Accountig for Fixed Assets

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Accounting for Fixed Assets

Fixed Asset Fixed Asset

Ev

Everery y busbusininesess s acacquiquireres s vavaririouous s tytypes pes of of fifixed xed asassesets ts susuch ch as as laland nd & & buibuildldining, g, plplanant t && mac

machinhineryery, , furfurnitnitureure, , vehivehiclecles s etcetc. . TheThese se assassets ets are are useused d to to derderive ive proproducductiotion n capcapaciacityty.. Therefore, they are also known as earning assets. Fixed assets are purchased for continued and 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 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 anticipated life by charging an annual amount calculated so as to eliminate the original cost, less scrap, over that period.

scrap, over that period.

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

investment in fixed assets.

Depreciation Depreciation

Except land, all fixed assets have a limited life. During such period, due to continuous use and/or Except 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 lapse of time, the value of some assets starts decreasing. Such a gradual decrement of value of asset

assets is s is callecalled d DeprecDepreciatiiation. Hence, depreciation. Hence, depreciation can on can be defined as be defined as a decline in a decline in the value of the value of anan asset due to constant use.

asset due to constant use.

Since these assets have limited life, sooner or later they have to be replaced. At the time of 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 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 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 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 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.

aside a fixed amount as expense in depreciation account is called Depreciation.

Characteristics of Depreciation Characteristics of Depreciation

The following are some of the features of depreciation: The following are some of the features of depreciation:

1.

1. DeprDeprecieciatiation may be phon may be physysicaical and funl and functictionaonal.l. 2.

2. DeprDeprecieciatiation on is a is a gragraduadual/pl/permermaneanent and nt and concontintinuous decruous decreasease e in the utilin the utility valuity value e of aof a fixed asset and it continues till the end of useful life of an asset.

fixed asset and it continues till the end of useful life of an asset. 3.

3. DeprecDepreciatiiation ariseon arises due to ts due to the use of he use of assetassets in prs in productioductive activve activitieities.s. 4.

4. The primThe primary objeary object of deprecct of depreciatiation is to ion is to allallocatocate e expexpireired d coscost of t of fifixed assexed assets agaits against anst a number of accounting periods.

number of accounting periods. 5.

5. DeDeprprececiaiatition on is is chchararged ged in in rerespspecect t of of fifixexed d asassesets ts onlonly y i.i.e.e., , buibuildldining, g, mamachchininerery,y, equipment and furniture etc.

equipment and furniture etc. 6.

6. DeprDeprecieciatiation is a chon is a chargarge agaie against pnst profrofitit.. 7.

7. Total depTotal depreciareciation of an astion of an asset can not eset can not exceed itxceed its deprecs depreciable valiable value (cost lue (cost less scress scrap valueap value).).

Causes of Depreciation Causes of Depreciation

De

Deprprececiaiatition on is is a a memeasasurure e of of rereduductctioion n in in ththe e ususe-e-valvalue ue of of an an asasseset. t. It It cacan n be be phyphysisicacall deterioration or decrease in the market value.

deterioration or decrease in the market value. The primary causes of depreciation are as The primary causes of depreciation are as follows:follows: 1.

1. Wear and Tear:Wear and Tear: Due to constant use, assets get worn or torn out.Due to constant use, assets get worn or torn out. 2.

2. Exhaustion:Exhaustion: Exhaustion is the depletion of some assets due to continuous use and lapseExhaustion 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 of time. In case of mines and oil wells, the continuous extraction of minerals or oil, a

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stage comes when the mine or well gets completely exhausted an nothing is left. stage comes when the mine or well gets completely exhausted an nothing is left. 3.

3. Obsolescence:Obsolescence: Some assets are discarded before they are completely worn out because of Some assets are discarded before they are completely worn out because of chan

changed ged conconditditionions. s. ThiThis s is is the case the case whewhen n an an assasset et becobecomes usefulmes usefulnesness s becabecause of use of technological advancement, new invention, change in style etc. in that asset.

technological advancement, new invention, change in style etc. in that asset. 4.

4. Efflux of time:Efflux of time: Certain assets get decreased in their value with the passage of time. ThisCertain 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.

is true in case of assets like leasehold properties, patents and copyrights etc. 5.

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

Objectives of making provision for depreciation Objectives of making provision for depreciation

Depreciation accounting is a must for every business for attaining

Depreciation accounting is a must for every business for attaining the following objectives:the following objectives:

1.

