UNIVERSITY QUESTIONS

DEPRECIATION

YEAR 2013 (UNIVERISTY QUESTIONS)

1.

Discuss the factors determining

the amount of depreciation. How
depreciation

are

books of accounts?

recorded

in

YEAR 2012 (UNIVERISTY QUESTIONS)

Rollex Chemicals Private Ltd. Purchased on 1st

April, 2003 a machinery costing Rs. 60, 000.
Further purchase of machinery was made on 1st
October, 2003 costing Rs. 40, 000 and on 1st july,
2004 costing Rs. 20, 000.
On 1st January, 2005, one third of the machinery
purchased on 1st April, 2003 was sold for Rs. 10,
000. Prepare machinery account in the books of
company up to 31st December, 2006 assuming
10%. Depreciation P.A. on straight line method.
The Calendar year is the accounting year of the
company. Your answer must be supported by
sufficient working notes.

YEAR 2011 (UNIVERISTY QUESTIONS)

1. Outline

the Concept and

causes of Depreciation.

1.

What

YEAR 2010 (UNIVERISTY QUESTIONS)

is

Depreciation?

Discuss any two methods of

calculating Depreciation and
bring out their relative merits
and demerits.

YEAR 2009 (UNIVERISTY QUESTIONS)

1. Discuss

the factors determining

the amount of depreciation.

How

depreciations

are

recorded in books of accounts?

YEAR 2008 (UNIVERISTY QUESTIONS)

1. Define

and discuss

Depreciation, Depletion
and Amortization.

DEPRECIATION

The term Depreciation implies gradual and permanent

decrease in the value of an asset due to use cost. It is non
cash expenditure transactions which is allowed expenses
for the calculation of profit.

Special features of Depreciation:

Depreciation is loss in the value of assets.
Loss should be gradual and constant.
Depreciation is the exhaustion of the effective life of
business.
Depreciation is the normal feature.
Maintenance of assets is not depreciation.
It is continuing decrease in the value of assets.

Causes of Depreciation:
Constant use : The loss in the value, efficiency and utility of
fixed assets due to its constant use is termed as depreciation.
Expiry of time : The effective life of assets goes on decreasing
with the passage of time.
Obsolescence : The old assets will become obsolete due to
new inventions, improved techniques and technological
advancements.
Depletion : Loss of mineral wealth due to constant working of
mines is also depreciation, but specially known as depletion.
Permanent fail in price : Though fluctuations in the market
value of fixed assets is not recorded in the books. Sometimes we
have to account for this loss such as permanent fall in the value
of investments.
Abnormal factors : Depreciation may also be due to the loss
in the value of assets by accidents and damage.

Need for charging Depreciation

For determination of net profit or net loss : Loss in the
value of assets is undoubtedly a business expense. It must
be recorded and shown at the debit side of the profit and
loss account for the correct calculation of net profit or net
loss.
For showing assets at fair and true value in the
balance sheet : If depreciation is not charged, the assets
will be shown as value more than its actual value.
Provision of funds for replacement of assets: The
assets acquired and used in the business will become
useless after expiry of its estimated life or even before that,
we will have to replace the obsolete assets with another
fresh asset.

Need for charging Depreciation

Ascertaining accurate cost of production :
Depreciation on factory plant and machinery is factory
overhead. It will increase the cost of production and
the price of the commodity will be fixed at appropriate
price.
Distribution of dividend out of profit only : If
depreciation is not charged, the profit will be more and
the excess dividend will be paid out of capital, which
should have been paid out of profit.
Legal Obligation : In addition to tax regulations, it is
necessary for certain types of business organizations,
such as joint stock companies, to charge depreciation
before declaring any dividends.

Factors affecting / determining the

amount of depreciation
There are some relevant factors must taken
into consideration for calculation amount of
depreciation to be shown in the financial
statement.

It is quite impossible to calculate the actual

and accurate amount of depreciation. It can
always be estimated, though we try our best
to be more accurate and correct.

