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BANK RECONCILIATION
The bank pass book indicates the amount paid into the bank and the amount withdrawn there from. The pass book balance on any given date must be the same as the balance shown by the bank column of the cash book on the same date. But in actual practice the bank pass book balance seldom agrees with the balance shown by the bank column of the cash book. This happens when some of the transactions appear in the cash book but not in the pass
1. Cheques issued but not presented for payment. When cheques are issued, the entry in the cash book is made immediately. In the books of the bank, the entry is made only when the cheque is presented for payment.. 2. Cheques paid into the bank but not yet cleared. As soon as the cheques arc deposited into the bank, the entry is passed on the debit side of the bank column in the cash book. The customer's account is credited by the bank only when the cheques are cleared. 3. Interest allowed by the bank. Bank
BASICS OF ACCOUNTING
DOUBLE ENTRY SYSTEM 3 TYPES OF ACCOUNTS: -- REAL: ASSETS OF BUSINESS, TANGIBLE AND IDENTIFIABLE. -- PERSONAL: THEY ARE HEADED WITH THE NAME OF PERSON/BUSINESS/FIRM. DEBTORS OR CREDITORS. -- NOMINAL: THEY RECORD TRANSACTIONS OF INTANGIBLES SUCH AS RENT EXPENSES.
EXAMPLES
X co .was maintaining account with KRB Bank Ltd. On 31st December,2006, Bank column of cash book of company showed a debit balance of Rs. 26000. Cheques deposited into the bank but not credited before 31st December,2006 amounted to Rs.4000 Bank charges of Rs. 500 were debited by the bank but no entry was made by the accountant of the company. From the above particulars, find out the balance as per KRB Banks books. A) Rs.30500 B) Rs.25500 C) Rs.21500 D) Rs.22500
Bank Reconciliation
Debit balance in the cash book means a) Overdraft b) Favourable balance c) Temperory overdraft d) None of the above
Bank Reconciliation
Bank reconciliation statement is
A) Ledger account B) Part of the cash book C) Statement containing differnece of cash book and bank pass book D) None of the above
Bank Reconciliation
Bank reconciliation statement is prepared by
A) B) C) D) Business man Bank Debtor None of the above
Bank Reconciliation
To reconcile the cash book with the pass book the un presented cheques are
A) B) C) D) added subtracted multiplied devided
Bank Reconciliation
To reconcile the cash book with the pass book when the cash book is overcast by Rs 100, Rs 100 will be
A) B) C) D) added subtracted multiplied devided
Bank Reconciliation
Undercasting of the credit side of Cash Book has the same effect as overcasting of the A) B) C) D) Debit side of the pass book. Credit side of the pass book. There is no relevance between the two None of the above
TRIAL BALANCE
DEFINITION IT IS A STATEMENT SHOWING CREDIT AND DEBIT BALANCES FROM THE LEDGER. HELPS ARITHMETICAL ACCURACY AND FACILITATES FINAL ACCOUNTS.
