accountig for fixed assets

Accounting for Fixed Assets, Financial AccountingRabin Hada

Accounting for Fixed Assets

Fixed AssetEvery business acquires various types of fixed assets such as land & building, plant & machinery, furniture, vehicles etc. These assets are used to derive production capacity. Therefore, they are also known as earning assets. Fixed assets are purchased for continued and long-term use in earning profit in a business. They are written off against profits over their anticipated life by charging an annual amount calculated so as to eliminate the original cost, less scrap, over that period.

The life of fixed assets spans over several years. Therefore, the business needs to make long term investment in fixed assets.

DepreciationExcept land, all fixed assets have a limited life. During such period, due to continuous use and/or lapse of time, the value of some assets starts decreasing. Such a gradual decrement of value of assets is called Depreciation. Hence, depreciation can be defined as a decline in the value of an asset due to constant use.

Since these assets have limited life, sooner or later they have to be replaced. At the time of replacement, the business incurs heavy cash outflow which can create liquidity problem in that year. In order to avoid such problem, a fixed amount out of profit is set aside as depreciation account. By the time the fixed asset expires, sufficient amount of fund will be accumulated in depreciation account which, then can be used to buy new asset. Hence, the process of setting aside a fixed amount as expense in depreciation account is called Depreciation.

Characteristics of DepreciationThe following are some of the features of depreciation:

1. Depreciation may be physical and functional.2. Depreciation is a gradual/permanent and continuous decrease in the utility value of a

fixed asset and it continues till the end of useful life of an asset.3. Depreciation arises due to the use of assets in productive activities.4. The primary object of depreciation is to allocate expired cost of fixed assets against a

number of accounting periods.5. Depreciation is charged in respect of fixed assets only i.e., building, machinery,

equipment and furniture etc.6. Depreciation is a charge against profit.7. Total depreciation of an asset can not exceed its depreciable value (cost less scrap value).

Causes of DepreciationDepreciation is a measure of reduction in the use-value of an asset. It can be physical deterioration or decrease in the market value. The primary causes of depreciation are as follows:

1. Wear and Tear: Due to constant use, assets get worn or torn out.

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2. Exhaustion: Exhaustion is the depletion of some assets due to continuous use and lapse of time. In case of mines and oil wells, the continuous extraction of minerals or oil, a stage comes when the mine or well gets completely exhausted an nothing is left.

3. Obsolescence: Some assets are discarded before they are completely worn out because of changed conditions. This is the case when an asset becomes usefulness because of technological advancement, new invention, change in style etc. in that asset.

4. Efflux of time: Certain assets get decreased in their value with the passage of time. This is true in case of assets like leasehold properties, patents and copyrights etc.

5. Accidents: Accidents can cause depreciation in the value of the asset.

Objectives of making provision for depreciationDepreciation accounting is a must for every business for attaining the following objectives:

1. To ascertain net profitDepreciation is the expense for the business. Hence to ascertain the net profit, it must be included in the total cost of sales.

2. To depict the true financial position of the businessThe balance sheet depicts true financial position of a business at a point of time. To depict the true financial position of the business the assets should be shown in balance sheet not in its original cost but at the depreciated cost. That is all fixed assets should be shown at cost less the amount of depreciation suffered by them till the date of the balance sheet.

3. To ascertain cost of productionDepreciation is an expense. Hence it is necessary to charge depreciation in the total cost of production to fix true sales price of the goods and service.

4. Replacement of assetsOne of the primary objectives of depreciation is the provision for the replacement cost on the retirement of original assets.

5. To follow the company actAccording to company act, it is compulsory to charge depreciation on fixed assets.

6. To ascertain income taxIf depreciation is not charged, the operation will show more profit. As a result, the taxable income will be higher. Hence, depreciation is charged for the correct ascertainment of total taxable income.

Accounting Treatment for DepreciationSince depreciation is an expense it must be charged to Profit & Loss a/c. The entire process begins with the purchase of fixed asset. In the next step, the following journal entries have to be passed for recording depreciation on assets.