The important factors affecting the amount of

depreciation are enumerated below:1.Total Cost of assets : Value of assets is determined after
adding all expenses of acquiring, installing and constructing
the assets. We should take into consideration the total cost of
assets for determining the rate and the amount of
depreciation.

Case Study : The purchase price of machinery Rs.100000/-,

installation charges Rs.10,000/-. In this case, the depreciation
will be calculated over Rs.110000/- rather Rs.100000/-.

2.Estimated useful life of assets : The estimated working

life of the assets may be measured in terms of years. In case of
depreciation the value of assets is allocated over the estimated
useful life of the asset. If expected life is more, the rate of
depreciation will be lesser and vice versa.

The important factors affecting the amount of

depreciation are enumerated below:3.Estimated scrap value : It is the residual value, which is
expected to be realized even if the asset become obsolete.
Suppose, we purchase a machine for Rs.10,000/- whose expected
life is ten years, if the scrap value is Rs.1000/-, we will have to
arrange Rs.9,000/- i.e. 10,000 1,000 in ten years. Every year
will bear a depreciation of Rs.900/- i.e. 9,000/10.
4.Chance to obsolescence : If the asset acquired is expected to
be obsolete within 5 years, we will have to split its value over 5
years.
5.Addition to assets : Depreciation should be charged on the
additions to the assets also. If book value of furniture on Jan. 1,
2006 is Rs.10,000/- and additions worth Rs.5000/- are made on
July 1, 2006.
6.Legal Provisions : The rate and method of depreciation being
used must be subject to legal provisions. Companies have to
honour the legal provision with regard to depreciation.

METHODS OF DEPRECIATION

Straight line method :

Basic Concepts:
Under this method, the amount of depreciation
remains same over the expected useful life of the
assets. That is why this method is called Fixed
Installment Method. This method is also called
as Original Cost Method because a fixed
percentage of the original cost of asset is charged
as depreciation during the estimated useful life
of the asset.

FORMULA
Formula :
The depreciation to be charged under this method can be
worked by using the following formula :

Amount of Depreciation (D)

Case Study:

A firm purchases a machine at a cost of Rs.510000 on

01.01.2013. The life of the machine is expected to be 5
years. At the end of 5th year, the firm will be able to sell the
machine for Rs.10000. under straight line method amount
of depreciation can be worked out as under:-

CASE STUDY
A firm purchases a machine at a cost of Rs.510000
on 01.01.2013. The life of the machine is expected
to be 5 years. At the end of 5th year, the firm will be
able to sell the machine for Rs.10000. under
straight line method amount of depreciation can be
worked out as under:-

Here:
Annual Depreciation
Thus Rs.1,00,000 will be charged each year as depreciation of the machine.

MERITS
The merits of straight line method are as under:Simplicity : This method is simple and
calculations are easier to understand.
Consistency : It is a consistent method since
amount of depreciation charged each year is equal.
It is a consistent method since amount of
depreciation charged each year is equal. So we
can easily compare the past performance.

MERITS
The Whole cost can be charged as
depreciation : Under this method, the value
of the asset can be reduced to its estimated
scrap value (if the asset has some residual
value) or nil (if the asset has no residual
value). This is not possible under any other
method.
Reasonable presentation : The balance
sheet shows reasonable and fair values of
the assets.

DE-MERITS
Following are the demerits of straight line method:
Not Iogical: It is well known that the efficiency of an asset
falls and the expense on its repairs and maintenance increases
gradually with the passage of time. However, under this
method the amount of depreciation remains constant. Thus,
the total charges (repairs and maintenance plus depreciation)
to profit and loss account increase in the later years.
Improper presentation : Under this method, the book value
is sometimes reduced to zero, however, it may happen that the
asset is being used in the enterprise. In that case balance
sheet does not show the true and fair view of the enterprise.
Unsuitability : This method becomes unsuitable for certain
assets in which maintenance cost is higher in later years like
plant and machinery, land and building etc.

SUITABILITY
This method is suitable where :
The estimated useful life of an asset can
be easily determined and the assets which
gives almost equal utility in terms of
productivity during the useful life of the
asset like Trademark, Copyright etc.
The maintenance and repair cost, cost of
the assets is almost the same during the
useful life of the asset like furniture etc.