TRIAL BALANCE
BASIC PRINCIPLE : SINCE IT IS DOUBLE ENTRY BOOK-KEEPING, HENCE ASSETS AND EXPENSES ARE DEBIT BALANCES LIABILITIES AND INCOMES ARE CREDIT BALANCES . IN CASE OF ARITHMETICAL INACCURACY IDENTIFY CLERICAL/PRINCIPLE ERRORS AND RECTIFY
TRIAL BALANCE
TYPES OF ERRORS: A) CLERICAL ERRORS -- ERRORS OF OMISSION --- OMISSION OF TRANSACTION FROM BOOKS --- COMPLETE OMISSION NOT AFFECTING TRIAL BALANCE --- PARTIAL OMISSION AFFECTING TRIAL BALANCE
TRIAL BALANCE
-- ERRORS OF COMMISSION --- FIGURE POSTED ON THE WRONG SIDE OR WITH WRONG AMOUNT -- COMPENSATING ERRORS --- ONE ERROR BALANCES ANOTHER ERROR . B) ERRORS OF PRINCIPLE -- ERRORS IN CONTRAVENTION OF ACCOUNTING PRINCIPLES
TRIAL BALANCE
RECTIFICATION OF ERRORS IS A SERIES OF STEPS: PASS THE CORRECT ENTRY COMPARE THE WRONG ENTRY WITH THE CORRECT ONE PASS THE RECTIFICATION ENTRY IF TRIAL BALANCE DOES NOT TALLY THEN DIFFERENCE IS TRANSFERRED TO SUSPENCE ACCOUNT
TRIAL BALANCE
TYPICAL TRIAL BALANCE NAME CAPITAL DRAWINGS PURCHASES SALES EXPENSES DEBTORS(CUSTOMRES) CREDITORS(SUPPLIERS) CASH SALES RETURN DEBIT X X X X X X X X CREDIT X
TRIAL BALANCE
TYPICAL ERRORS: -- CLERICAL: A) SALARY PAID 1000/- BUT POSTED AS 10, 000/-. RECTIFICATION: CREDIT SALARY WITH 9000/-. B) SALARY PAID 1000/- BUT POSTED IN RENT A/C. RECTIFICATION: DEBIT SALARY AND CREDIT RENT WITH 1000/-. C) GOODS WORTH 100/- SOLD TO VIJAY WRONGLY RECORDED IN PURCHASE REGISTER. RECTIFICATION: CREDIT SALES AND PURCHASE A/Cs WITH 100/- EACH AND DEBIT VIJAY WITH 200/-.
TRIAL BALANCE
AFTER TRIAL BALANCE IS PREPARED ONE FINDS . . D) SALES OF 500/- POSTED AS 5000/- WHILE RENT PAID 500/- POSTED AS 5000/-. RECTIFICATION: DEBIT SALES WITH 4500/-, CREDIT SUSPENCE WITH 4500/-, CREDIT RENT WITH 4500/-, DEBIT SUSPENCE WITH 4500/-. E) SALARY PAID AS 1000/- BUT POSTED AS 10,000/- IN RENT A/C. RECTIFICATION: DEBIT SALARY WITH 1000/- SUSPENCE WITH 9000/-; CREDIT RENT WITH 10000/F) A PURCHASERS DEBIT BALANCE OF 9000/- HAS NOT BEEN TAKEN. RECTIFICATION: DEBIT DEBTORS, CREDIT SUSPENCE TO THE EXTENT OF 9000/-.
Rectification of Errors-Examples
Sales to Navin of Rs.1000 is debited to Ravin A/c. this will be rectified by---- Debiting Navin a/c and Crediting Ravin A/c Debiting both Accounts Debiting Ravin a/c and Crediting Navin A/c Debiting Navin A/c and crediting Sales A/C
Rectification of Errors-Examples
i. ii. iii. iv. sale of Rs.5000 to Suresh is posted to his credit, then rectification is Credit Suresh to the extent of Rs.10,000 Credit Suresh to the extent of Rs.5,000 Debit Suresh to the extent of Rs.10,000 Debit Suresh to the extent of Rs.5000 Credit
BASIC PRINCIPLE: . ALL EXPENSES AND RECEIPTS OF REVENUE NATURE ARE TAKEN TO TRADING AND PROFIT & LOSS ACCOUNT . ALL EXPENDITURES AND RECEIPTS OF CAPITAL NATURE ARE TAKEN TO BALANCE SHEET
Improve or enhance earning capacity Maintain asset Long duration benefit Non- recurring Balance sheet item Short duration recurring Trading /P & L A/c item
Examples
(4)Preliminary expenses , discount allowed on issue of shares are the examples of
a. b. c. Capital expenditure Deferred revenue expenditure Revenue expenditure
(5) Machinery costing Rs.10,000, whose current book value is Rs.7000 is sold for Rs.12000 what is the amount of capital & revenue receipt
a. b. c. Capital receipt of Rs. 2000 & Rev. Receipt of Rs.10000 Capital receipt of Rs. 9000 & Rev. Receipt of Rs.3000 Capital receipt of Rs. 12000 & Rev. Receipt of Rs.Nil
INVENTORY VALUATION
VALUATION OF STOCKS IS IMPORTANT FROM THE POINT OF INCOME DETERMINATION. THE DANGER COULD BE OF EITHER OVERVALUATION OR UNDERVALUATION OF STOCKS RESULTING IN OVERSTATING OR UNDERSTATING OF PROFITS. METHODS OF VALUATION: -- FIFO -- LIFO -- AVERAGE OR WEIGHTED AVERAGE COST METHOD -- BASE STOCK METHOD -- ADJUSTED SELLING PRICE METHOD
INVENTORY VALUATION
UNDER FIFO GOODS ISSUED TO PRODUCTION IS VALUED AT THE EARLIEST PRICE WHEREAS THE CLOSING STOCK IS AT THE LATEST PRICE. UNDER LIFO GOODS ISSUED TO PRODUCTION IS VALUED AT THE LATEST PRICE WHEREAS THE CLOSING PRICE IS AT THE EARLIEST PRICE. UNDER WEIGHTED AVERAGE COST METHOD ARITHMETIC MEAN OF TOTAL PRICE BY TOTAL QUANTITY RECEIVED IS TAKEN FOR VALUATION.