1. For purchase of fixed assets

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Fixed assets a/c Dr. ………………To, Cash/Bank a/c ………………(For purchase of fixed assets)

2. For charging depreciation at the end of the yearDepreciation a/c Dr. ………………To, Fixed asset a/c ………………(For depreciation on asset)

3. For transferring depreciation to PL a/cProfit & Loss a/c Dr. ………………To, Depreciation a/c ………………(For transfer of depreciation to P/L a/c)

Additional Entries4. For sale of fixed assets

Cash/Bank a/c Dr. ………………To, Fixed asset a/c ………………(For sale of fixed asset)

5. For gain on sale of fixed assetsFixed asset a/c Dr. ………………To, Profit & Loss a/c ………………(For gain on sale of fixed asset)

6. For loss on sale of fixed assetProfit & Loss a/c Dr. ………………To, Fixed asset ………………(For loss on sale of fixed asset)

Methods of DepreciationThere are a number of different methods of providing depreciation for the assets. The method of depreciation depends on a number of factors such as type of asset, life, policy organization etc. The following are the list of methods of depreciation:

1. Fixed installment method2. Diminishing Balance method3. Sum of the year digits method4. Annuity method5. Depreciation Fund method6. Insurance policy method 7. Revaluation method8. Depletion method9. Machine hour rate method10. Double declining methods11. MACRS (Modified Accelerated Cost Recovery System) method

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As per the syllabus of BIM 4th Semester, we will discuss following 3 methods only:1. Straight Line Method2. Written Down Method3. Depreciation Fund Method

Straight Line MethodThis method is also known as Fixed Installment Method, Equal Installment Method, Original Cost Method, Simple or Historical Cost Method. Under this method, a fixed proportion of original cost of the asset is written-off annually so that by the time asset is worn out, its value in the books is reduced to zero or residual value.

The amount of depreciation to be charged each year can be found out as follows:

Advantages1. It is simplest to understand and easy to apply.2. The value of asset can be reduced to zero or its scrap value.

Disadvantages1. This method does not take in account the effective utilization of the asset. The same

amount of depreciation is charged from year to year, irrespective of use of the asset.2. With the passage of time, efficiency of asset decreases but the amount of depreciation

remains the same, which does not seem to be justified.

Accounting Treatment1. Pass the necessary journal entries2. Fixed asset account3. Depreciation account

Illustration 1

A machine was bought on January 1, 1990 for Rs.8,000. It cost Rs.1,000 for transportation and Rs.1000 for installation. The scrap value of the machine is estimated to be Rs.1,000 at the end of its three years of working life. Prepare plant account with the help of journal entries for 3 years after charging depreciation according to Straight Line Method.Solution:

Total cost of machine = Rs.8,000 + 1,000 + 1,000= Rs.10,000

Estimated scrap value = Rs.1,000

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= Rs.3,000

Journal Entries

Date Particular LF Debit CreditJan 1, 1990 Machine a/c Dr.

To, Bank a/c(For purchase of machine)

10,00010,000

Dec. 31, 1990

Depreciation a/c Dr.To, Machine a/c(For charging depreciation on machine)

3,0003,000

Dec. 31, 1990

Profit & Loss a/c Dr.To, Depreciation a/c(For transfer of depreciation to P/L a/c)

3,0003,000

Dec. 31, 1991


3,0003,000

Dec. 31, 1991


3,0003,000

Dec. 31, 1992


3,0003,000

Dec. 31, 1992


3,0003,000

Dec. 31, 1992

Cash/Bank a/c Dr.To, Machine a/c(For realization of scrap value)