DIMINISHING BALANCE METHOD/

W.D.V METHOD
Basic Concepts

Under this method, depreciation is

charged as a fixed percentage on the
book value of the asset every year.
Instead of charging depreciation on
the original cost, depreciation is
charged on reducing balance of every
year.

DIMINISHING BALANCE METHOD

MERITS:

Equal burden on income statement

In the initial year, the depreciation charges are more and repair
expenses are less while in later years, depreciation charges are les
and repair expenses are more. Therefore, the total burden on profit
and loss account remains approximately the same throughout the life
of the asset.
Complying with matching principle
Under this method, higher amount of depreciation is charged on the
profit and loss account in the initial years when the machine is more
efficient giving higher production than the later years when machine
becomes older and produces less.
Logical approach
Written down value method is more logical method than the straight
line method because in the initial years cost of the machine is high so
more amount on account of depreciation is to be charged through
profit and loss account.

DIMINISHING BALANCE METHOD

MERITS:

Approved method by income tax authorities

The method is approved by income tax authorities
Suitable for assets having long life
This method is suitable for those assets which have long life. It is also
suitable for those assets, where additions and extensions are common
feature, such as land, building, plant and machinery.

DIMINISHING BALANCE METHOD

DEMERITS:
Improper presentation
Under this method, the book value of the asset can never be
written down to zero. However, it may happen that some assets
have zero value after some time. Sometimes, to bring down the
book value of the asset to the estimated scrap value some
adjustments are to be carried out in the last year.
Complexity
Under this method, the amount of depreciation cannot be
determined easily. Lot of figure work is involved in this
calculation. It becomes impossible when scrap value of the
asset is zero.
Unsuitability
This method is not suitable for those assets which give a
uniform benefit during their entire useful life.

DIMINISHING BALANCE METHOD

DEMERITS:
No Funds for replacement
Though depreciation is charged every year but the amount
charged is retained in the business and used in routine
business operations. At the time of replacing assets, firm has to
bother for making arrangements of funds, although it has
charged depreciation every year.
Loss of interest
The amount charged as depreciation is not invested outside the
business, so no interest is received. In certain methods, the
amount is invested outside the business in securities and
interest is received.

DIMINISHING BALANCE METHOD

DEMERITS:
Higher rate of Depreciation
The rate of depreciation in this method is higher, because it
will require longer period to write off the asset, if the rate is
lower and the assets may become useless earlier.
In equal burden on profit and loss account
The amount of depreciation goes on declining year after year,
whereas the asset is used equally by every year.

DIMINISHING BALANCE METHOD

SUITABILITY:
This method is useful :
Where the cost of maintenance and
repairs are high in the later years as
compared to the initial years e.g. plant and
machinery.
Where the additions and repairs are
higher in the later years e.g. land and
buildings.

CASE STUDY OF

DIMINISHING BALANCE METHOD

For example : if a machine has been acquired for `. 1,00,000 and depreciation
is charged @ 10% according to written down value method the depreciation
to be charged will be made as illustrated below.
1st Year on `. 1,00,000 @ 10% =
2nd Year on `. 90,000 i.e `10,000 - 10, 000= 90,000 x
3rd Year on `. 81,000 i.e `90,000 - ` 9, 000= 81,000 x
4th Year on `. 72,900 i.e `81,000 - ` 8,100= 72,900 x
It is observed that the balance of machine upon which depreciation is
calculated goes on reducing/diminishing. The amount of depreciation goes on
declining year after year.