INVENTORY VALUATION
ADJUSTING SELLING PRICE METHOD IS GENERALLY USED BY SMALL BUSINESSMEN WHO ARE UNABLE TO DIFFERENTIATE VARIOUS COSTS. HENCE THEY VALUE THE STOCKS AT SELLING PRICE AND THEN REDUCE ITS VALUE TO THE EXTENT OF ESTIMATED GROSS MARGIN.
INVENTORY VALUATION
BASE STOCK METHOD IT IS ON THE ASSUMPTION THAT A MINIMUM QUANTITY OF INVENTORY ( BASE STOCK ) MUST BE HELD AT ALL TIMES IN ORDE TO CARRY ON THE BUSINESS PRESENTLY ACCOUNTING STANDARDS PERMIT FIFO(HISTORICAL PRICE) OR WEIGHTED AVERAGE COST METHOD. VALUE OF STOCK CAN BE ASCERTAINED BY PERIODIC(PHYSICAL VERIFICATION) OR PERPETUAL INVENTORY ( MAINTAINENCE OF STOCK REGISTER).
INVENTORY VALUATION
CHARACTERISTICS OF DIFFERENT METHODS OF INVENTORY VALUATION FIFO : -- IN RISING MARKET FIFO RESULTS IN HIGHER PROFITS LOCKING UP OF SCARCE W. C. -- GOODS ARE SOLD AT CURRENT HIGHER PRICES WHILE COST OF GOODS REFLECTS LOWER THAN CURRENT COSTS -- IN FALLING MARKET FIFO RESULTS IN LOWER PROFITS
INVENTORY VALUATION
-- LIFO : -- IN FALLING MARKET THE EFFECT IS THE SAME AS THAT OF FIFO IN RISING MARKET -- IN RISING MARKET THE EFFECT IS SAME AS THAT OF FIFO IN FALLING MARKET.
INVENTORY VALUATION
IN THIS CHAPTER IT IS IMPORTANT TO DISCUSS THE VARIOUS ACCOUNTING CONVENTIONS CONSERVATISM CONCEPT: RECOGNITION OF INCREASES IN EARNINGS REQUIRES BETTER EVIDENCE THAN DOES RECOGNITION OF DECREASES THAT IS EXPENSES REALISATION CONCEPT: RECOGNITION OF AMOUNT OF REVENUE THAT HAS CERTAINTY OF REALISATION MATCHING CONCEPT: RECOGNITION OF REVENUES AND EXPENSES FOR A CERTAIN EVENT.
INVENTORY VALUATION
CONSISTENCY CONCEPT: ONCE A CERTAIN METHOD IS DECIDED UPON FOR ALL SUBSEQUENT EVENTS OF THE SAME CHARACTER THE SAME METHOD SHOULD BE USED UNLESS THERE IS A SOUND REASON TO CHANGE MATERIALITY CONCEPT: DEPENDING UPON JUDGEMENT AND COMMON SENSE IMMATERIAL EVENTS / TRIVIAL MATTERS SHOULD NOT BE GIVEN MORE IMPORTANCE THAN WARRANTED. HISTORICAL COSTS: COST OF ACQUISITION DISCOUNTS, IF ANY, + COSTS INCIDENTAL TO BRINGING THE ASSET/ ERECTING THE ASSET.