1,0001,000

Dr. Depreciation Account Cr.Date Particular LF Amount Date Particular LF Amount

Dec.31, 1990

To, Machine a/c 3,000 Dec.31, 1990

By, P/L a/c 3,000

3,000 3,000

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Dec.31, 1991

To, Machine a/c 3,000 Dec.31, 1991

By, P/L a/c 3,000

3,000 3,000Dec.31,

1992To, Machine a/c 3,000 Dec.31,

1992By, P/L a/c 3,000

3,000 3,000

Dr. Machine Account Cr.Date Particular LF Amount Date Particular LF Amount

Dec.31, 1990

To, Bank a/c 10,000 Dec.31, 1990

By, Dep. a/cBy, Bal c/d

3,0007,000

10,000 10,000Dec.31,

1991To, Bal b/d 7,000 Dec.31,

1991By, Dep. a/cBy, Bal c/d

3,0004,000

7,000 7,000Dec.31,

1992To, Bal b/d 4,000 Dec.31,

1992By, Dep. a/cBy, Bank a/c

3,0001,000

4,000 4,000

ProblemA trader bought machinery on 1st January, 1993 for Rs.1,25,000 whose useful life has been estimated 5 years. After the expiry of useful life the scrap will realize Rs.25,000. Prepare machinery account and depreciation account, charging depreciation by fixed installment method for 5 years. Also pass necessary journal entries.

Addition and sale of assets during the yearDuring the accounting period, a firm can buy and/or sale its fixed assets. The additional purchase of assets increase the amount of depreciation whereas sales of existing assets decrease the amount of depreciation at the end of the period.

Addition of assetThe depreciation for the additional assets purchased during the accounting period may be provided on either of the following two basis:

1. Depreciation may be provided for a year for the additional assets irrespective of use period. That is, depreciation may be provided for a year even if assets are added in middle or near to end of accounting period.

2. Depreciation may be provided on assets added for the use period only. That is, depreciation should be provided for the period of the date of purchase to end of accounting period, i.e., for use period only.

Note: If date of addition and method of charging deprecation is given in the problem, then depreciation on additional assets should be provided for use period only.

Illustration 2

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The financial year of a firm is closed on December 31, each year. It purchased the following machinery:

On January 1, 1996 Machine costing Rs.30,000On July 1, 1996 Machine costing Rs.20,000On April 1, 1997 Machine costing Rs.10,000

The machinery is to be depreciated by fixed installment method at 10% p.a. Show the machinery account for 1996 and 1997.Solution:

Year Particular Machine TotalDepreciation1 2 3

1996 CostDepreciation

30,0003,000

20,0001,000

-- 4,000

1997 Bal b/dDepreciation

27,0003,000

19,0002,000

10,000750 5,750

Balance 24,000 17,000 9,250

Note: - Depreciation for 1st machine is provided for a year in 1996 and 1997.- Depreciation on 2nd machine is provided only for 6 months in 1996 and for a year in 1997.- Depreciation on 3rd machine is provided for 9 months in 1997.

Dr. Machinery Account Cr.Date Particular LF Amount Date Particular LF AmountJan 1, 1996

July 1, 1996

To, Bank a/c

To, Bank a/c

30,000

20,000

Dec.31, 1996


4,00046,000

50,000 50,000Jan 1, 1997

April 1, 1997

To, Bal b/d

To, Bank a/c

46,000

10,000

Dec.31, 1991


5,75050,250

56,000 56,000

ProblemOn 1st January 1999 a company purchased a plant and machinery costing Rs.1,00,000. It is estimated that the working life of the plant is 10 years after which its break up value will be zero.

Additions are made on 1st April, 2000 to the value of Rs.50,000. Its probable life was estimated at 5 years and scrap value at the end of life is Rs.10,000.

More additions are made on 1st July, 2001 to the value of Rs.44,000 (Break up value Rs.4,000). The working life was estimated at 4 years.

It was decided to write off depreciation by Straight Line Method. The accounts are closed on 31 st

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December each year.Required: Show the plant and machinery account for the first 4 years.