DIAGRAMMITIC REPRESENTATION OF

DIMINISHING BALANCE METHOD

10,000

A
B

9,000

8,000

ILLUSTRATION OF

DIMINISHING BALANCE METHOD

(WDV: Sale of assets). Kaushal Traders purchased a second hand
machinery on 1st January 2010 for ` 23,000 and spent ` 2,000 on its
repairs. It was decided to depreciate the machinery at 20% every year,
according to diminishing balance method. Prepare the machinery
account from 2010 to 2012 and show profit or loss as it was sold on 31st
December 2012 for ` 10, 800. The accounts are closed on December 31
every year

Dr.
Date

Cr
Particulars

J.F

Amount
()

2010
Jan 1

Date

Particulars

To Bank A/c

23,000

Dec 31

By Depreciation
A/c

To Bank A/c

2,000

Dec 31

By Balance c/d

2011

5, 000
20, 000
25,000

2011
To Balance b/d

20,000

Dec 31

By Depreciation
A/c

4,000

By Balance c/d

6,000

20,000
2012
Jan 1

Amount

2010

25,000

Jan 1

J.F

20,000
2012

To Balance b/d

16,000

Dec 31

By Depreciation
A/c

3,200

Difference between Straight Line Method and

Written Down Value Method:
Basis
Basis of
Calculation

Straight Line Method

Depreciation is calculated on original
cost of the asset.

Written down value method

Depreciation is calculated on written
down value of the asset.

Amount of
Depreciation

Amount of depreciation remains

same during the useful life of the
asset

Amount of depreciation keeps on

reducing every year.

Book Value

Book-value of the asset can be

reduced to zero or to its scrap value

Book value never gets reduced to zero.

Applicability

Not applicable for income tax

purposes.

Applicable for income tax purposes.

Total Charge

In the initial years, total charge

(depreciation plus repair) is less but
in the later years, total charge
increases as repairs increase while
depreciation remains the same.

The total charge remains almost the

same as in the initial years repairs are
less and depreciation is high while in
later years, repairs increase and
depreciation decreases.

Suitability

Suitable for assets which give almost This method is suitable for assets which
equal utility in terms of productivity
gives higher utility in the initial years like
during the entire useful life of the
Machinery etc.
assets like Trademarks, Copyright
etc.

PROVISIONS:
Provision means setting aside a part of the profits for
meeting a liability in future, the amount of which is not
known accurately at the time of finalization of financial
statements. Provision is to be made in respect of a liability,
which is certain to be incurred, but its exact amount is not
known. If the exact amount can be known, it becomes a
liability and not provision. Provision for Legal Damages,
Provision for Depreciation, Provision for Taxation,
Provision for doubtful debts, and Provision for Discount
for Debtors are few examples of provisions.

OBJECTIVES:
For ascertainment of true net profit: In practice provision
should be created for those expenses or liabilities for which the
exact amount is unknown or cannot be ascertained accurately. For
example: provision created for doubtful debts, provision for discount
on debtors etc.
For ascertainment of true financial position: The business
must make adequate provisions for all expenses and losses, only
then the Balance sheet will depict the true and fair view of the
financial position of business.
To provide for known losses in the future: For meeting a
liability in future, the amount for which is unknown, steps should
be taken to set, aside a part of profits. For example, provision for
taxation, provision for repairs, provision for bad-debts etc.
For uniform charge on income statements: Provisions are
required to be created for equal distribution of expenses and losses
in all the years so that proper analysis can be made.

IMPORTANT OF PROVISIONS:
The importance of Provisions are as follows:
Funds for replacement of asset: Since fixed assets have limited useful
life, they have to be replaced by new assets when they became obsolete. For
this purpose, Provision for Depreciation, is to be made. When provision for
depreciation is made, the amount of depreciation charged to Profit and Loss
Account is retained in the business and can be used for replacement of the
asset in future years.
Funds for diminution in the value of assets: In the case of
diminution in the value of some assets like investments, adequate provision
in respect of provisions for fluctuation in investments is to be made. For this
purpose Investment Fluctuation Fund is to be made.
Uniform charge of income statements: Provision has to be created for
equal distribution of expenses an losses in all the years so that proper
analysis for deviation in income for any year can be examined.
Incompliance of principle of prudence: As per the convention of
conservatism or prudence, provision must be made for all expected losses so
that the business enterprise can be saved from the burden of heavy losses in
future.

EXAMPLES OF PROVISION
Depending upon the need, size and nature
of the operations of the business, different
types of provisions are maintained by the
business enterprise. Usually, a business
enterprise creates Provision for Legal
Damage, Provision for Depreciation,
Provision for Taxation, Provision for
Doubtful Debts, and Provision for
Discount on Debtors.