Example Let's examinethe inventory of Cory's Tequila Co. (CTC) to see how the different inventory valuation methods can affect the financial analysis of a company.
Units Purchased 1,000 1,000 1,000 3,000 Cost/unit Rs10 Rs12 Rs15 Total Value Rs10,000 Rs12,000 Rs15,000
Beginning Inventory = 1,000 units purchased at Rs8 each (a total of 4,000 units)
Income Statement (simplified): January-March* Item Sales = 3,000 units @ Rs20 each Beginning Inventory Purchases Ending Inventory (appears on B/S) *See calculation below COGS Expenses Net Income LIFO Rs60,000 8,000 37,000 8,000 FIFO Rs60,000 8,000 37,000 15,000 Average Rs60,000 8,000 37,000 11,250
LIFO Ending Inventory Cost = 1,000 units X Rs8 each = Rs8,000 Remember that the last units in are sold first; therefore, we leave the oldest units for ending inventory. FIFO Ending Inventory Cost = 1,000 units X Rs15 each = Rs15,000 Remember that the first units in (the oldest ones) are sold first; therefore, we leave the newest units for ending inventory.
Average Cost Ending Inventory = [(1,000 x 8) + (1,000 x 10) + (1,000 x 12) + (1,000 x 15)]/4000 units = Rs11.25 per unit 1,000 units X Rs11.25 each = Rs11,250 Remember that we take a weighted average of all the units in inventory
BILLS OF EXCHANGE
BILL OF EXCHANGE IS THE VEHICLE FOR CREDIT TRANSACTIONS IN BUSINESS; HAS 3 PARTIES: DRAWER WHO MAKES THE BILL/ CREDITOR; DRAWEE ON WHOM THE BILL IS DRAWN; PAYEE -- WHO RECEIVES THE MONEY;
SOMETIMES DRAWER & PAYEE ARE THE SAME. ACCEPTANCE TO PAY BY THE DRAWEE IS ESSENTIAL. .
BILLS OF EXCHANGE
. PROMISSORY NOTE IS SIMILAR ; HAS ONLY 2 PARTIES BUT SIGNED BY DEBTOR; NOTING NECESSARY. . ACCOMODATION BILL : THERE IS NO TRANSACTION; THE BILL IS DISCOUNTED TO RAISE MONEYS FOR BOTH PARTIES, WHO SHARE THE AMOUNT.
BILLS OF EXCHANGE
TYPICAL ENTRIES: . THE ENTRIES IN THE BOOKS OF DRAWER A ARE: DIRECT BILL TRANSACTION BILLS RECEIVABLE a/c DR. TO DRAWEE B . CASH a/c TO BILLS RECEIVABLE ( BILL IS MET ON DUE DATE) DR.
BILLS OF EXCHANGE
BILL ENDORSED TO C . Cs a/c TO BILLS RECEIVABLE ( NO ENTRY WHEN BILL IS MET) BILL SENT FOR COLLECTION . . .
. .
DR.
BANK FOR BILL COLLECTION a/c TO BILLS RECEIVABLE CASH a/c TO BANK FOR BILL COLLECTION ( BILL SENT FOR COLLECTION IS MET)
DR. DR.
BILLS OF EXCHANGE
IN CASE OF DISCOUNTING CASH a/c DISCOUNT a/c TO BILLS RECEIVABLE ( NO ENTRY WHEN BILL IS MET)
DR. DR.
THE ENTRIES IN THE BOOKS OF DRAWEE B: .. As a/c DR. TO BILLS PAYABLE . BILLS PAYABLE a/c TO CASH ( BILL IS PAID) DR.
BILLS OF EXCHANGE
THERE ARE CASES WHEN BILLS ARE DISHONOURED. IN THAT CASE THE ENTRIES ARE AS FOLLOWS: IN As BOOKS: BILL DIRECTLY SENT FOR PAYMENT Bs A/C DR. TO BILLS RECEIVABLE TO CASH ( CASH IS THE NOTING CHARGE) DISHONOUR OF DISCOUNTED BILL . BILLS RECEIVABLE A/C DR. NOTING CHARGES A/C DR. TO CASH (CASH (notary charges) IS PAID TO THE BANK)
BILLS OF EXCHANGE
-- Bs a/c TO BILLS RECEIVABLE TO NOTING CHARGES (BILL RETURNED TO A) DR.