1. To aTo ascscerertatain nin net pet prorofifitt

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

included in the total cost of sales.sales.

2.

2. To depTo depict thict the true fe true finaninanciacial posil position otion of the buf the businesinessss

The balance sheet depicts true financial position of a business at a point of time. To The 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 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 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 shown at cost less the amount of depreciation suffered by them till the date of the balance sheet.

sheet.

3.

3. To aTo ascscertertain cain cost ost of pof proroducductiotionn

Depreciation is an expense. Hence it is necessary to charge depreciation in the total cost Depreciation is an expense. Hence it is necessary to charge depreciation in the total cost of production to fix true sales price of the

of production to fix true sales price of the goods and service.goods and service.

4.

4. ReReplplacacememenent of at of assssetetss

One of the primary objectives of depreciation is the provision for the replacement cost on One of the primary objectives of depreciation is the provision for the replacement cost on the retirement of original assets.

the retirement of original assets.

5.

5. To To folfollow low ththe ce comompapany ny actact

According to company act, it is compulsory to charge depreciation on fixed assets. According to company act, it is compulsory to charge depreciation on fixed assets. 6.

6. To ascertain income taxTo ascertain income tax

If depreciation is not charged, the operation will show more profit. As a result, the If depreciation is not charged, the operation will show more profit. As a result, the ta

taxaxablble e inincocome me wiwill ll be be hihighgherer. . HeHencnce, e, dedeprprececiaiatition on is is chcharargeged d fofor r ththe e cocorrrrecectt ascertainment of total taxable income.

ascertainment of total taxable income.

Accounting Treatment for Depreciation Accounting Treatment for Depreciation

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

passed for recording depreciation on assets.

1.

1. FoFor pur purcrchashase of e of fixfixed aed assssetsets

F

Fiixxeed d aasssseetts s aa//cc DDrr.. ……… T

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(For purchase of fixed assets) (For purchase of fixed assets)

2.

2. For cFor chargharging ding depreepreciatciation at tion at the enhe end of thd of the yeae yearr

D

Deepprreecciiaattiioon n aa//cc DDrr.. ……… T

Too, , FFiixxeed d aasssseet t aa//cc ……… (For depreciation on asset)

(For depreciation on asset)

3.

3. For For trantransfersferring ring deprdepreciaeciation tion to Pto PL a/L a/cc

P

Prrooffiit t & & LLoosss s aa//c c DDrr.. ……… T

Too, , DDeepprreecciiaattiioon n aa//cc ……… (For transfer of depreciation to P/L a/c)

(For transfer of depreciation to P/L a/c)

Additional Entries Additional Entries

4.

4. FoFor sar sale ole of fif fixexed asd assesetsts

C

Caasshh//BBaannk k aa//cc DDrr.. ……… T

Too, , FFiixxeed d aasssseet t aa//cc ……… (For sale of fixed asset)

(For sale of fixed asset)

5.

5. FoFor gar gain oin on san sale ole of fif fixexed asd assetsetss

F

Fiixxeed d aasssseet t aa//cc DDrr.. ……… T

Too, , PPrrooffiit t & & LoLosss s aa//cc ……… (For gain on sale of fixed asset)

(For gain on sale of fixed asset)

6.

6. FoFor lor loss oss on san sale ole of fif fixexed asd assetset

P

Prrooffiit t & & LLoosss s aa//cc DDrr.. ……… T

Too, , FFiixxeed d aasssseett ……… (For loss on sale of fixed asset)

(For loss on sale of fixed asset)

Methods of Depreciation Methods of Depreciation

There are a number of different methods of providing depreciation for the assets. The method of There are a number of different methods of providing depreciation for the assets. The method of deprec

depreciatioiation n depends on a depends on a number of factors such as number of factors such as type of type of assetasset, , lifelife, , policpolicy organizatiy organization on etc.etc. The following are the list of methods of d

The following are the list of methods of depreciation:epreciation: 1.

1. FiFixexed insd instatallllmement ment meththodod 2.

2. DiDimimininishshining Balg Balanance mece meththodod 3.

3. Sum Sum of of the the yeayear r digdigits its metmethodhod 4.

4. AnAnnunuiity ty mmetethohodd 5.

5. DeDeprprececiaiatition Fon Funund med meththodod 6.

6. InInsusurarance nce polpolicicy my metethohodd 7.

7. ReRevavaluluatatioion men meththodod 8.

8. DeDeplpletetioion mn metethohodd 9.

9. MaMachchinine hoe hour ur rarate te memeththodod 10.

10. Double deDouble decliniclining methong methodsds 11.

11. MACRS (Modified MACRS (Modified Accelerated Cost Recovery Accelerated Cost Recovery System) System) methodmethod As per the syllabus of BIM 4

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1.