RESERVES
Reserve means an appropriation of profits
or other surplus to strengthen the liquid
resources of the business enterprise and
not for meeting any liability, contingency or
any commitment of the business. In other
words, reserve means the amount set aside
out of profit and other surpluses, which are
not earmarked in any way to meet any
particular liability known to exist on the
date of Balance Sheet.

RESERVES - IMPORTANCE
Strengthening the Financial Position: Reserves help in
strengthening the financial position of the enterprise, since it
can be used to meet any unforeseen losses that may arise in
future.
Source of Internal Financing: By creating the reserves,
profits are ploughed back into the business which can be used
as source of finance.
Enhancing the reputation of enterprise: In order to
enhance the reputation or image of the company, regular
dividends must be paid to be shareholders in time. It can be
achieved if the company maintains reserves because in the
years of inadequacy of profits, amount can be withdrawn from
these reserves and paid to the shareholders.

RESERVES - IMPORTANCE
Keeping working
increases the working
enterprise.

capital intact: Reserve

capital of the business

Facilitating heavy amount when needed:

Reserve can be created for some specific purpose which
can be used to meet that purpose only. For the
redemption of debentures, company has to pay huge
amount to debenture holders. When the debentures
become due for payment, the company may face a
financial difficulty, because a large amount is generally
required for redemption of debentures.

DIFFERNECE BETWEEN
PROVISIONS AND RESERVES
BASIS
Appropriation
Or charge
Availability of
Profit

PROVISIONS
Provisions are charge on profits

RESERVES
Reserves are an appropriation on profits

Purpose

They are created to meet known

liability

Reserves are created to strengthen the liquid

resources of the business enterprise.

Necessity

Creation of provision is necessary as

per law

Maintenance of reserves is not necessary

because they are created as per financial
prudence.

Accounting
treatment
Sides of balance
sheet

Provisions are recorded on the debit

Reserves are recorded on the debit side of Profit
side of Profit and Loss Account
and Loss Appropriation Account
Provisions may appear on the either
Reserves are always shown on the liabilities side
side of the balance sheet by way
deduction form the concerned asset or
separately on the liabilities side

Investment
Distribution

Provision can never be invested

outside business
Provision can never be distributed as
profit unless actual liability is less than
the amount provided for.

Reserves can be invested outside business and

known as Reserve Fund
Reserves, other than capital reserves, can be
distributed as profit

Effect

Provision reduces net profit

Reserves reduces divisible profits

Creation of provision does not depend Reserves depend upon profit. In the absence of
on profit. They have to be created even adequate profits, reserves cannot be created
if there are inadequate profits or heavy
losses

TYPES OF RESERVES
Broadly, there are two types of reserves:
(1) Revenue Reserves (2) Capital Reserves

Terms used for Different Assets

Broadly, there are two types of reserves:
(1) Revenue Reserves (2) Capital Reserves
The following are the different terms used for different types of
assets:Depreciation This term is used when expired utility of a
physical asset is to be recorded. e.g. building, machinery, vehicle.
Amortization This term is used for describing the process of
writing down the long term investments in intangibles such as
leaseholds, patents, copyright, trade marks, goodwill and heavy
organizational costs.
Depletion : This term is applied to the process of measuring
and recording the exhaustion of natural resources e.g., ore
deposits, oil-wells, timber stands, quarries etc.

Terms used for Different Assets

Obsolescence This term refers to disappearing usefulness
resulting from invention, change of style, legislation or other causes
having no physical relation to the object affected. It is distinguished
from exhaustion, wear and tear and deterioration in that these terms
refers to functional loss arising out of a change in physical condition.
Dilapidations When a property is returned to the landlords after
the expiry of lease period then landlord is entitled to demand that it be
in as good a condition as when it was leased out. For this leaseholders
often set aside a certain amount each year to provide for any
dilapidation that may need to be set right when the property is returned.
For accounting purposes the expected amount of dilapidations is
added to the cost of leased property. The depreciation is provided on
the total cost, thus arrived at.