Sale of assetsDuring the accounting period, the firm may sell its partial or whole assets due to various reasons before the expiry of their useful life. In such a case, the depreciation should be provided on those assets up to their date of sales. The assets can be sold at book value (original cost – accumulated depreciation) or at a profit or at loss. The gain or loss should be accounted accordingly.

Illustration 3Clinton maintains his books of accounts on calendar year basis. He purchased on 1.1.94 a machine for Rs.40,000. He purchased another machine on 1st October 1994 for Rs.20,000 and on 1st July 1995 for Rs.10,000. On 1st July, 1996 one fourth of the machine installed on 1st January, 1994 became obsolete and was sold for Rs.6,800.

Show hoe the machinery account will appear in the books of Clinton for all the 3 years under fixed installment method. Depreciation is to be charged at 10% per annum.Solution:

Year Particular Machine TotalDepreciation1 2 3

1994 CostDepreciation

40,0004,000

20,000500

-- 4,500

1995 Balance & costDepreciation

36,0004,000

19,5002,000

10,000500 6,500

1996 BalanceDepreciation

32,0003000+500

17,5002,000

9,5001,000 6,500

Dr. Machinery Account Cr.Date Particular LF Amount Date Particular LF Amount1.1.941.10.94

To, Bank a/cTo, Bank a/c

40,00020,000

31.12.94 By, Dep. a/cBy, Bal c/d

4,50055,500

60,000 60,0001.1.951.7.96

To, Bal b/dTo, Bank a/c

55,50010,000

31.12.95 By, Dep. a/cBy, Bal c/d

6,50059,000

65,500 65,5001.1.96 To, Bal b/d 59,000 31.12.96 By, Bank a/c

By, Dep. sold machineBy, P/L a/c (loss)By, Dep. a/cBy, Bal c/d

6,800500

700

6,00045,000

59,000 59,000

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ProblemA machine was purchased for Rs.10,000 on 1st January, 1988. It was decided to depreciate it at the rate of 10% on original cost method. On 1st July, 1989 another machinery was purchased for Rs.20,000. On 1st January, 1990 the machinery bought on 1st January, 1998 was sold for Rs.8,500.

Prepare machinery account for 3 years, assuming that the books are closed on 31st December each year.

(Ans: Profit on sale of machinery Rs.500; Balance on machinery account on 31 st Dec, 1990, Rs.17,000).

Written Down MethodThis method is also known as Diminishing Balance method, Reducing Balance method. Under this method, a fixed percentage of depreciation is charged on the reducing balance of asset (cost - depreciation) till the amount is reduced to scrap value. Since a constant percentage rate is being applied to the written down value, the amount of depreciation charged every year decreases over the life of the asset. This method assumes that an asset should be depreciated more in earlier years of use than later years because the maximum loss of an asset occurs in the early years of use.

The fixed percentage rate, to be applied to the allocation of net cost as depreciation, can be obtained by following formula –

Where, n = Estimated useful life of the asset

ExampleThe cost of asset is Rs.2,16,000 and salvage value at the end of useful life is Rs.27,000. The estimated useful life of asset is three years. It is decided to depreciate the asset under written down value method.Required: Rate of Depreciation

Solution:

= 50%

Advantages1. The amount of depreciation decreases continuously with the gradual decrease in the

service potential of asset.

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2. When additions are made to the asset, fresh calculation of depreciation is not required.3. Under this method larger amount of depreciation is provided in earlier years and thus

method minimizes the impact of obsolescence.

Disadvantages1. Amount of depreciation expenses decreases even if the efficiency of asset is maintained

by way of repairs and maintenance.2. Heavy depreciation expenses will be charged to profit and loss account in earlier years.3. Even after becoming obsolete, the book value of asset can never be zero.