DISHONOUR OF BILL SENT BY BANK FOR PAYMENT . BILL RECEIVABLE a/c DR. NOTING CHARGE a/c DR. TO CASH TO BANK FOR BILL COLLECTION ( DISHONOUR OF BILL FOR COLLECTION) Bs a/c TO BILLS RECEIVABLE TO NOTING CHARGES (BILL RETURNED TO B) DR.
BILLS OF EXCHANGE
DISHONOUR OF ENDORSED BILL DR. DR.
. BILLS RECEIVABLE a/c NOTING CHARGES a/c TO C Bs a/c TO BILLS RECEIVABLE TO NOTING CHARGES (BILL RETURNED TO B)
DR.
CONSIGNMENT ACCOUNT
WHEN OWNER SENDS GOODS TO HIS AGENT FOR THE PURPOSE OF SELLING THEN IT IS CALLED CONSIGNMENT. IT IS DIFFERENT FROM SALE IN THAT THE CONSIGNEE CANNOT DISPOSE OFF THE GOODS ACCORDING TO HIS CHOICE; DOES NOT RECEIVE ANY RISK FROM THE CONSIGNOR; CAN RETURN THE GOODS IF NOT MARKETABLE.
CONSIGNMENT ACCOUNT
IN CONSIGNMENT ACCOUNTING THERE ARE 3 ACCOUNTS: CONSIGNMENT ACCOUNT; WHICH SHOWS GOODS/STOCK AT COST INCLUDING EXPENSES INCURRED IN SENDING THE GOODS. CONSIGNEE ACCOUNT; WHICH IS NET OF HIS SELLING PRICE AND THE NON-RECURRING OR DIRECT EXPENSES INCURRED BY HIM. GOODS SENT ON CONSIGNMENT ACCOUNT.
Consignment Inventory is inventory that is in the possession of the customer, but is still owned by the supplier. In other words, the supplier places some of his inventory in his customers possession (in their store or warehouse) and allows them to sell or consume directly from his stock. The customer purchases the inventory only after he has resold or consumed it. The key benefit to the customer should be obvious; he does not have to tie up his capital in inventory. This does not mean
For a more specific example, consider a bicycle manufacturer that produces a wide range of bicycles ranging in price from a couple hundred dollars to several thousand dollars. He has customers (local independent bicycle shops) that stock his low-to-midpriced models but are hesitant to stock the more expensive bikes because they do not have the confidence that their customers are willing to pay that much for a bike. And, if they do get a customer that wants a high-end bike, they could always special order it for them. The bicycle manufacturer strongly believes that getting his high-end bikes in the shops where customers can see and touch them is critical in driving up sales for these models as well as helping to promote his brand which ultimately drives up sales for the lower cost models. The solution? Well I think you can take it from here. This is a classic consignment model because it is the best-case scenario for applying the consignment inventory model. It works well for:
CONSIGNMENT ACCOUNT
A TYPICAL CONSIGNMENT ACCOUNT WILL APPEAR AS FOLLOWS: DR. CR To goods sent on by consignee consignment (goods sold by (invoice value) consignee) To bank by closing stock (all expenses incurred by Consignor in transporting) To consignee (all expenses incurred by Consignee in selling) To profit & loss a/c
CONSIGNMENT ACCOUNT
NOTES: CLOSING STOCK IS VALUED AT COST/INVOICE PRICE + PROPORTIONATE AMOUNT OF COST INCURRED BY CONSIGNOR IN TRANSPORTING. IF GOODS ARE LOST IN TRANSIT THE SAME METHOD OF COSTING IS APPLIED AND THAT AMOUNT IS CREDITED TO THE CONSIGNMENT ACCOUNT. NOMINAL LOSSES ARE PROPORTIONATELY CHARGED TO ALL STOCK WHETHER SOLD OR NOT. ABNORMAL LOSS IS DIRECTLY CHARGED TO P&L A/C. APART FROM FIXED RATE OF COMMISSION ON THE GOODS SOLD AN ADDITION DEL CREDERE COMMISSION IS PAID TO THE CONSIGNEE FOR ENCOURAGING SALES ON CREDIT BASIS. HOWEVER THE INHERENT RISKS REMAIN WITH THE CONSIGNEE.