REVENUE
RESERVES

REVENUE RESERVES
Revenue reserves are created out of profits
which have been earned in the normal course
and from the day to day activities of the
business concern.
Revenue reserves may further be classified as
(A) General Reserve
(B) Specific Reserve
(C) Secret Reserve

General reserves is that amount of

profits which are set aside to meet
some future contingencies and not
created for any specific purpose.
These are generally retained for
strengthening the financial position of
the business concern and to provide
additional working capital for the
business when needed.

To

strengthen the financial position of

the business concern.
To make available additional working
capital all the times.
To meet any liability or contingency, in
case of unforeseen circumstances.
To equalize the rate of dividend over
the years in case of inadequate profits.

Specific reserves are created for some

specific purposes. These reserves
cannot be utilized for any purpose other
than the purpose for which they were
created. However, if the article of
association permits then at the discretion
of board of directors, specific reserves
may be used for a purpose other than the
purpose of its creation.

Dividend

Equalization Reserve.

Debenture

Redemption Reserve.

Investment

Fluctuation Reserve.

Workmen

Compensation Fund.

Secret reserve is a reserve that

do not appear in the balance
sheet. It can be created in the
years of higher profits and can
be merged with the profits
during the lean periods.

 By

undervaluing stock,
By making excessive provisions then the required,
By charging capital expenditure to revenue,
By
showing contingent liabilities as actual
liabilities of the enterprise.
Secret reserve is secret in the sense that it is not
known to the outsides. It is suggested that
keeping in view the requirements of the case,
secret reserve should be created within
reasonable limits.

CAPITAL
RESERVES

Capital reserves are the reserves created out

of capital profits. Following are the examples
of some items which may form capital
reserves:Profit on Sale of Fixed Assets
Profit on Revaluation of Fixed Assets
Securities Premium received on Issue of Shares or
Debentures
Profits on Redemption of Debentures.
Profit prior to Incorporation

Profit on Reissue of Forfeited Shares, etc.

Capital reserves can be utilized for writing off capital losses.

DIFFERENCE BETWEEN

REVENUE RESERVE AND CAPITAL

RESERVE
BASIS

REVENUE RESERVE

CAPITAL RESERVE

1. Source

It is created out of revenue It is created out of capital

profits.
profits.

2. Period

It cannot arise during the It may arise during the period

pre-incorporation period
prior to incorporation.

3. Creation

It is created by retaining It is not created by retaining

profit.
profit.

4. Dividend

It can be used for payment It can be used for payment of

of dividends without any dividend only when certain
precondition.
conditions of Companies Act
are satisfied.

5. Object

It is created to strengthen It is created to meet capital

the financial position, to loss or for companies of legal
meet
unforeseen requirements or accounting

DIFFERENCE BETWEEN

GENERAL RESERVE & SPECIFIC RESERVE

BASIS

GENERAL RESERVE

SPECIFIC RESERVE

1. Meaning

Reserve created not for any Reserve created for some

specific and earmarked purpose specific and earmarked
is known as general reserve.
purpose is known as
specific reserve.

2. Purpose

General reserve is created to Specific reserve is created

meet some future contingencies for some specific purpose.
and for strengthening financial
position of a business concern.

3. Utilization

General reserve is utilized to Specific reserves can be

meet any unknown liability.
utilized only for the
purpose for which they
were created.

4. Dividend

In case of need, general reserve Usually, dividend can not

DIFFERENCE BETWEEN
RESERVE AND RESERVE
FUND
BASIS

GENERAL RESERVE

1. Meaning

Reserve is the amount set Reserve fund is the

aside out of profits and amount of reserve which
other surpluses, securities.
is invested in outside.

2. Purpose

The
basic
purpose
of The basic purpose is to
keeping reserve is to meet earn regular income
any contingent liability
from securities.

3.

Sale

SPECIFIC RESERVE

of As the amount of reserve is There may be profit or

investments

not
kept
outside
the loss
on
sale
of
business in any form so the investments in which
question of selling does not the amount of reserve is
arise.
invested outside the
business.