IllustrationAn asset was purchased for Rs.50,000 on 1st January, 1998. Assuming annual depreciation to be 10%, show the asset account for 3 years under written down value method.Solution:

Calculating depreciation for 3 yearsYear Balance of asset Depreciation

1 50,000 5,0002 45,000 4,5003 40,500 4,050

Asset AccountDate Particular LF Amount Date Particular LF Amount

1.1.1998 To, Bank a/c 50,000 31.12.98 By, Dep. a/cBy, Bal c/d

5,00045,00

50,000 50,0001.1.98 To, Bal b/d 45,000 31.12.98 By, Dep. a/c

By, Bal c/d4,500

40,50045,000 45,000

1.1.98 To, Bal b/d 40,500 31.12.98 By, Dep. a/cBy, Bal c/d

4,05036,450

40,500 40,500

Dr. Depreciation Account Cr.Date Particular LF Amount Date Particular LF Amount

31.12.98 To, Asset 5,000 31.12.98 By, P/L a/c 5,0005,000 5,000

31.12.98 To, Asset 5,000 31.12.98 By, P/L a/c 5,0005,000 5,000

31.12.98 To, Asset 5,000 31.12.98 By, P/L a/c 5,0005,000 5,000

ProblemA firm purchased plant and machinery on 1st April 1993 for Rs.50,000. Depreciation is written-

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off at the rate of 10% per annum. Show 5 years plant and machinery account and depreciation account under reducing balance method. The firm closes its books on 31st December each year.[Ans: Balance 30,344]

Purchases of assetIllustrationA machine was bought for Rs.40,000 with an estimated life of 10 years. Write off 10% depreciation each on diminishing balance system and show the ledger account for the first five years. At the commencement of third year a new machine worth Rs.5,000 was added.Solution:

Journal Entries

Date Particular LF Debit Credit1st year Machine a/c Dr.

To, bank a/c(Being purchase of machine)

40,00040,000

At the end of 1st year

Depreciation a/c Dr.To, Machine a/c(Being depreciation charged at 10%)

4,0004,000

Profit & Loss a/c Dr.To, Dep. a/c(Being transfer of depreciation to P/L a/c)

4,0004,000

At the end of 2nd year


3,6003,600


3,6003,600

In the beg. of 3rd year

Machine a/c Dr.To, Bank a/c(Being purchase of new machinery)

5,0005,000

At the end of 3rd year


3,7403,740


3,7403,740

At the end of 4th year


3,3663,366

Profit & Loss a/c Dr. 3,366

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To, Dep. a/c(Being transfer of depreciation to P/L a/c)

3,366

At the end of 5th year


3,0293,029


3,0293,029

Dr. Machinery Account Cr.Date Particular LF Amount Date Particular LF Amount

1st year To, Bank 40,000 1st year By, Dep. a/cBy, Bal c/d

4,00036,000

40,000 40,0002nd year To, Bal b/d 36,000 2nd year By, Dep. a/c

By, Bal c/d3,600

32,40036,000 36,000

3rd year To, Bal b/dTo, Bank

32,4005,000

3rd year By, Dep. a/cBy, Bal c/d

3,74033,660

37,400 37,4004th year To, Bal b/d 33,660 4th year By, Dep. a/c

By, Bal c/d3,366

30,29433,660 33,660

5th year To, Bal b/d 30,294 5th year By, Dep. a/cBy, Bal c/d

3,02927,265

30,294 30,2946th year To, Bal b/d 27,265

Sale of assetsOn January 1991 a company acquired machinery for Rs.120,000 and on June 30 th, 1992 it purchased additional machinery at cost of Rs.20,000. On March 31, 1993 one of the original machines which cost Rs.5,000 was found to have become obsolete and was sold as scrap for Rs.500. On that date it purchased a new machine costing Rs.8,000. Depreciation is to be provided at the rate of 15% per annum on written down value on December 31 st of each year. You are asked to write up machinery account for four years.

[Ans: Balance Rs.7,932]

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Depreciation Fund MethodUnder this method, a fixed amount of depreciation is transferred to a fund called Depreciation fund or Sinking fund to accumulate the amount required to replace an asset. This fund is then invested into easily realizable securities. This method takes into account the time value of money. It is based on the concept of present value.

