to replace an asset at the end of five years]
OLD LEASE ACCOUNT
To bal b\d 900000 By sinking fund a\c [transfer]
900000
To bank a\c 900000
NEW LEASE ACCOUNT
2. Sinking fund [to repay a liability at the end of five years]To reserve fund [transfer]
900000 By bal b\d 900000
DEBENTURES ACCOUNT
To bank a\c 900000 By bal b\d 900000