Joint Venture
A joint venture (often abbreviated JV) is an entity formed between two or more parties to undertake economic activity together. The parties agree to create a new entity by both contributing equity, and they then share in the revenues, expenses , and control of the enterprise. The venture can be for one specific project only, or a continuing business relationship such as the
JOINT VENTURE
JOINT VENTURE ACCOUNTS ARE TEMPORARY IN NATURE ; FOR THE AD HOC PURPOSE OF AN ASSIGNMENT UNDERTAKEN. IT IS SIMILAR TO A PARTNERSHIP EXCEPT SUCH ASSOCIATIONS ARE TEMPORARY IN NATURE. ALSO IN PARTNERSHIP THE ACCOUNTING IS ON ACCRUAL BASIS WHILE IN JOINT VENTURE ACCOUNTING IS ON CASH BASIS.
JOINT VENTURE
THERE ARE 3 ACCOUNTS: -- JOINT BANK WHICH SHOWS EACH CO-VENTURERS INVESTMENT; -- CO-VENTURERS ACCOUNT -- JOINT VENTURE INTO WHICH THE FINAL PROFIT/LOSS IS TRANSFERRED.
BASIS
Meaning
Option to user
No option is provided to the lessee (user) to purchase the goods Lease rentals paid by the lessee are entirely revenue expenditure of the lesse
Nature of expenditure
LEASING
Contract between two parties Owner of an asset transfers his right of use to other party on payment of a fixed rent periodically Types >> Finance or Capital Lease Operating Lease Service Lease Leveraged Lease
. LEASING HELPS IN IMPROVING SALES VOLUME OF GOODS; REDUCES CAPITAL INVESTMENT FOR LESSEE, INCREASES HIS BORROWING CAPACITY, REDUCES TAX LIABILITY AS RENTALS ARE FULLY TAX DEDUCTABLE, HOWEVER BURDENSOME.
THE LESSOR BREAKS UP THE RENTALS RECEIVED INTO FINANCE INCOME AND ANNUAL LEASE CHARGE. FINANCE INCOME = TOTAL RENTALS OVER THE LEASE PERIOD + RESIDUAL VALUE OF LEASED ASSET -- COST OF LEASED ASSET ( FAIR VALUE ).
Explanation The concept of lease equalisation account is an equaliser between the capital recovery inherent in lease rentals and the depreciation chargeable as per Companies Act. The objective of the lessor is to write-off an amount equal to the capital recovery inherent in lease rentals, so as to leave in the revenue statement only the financing charges
P&L a/c dr. to depreciation (depn. Charged to P & L a/c) if annual lease charge>depn. Lease equalisation a/c dr. to lease terminal adj. P & L a/c to lease equalisation dr.
if annual lease charge<depn . Lease terminal adj. a/c dr. to lease equalisation charge. P&L a/c dr. to other expenses (all other expenses debited)
P & L a/c dr. to lease rent (lease rent charged to P & L) IF LEASE RENT IS PAID FOR THE ENTIRE PERIOD THE SAME IS ACCOUNTED FOR IN BANK A/C AND AN ANNUAL AMOUNT IS CHARGED TO P & L A/C EVERY YEAR
NON-TRADING ORGANISATIONS
NON-TRADING ORGANISATIONS ARE NON PROFIT MAKING BODIES, RENDERING SERVICES TO PUBLIC, COLLECTING MONEYS BY WAY OF MEMBERSHIP FEES, SUBSCRIPTIONS, DONATIONS. HOWEVER TO PREVENT MISUSE OF FUNDS, ACCOUNTS ARE MAINTAINED. RECEIPTS & PAYMENTS STATEMENT CONTAINS REAL ACCOUNTS, ACTUAL RECEIPTS AND PAYMENTS, BOTH CAPITAL AND REVENUE ITEMS. INCOME & EXPENDITURE STATEMENT CONTAINS NOMINAL ACCOUNTS, OF REVENUE ITEMS OF INCOME & EXPENSES FOR A FIXED PERIOD.