Under this method, a fund is created by debiting Depreciation account and crediting Sinking fund account. Depreciation account is ultimately transferred to Profit and Loss account. An amount equivalent to depreciation charged is invested outside this business or other securities and is allowed to accumulate at compound interest so as to produce the required amount to replace the asset after a specified period of time. The main advantage of this method is that it avoids strain on working capital, if substantial sums are withdrawn from the business to replace the asset at the end of its life. However, during inflation, the depreciable cost of an asset is likely to be less than the replacement cost of the asset.

The asset is shown in balance sheet every year, at its original value. Sinking fund is shown on the liabilities side and sinking fund investment is shown on the asset side of the balance sheet. At the end of the useful life of the asset, all investments are sold away. The proceeds are utilized for purchasing the new asset. The asset account is closed by setting it off against the Sinking fund account. It should be noted that profit or loss on sale of investment is also transferred to the Sinking fund account.

Advantages 1. This method of depreciation assists the business to provide funds for the replacement of

asset when it gets worn out.2. As the amount equal to depreciation is invested outside the business, it results into

generation of extra income on account of interest received.3. As the amount of annual depreciation remains the same thus each year’s profit and loss

account is burdened uniformly.

Disadvantages1. Each year’s depreciation is required to be invested in purchase of investments, interest is

required to be collected and in the last year of life of asset these investments are to be sold, all these activities involve lot of time and labour cost.

2. If the market price of investment falls, it will result in loss to the business.3. In order to purchase investments each year, funds are required to be arranged.4. From accounting point of view also this method is quite time consuming and complex.

Amount of DepreciationThe equal amount of cash to be invested each year is ascertained from the sinking fund table. It can be calculated as follows:

Amount of Depreciation = Original cost – Scrap value Future value of Annuity of Re.1 for given period at given rate

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For e.g.:ABC Co. purchased a machine costing Rs.13500 with an estimated scrap value of Rs.1000. The estimated life of the machine is 5 years. The rate of interest on the investment is 4%. Calculate the amount of depreciation to be charged each year.Sol:

Original cost = Rs.13500Less: Scrap Value = Rs.1000Depreciable value = Rs.12500

Amount of depreciation = Depreciable value FVIFA4%,5yrs= Rs.12500 5.4163= Rs.2307.88

Journal Entries1. At the end of the first year

a. For setting aside the required amountDepreciation a/c Dr.To, Dep. fund a/c

b. For transferring depreciation to P/L a/cProfit and Loss a/c Dr.To, Depreciation a/c

c. For investing the amountDep. Fund Investment a/c Dr.To, Bank a/c

2. Second and subsequent yearsa. For interest on investment

Bank a/c Dr.To, Interest on Dep. Fund Investment a/c

Interest on Dep. Fund Investment a/c Dr.To, Dep. Fund a/c

b. For setting aside the amountDep. a/c Dr.To, Dep. Fund a/c

c. For transferring Depreciation to Profit and Loss a/cDep. a/c Dr.To, P/L a/c

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d. For investing (amount of depreciation plus interest)Dep. Fund Investment a/c Dr.To, Bank a/c

3. Last Yeara. For interest on investment

Bank a/c Dr.To, Interest on Dep. Fund Investment a/c

Interest on Dep. Fund Investment a/cTo, Dep. Fund a/c

b. For setting aside the amountDep. a/c Dr.To, Dep. Fund a/c

c. For sale of investmentBank a/c Dr.To, Dep. Fund Investment a/c

d. For transferring profit or loss on sale of investment(i) For ProfitDep. Fund Investment a/c Dr.To, Dep. Fund a/c

(ii) For LossDep. Fund a/c Dr.To, Dep. Fund Investment a/c

e. For sale of scrapBank a/c Dr.To, Asset a/c

f. For closing Dep. Fund accountDep. Fund a/c Dr.To, Asset a/c

g. For closing Asset accountIf there is any balance in the asset account, it is transferred to Profit & Loss account.

IllustrationSanjay Bros. bought a machine whose estimated life was 5 years. The date of purchase was 1st

January 1990 and its cost was Rs.13500, with a scrap value of Rs.1000. They decided to

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depreciate the machine by sinking fund method. The rate of interest on investments is 4% per annum. At the end of 1994 the investments realized Rs.9700. Show the entries and prepare necessary accounts.

Note: Table shows that Re.0.18463 invested each year at 4% interest amounts to Re.1 after 5 years.Solution:

Cost of machine Rs.13500Less: Scrap Value Rs.1000Amount to be written-off Rs.12500Annual amount of depreciation = 0.18463 X Rs.12500 = Rs.2307.88

Journal EntriesAt the time of machine purchase

1.1.90 Machine a/c DrTo, Bank(Purchase of machine)

Rs.13500Rs.13500

At the end of first year31.12.90 Dep. a/c Dr.

To, Dep. Fund a/c(Annual depreciation credited to Dep. Fund a/c)

2307.882307.88

31.12.90 Profit & Loss a/c Dr.To, Dep. a/c(Depreciation charged to PL a/c)

2307.882307.88

31.12.90 Dep. Fund Investment a/c Dr.To, Bank a/c(Investment purchased)

2307.882307.88

Second years31.12.91 Bank a/c Dr.

To, Interest on Dep. Fund Investment a/c(Interest received)

92.3292.32

31.12.91 Interest on Dep. Fund Inv. a/c Dr.To, Dep. Fund a/c(Interest credited to Dep. Fund a/c)

92.3292.32

31.12.91 Dep. a/c Dr.To, Dep. Fund a/c(Depreciated credited to Dep. Fund a/c)

2307.882307.88

31.12.91 Profit & Loss a/c Dr.To, Dep. a/c(Depreciation debited to PL a/c)

2307.882307.88

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2400.202400.20

Third year31.12.92 Bank a/c Dr.


188.32188.32


188.32188.32


2307.882307.88


2307.882307.88


2496.202496.20

Fourth year31.12.93 Bank a/c Dr.


288.16288.16


288.16288.16


2307.882307.88


2307.882307.88


2596.042596.04

Fifth year31.12.94 Bank a/c Dr.

To, Interest on Dep. Fund 392.01

392.01

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Investment a/c(Interest received)


392.01392.01


2307.882307.88


2307.882307.88

At the sale of Investment31.12.94 Bank a/c Dr.

To, Dep. Fund Investment a/c(Investment sold)

9700.009700.00

31.12.94 Dep. Fund a/c Dr.To, Dep. Fund Investment a/c(Loss on sale of Investment transferred to Dep. Fund a/c)

100.32100.32

31.12.94 Bank a/c Dr.To, Machine a/c(Scrap value of machine)

1000.001000.00

31.12.94 Dep. Fund a/c Dr.To. Machine a/c(Balance of Dep. Fund transferred to Machine a/c)

12500.0012500.00

31.12.94 Profit & Loss a/c Dr.To, Machine a/c(Balance of machine a/c transferred to PL a/c)

100.11100.11

Problem 1A company purchased a plant for Rs.11000. It estimated the turn in value Rs.1000 and useful life 8 years. It decided to make provision for depreciation by means of sinking fund. Show necessary ledger accounts for the first three years. It is ascertained from sinking fund table that Re.0.10472181 invested annually at 5% per annum at compound interest will provide Re.1 a the end of 8 years.