NON-TRADING ORGANISATIONS
A TYPICAL WAY OF CONVERTING RECEIPTS & PAYMENTS STATEMENT INTO INCOME & EXPENDITURE STATEMENT IS TAKE THE RECEIPTS/PAYMENTS OF THE CURRENT YEAR SUBTRACT THE OPENING BALANCE OF THE CURRENT YEAR AND ADD THE CLOSING BALANCE ( IF ANY ). THE CLOSING BALANCES WILL CONSTITUTE THE BALANCE SHEET.
DEPRECIATION
DEPRECIATION IS A CHARGE ON PROFITS, TO ACCOUNT FOR THE FALL IN THE VALUE( NOTIONAL OR OTHERWISE ) OF AN ASSET DURING THE PERIOD OF USE. DEPRECIATION OR WRITING OFF OF A CERTAIN PORTION OF AN ASSET ON AN ANNUAL BASIS IS A PRUDENT WAY OF SAVINGS FOR REPLACEMENT OF THE ASSET AFTER ITS USEFUL LIFE IS OVER. SINCE DEPRECIATION IS AN OPERATING COST AND THEREFORE TAX DEDUCTIBLE, EACH YEAR THE SAVING IS TO THE EXTENT OF (TAX RATE)* ANNUAL DEPRECIATION.
DEPRECIATION
DEPRECIATION CAN ALSO BE LOOKED IN A DIFFERENT WAY. DEPRECIATION IS AN ACCOUNTING PROCESS FOR THE GRADUAL CONVERSION OF THE CAPITALIZED COST OF FIXED(TANGIBLE) ASSETS INTO EXPENSE. SIMILARLY, INTANGIBLE ASSETS ARE CONVERTED INTO EXPENSE BY AMORTISATION. WHILE ASSETS SUCH AS NATURAL RESOURCES ARE CONVERTED BY PROCESS CALLED DEPLETION.
DEPRECIATION
WHAT CAUSES DEPRECIATION ? SIMPLY WEAR AND TEAR MISHAPS OBSOLESCENCE PASSAGE OF TIME FALL IN VALUE
DEPRECIATION
IN ORDER TO CALCULATE DEPRECIATION THERE ARE BASIC ISSUES TO BE ASCERTAINED : -- ESTIMATED USEFUL LIFE OF THE ASSET(YEARS). -- THE RESIDUAL VALUE OF THE ASSET. -- METHOD TO BE USED FOR PROVIDING DEPRECIATION.
DEPRECIATION
METHODS OF DEPRECIATION : . STRAIGHT LINE METHOD. EQUAL FRACTION OF THE NET COST(COST OF THE ASSET LESS THE RESIDUAL VALUE) IS CHARGED EACH YEAR. WRITTEN DOWN VALUE METHOD. EQUAL PERCENTAGE OF THE WRITTEN DOWN VALUE IN THE BOOKS OF THE COMPANY IS CHARGED EACH YEAR. SINKING FUND METHOD. IT IS STRAIGHT LINE METHOD BUT THE DEPRECIATION CHARGED OR A PORTION OF IT IS KEPT AS A RESERVE, INVESTED IN MARKETABLE SECURITIES. THE FUND GROWS INTO REPLACEMENT VALUE OF THE ASSET.
Straight line depreciation Year Depreciation 2006Rs 1 8,000 2007Rs 1 8,000 2008Rs 1 8,000 2009Rs 1 8,000 2010Rs 1 8,000 Total Rs 9 0,000 =(Rs110,000 - Rs20,000) x 1/5 =(Rs110,000 - Rs20,000) x 1/5 =(Rs110,000 - Rs20,000) x 1/5 =(Rs110,000 - Rs20,000) x 1/5 =(Rs110,000 - Rs20,000) x 1/5
(*1) Depreciation stops when accumulated depreciation reaches depreciation base. Depreciation base = cost - salvage value = Rs110,000 - Rs20,000 = Rs90,000