[Ans: Annual depreciation Rs.1047.22; Balance at the end to 3rd year Rs.3301.36]

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Question

Objective Type Questions:1. State which of the following alternatives is correct

a. The main objective of providing depreciation is i. To calculate true profit

ii. To show true financial position in the balance sheetiii. To reduce tax burdeniv. To provide funds for replacement of fixed assets

b. Depreciation arises because of:i. Fall in the market value of an asset

ii. Physical wear and tear iii. Fall in the value of money

c. Under the straight line method of charging depreciation, it:i. Increases every year

ii. Decreases every yeariii. Is constant every year

d. Under the diminishing balance method, depreciation is calculated on:i. The original cost

ii. Written down valueiii. The scrap value

e. A diminishing balance method of providing for depreciation is one, according to which:

i. The amount on which depreciation is calculated, is reduced from year to year

ii. The rate per cent declines from year to year, at which depreciation is charged

iii. The rate per cent as well as amount reduces every yearf. The amount of depreciation charged on machinery will be debited to

i. Machinery accountii. Depreciation account

iii. Cash accountg. Loss on the sale of plant and machinery should be written of against:

i. Share premium accountii. Depreciation fund account

h. Depreciation on the diminishing balance method on a machinery of Rs.2000 at the rate of 10% per annum after three years will be:

i. Rs.1400ii. Rs.145.8

iii. Rs.542iv. None of the above

i. Depreciation is process of:i. Valuation

ii. Allocationiii. Both valuation and allocationiv. None of these

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j. If the cost of the asset is Rs.21000 and the scrap value is Rs.1000 then the amount of depreciation @10% p.a. for the year under the straight line method would be:

i. Rs.2100ii. Rs.2000

iii. Rs.2200

2. Fill up the blanks:a. Depreciation refers to ………………… in the value of assets.b. When depreciation is charged, asset account is ………………… and depreciation

account is …………………c. Depreciation is provided on ………………… assets.d. The sales value of an asset after it becomes useless is called …………………e. Discarding the old machinery due to new invention is called …………………

3. Short Questions:a. What is depreciation? What are its causes?b. How does diminishing balance method differ from fixed installment method?c. What is Depreciation Fund method? What are the objectives of this method?d. Is it compulsory to provide depreciation on fixed assets in a sole trading concern?e. What are the factors to be considered while calculating depreciation?

4. Practical Problems:a. Straight Line Method

i. A company purchased a plant for Rs.4000. The useful life of the plant is 10 years and the estimated scrap value is Rs.400. Determine the rate of depreciation when the management wants to depreciation it by straight line method.[Ans. 9%]

ii. On 1st January, 1990 an asset was purchased for Rs.35000. The estimated life of the asset is 5 years after which its break up value will be Rs.5000 only. Prepare the asset account for the first three years, by straight line method assuming that the books are closed on 31st December.[Ans: Balance of machinery account 31st Dec. 1992, Rs.19500]

b. Written Down Methodi. The original cost of furniture and fixtures amounted to Rs.4000 and it is

divided to write off 5% on the diminishing value of asset as depreciated at the end of the each year. Show the ledger account as it will appear during the first four years.[Ans: Balance of machinery account after four years, Rs.3258.03]

ii. A plant is purchased for Rs.25600. Depreciation is to be provided at 25% pa. on written down value method. The turn in value of plant at the end of its economic life of 4 years is expected to be Rs.8100. You are required to show plant account for 4 years.

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[Ans: The balance in plant account Rs.8100]

c. Depreciation Fund Methodi. A company purchased a lease for Rs.30000 on 1st January 1989. It is to be

renewed at the end of three years. For this purpose a depreciation fund is established. The depreciation fund investments will realize 5%. Sinking fund table shows that Re.0.317208 must be invested each year to obtain Re.1 at the end of 3 years, the rate of interest being 5%.

On 31st Dec., 1991, the investments were realized Rs.19400. A new lease was purchased on the same date for Rs.35000. The balance at the bank before realization of investments was Rs.20000. Give journal entries in the books of the company.

[Ans: Loss on sale of investments Rs.108.29]

End of the Chapter

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21

accountig for fixed assets

Documents

total depreciation

recording depreciation

features of depreciation

use of assets

respect of fixed assets

replacement of assets

case of assets

net profit depreciation