1. StStraraigight ht LiLine ne MeMeththodod 2.

2. WrWrititteten Don Down Mwn Metethohodd 3.

3. DeDeprprececiaiatition Fon Funund Med Meththodod

Straight Line Method Straight Line Method

This method is also known as Fixed Installment Method, Equal Installment Method, Original This 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 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 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 books is reduced to zero or residual value.

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

asset asset of of Life Life value value scrap scrap estimated estimated asset asset fixed fixed of of Cost Cost Original Original on on Depreciati Depreciati Annual Annual == −− Advantages Advantages 1.

1. It is sIt is simpimpleslest to undt to underserstantand and easd and easy to appy to applyly.. 2.

2. The valThe value of aue of asset sset can be rcan be reduced educed to zerto zero or io or its sts scrap vacrap value.lue.

Disadvantages Disadvantages

1.

1. ThiThis methos method d doedoes not take in accouns not take in account the effect the effectivtive utilie utilizatzation of the asseion of the asset. The samet. The same amount of depreciation is charged

amount of depreciation is charged from year to year, irrespective of use of the asset.from year to year, irrespective of use of the asset. 2.

2. WitWith h the passthe passage of age of timtime, effice, efficieniency of cy of assasset decreet decreaseases but s but the amouthe amount of nt of depdeprecreciatiationion remains the same, which does not seem to be justified.

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

Accounting Treatment Accounting Treatment

1.

1. PasPass ths the nee necescessarsary joy journurnal eal entrntriesies 2.

2. FiFixexed asd asseset act accocoununtt 3.

3. DeDeprprececiaiatition on acaccoucountnt

Illustration 1 Illustration 1

A machine was

A machine was bought on January 1, bought on January 1, 1990 for Rs.8,000. It cost 1990 for Rs.8,000. It cost Rs.1,0Rs.1,000 for 00 for transtransportaportation andtion and Rs.1000 for installation. The scrap value of the machine is estimated to be Rs.1,000 at the end of 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 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

after charging depreciation according to Straight Line Method.Method.

Solution: Solution:

To

Totatal cl cosost ot of mf macachihinene = Rs.= Rs.8,8,00000 + 0 + 1,1,00000 + 0 + 1,1,000000 = Rs.10,000

= Rs.10,000 E

Essttiimmaatteed sd sccrraap vp vaalluuee = R= Rss..11,,000000

asset asset o of f Life Life value value scrap scrap estimated estimated machine machine of of cost cost Total Total on on Depreciati Depreciati Annual Annual == −−

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3 3 0 00000 ,, 1 1 0 00000 ,, 0 0 1 1 −− = = = Rs.3,000 = Rs.3,000 Journal Entries Journal Entries D

Daattee PPaarrttiiccuullaarr LLFF DDeebbiitt CCrreeddiitt

Ja

Jan n 1, 1, 19199090 MaMachchinine e a/a/c c DrDr.. To, Bank a/c

To, Bank a/c

(For purchase of machine) (For purchase of machine)

10,000 10,000 10,000 10,000 Dec. 31, Dec. 31, 1990 1990 D

Deepprreecciiaattiioon n aa//cc DDrr.. To, Machine a/c

To, Machine a/c

((FoFor r chcharargiging ng dedeprprececiiatatiion on onon machine) machine) 3,000 3,000 3,000 3,000 Dec. 31, Dec. 31, 1990 1990 P

Prrooffiit t & & LLoosss s aa//cc DDrr.. To, Depreciation a/c

To, Depreciation a/c

(For transfer of depreciation to P/L (For transfer of depreciation to P/L a/c) a/c) 3,000 3,000 3,000 3,000 Dec. 31, Dec. 31, 1991 1991 D

To, Machine a/c

(For transfer of depreciation to P/L (For transfer of depreciation to P/L a/c) a/c) 3,000 3,000 3,000 3,000 Dec. 31, Dec. 31, 1992 1992 D

To, Machine a/c

(For transfer of depreciation to P/L (For transfer of depreciation to P/L a/c) a/c) 3,000 3,000 3,000 3,000 Dec. 31, Dec. 31, 1992 1992 C

Caasshh//BBaannk k aa//cc DDrr.. To, Machine a/c

To, Machine a/c

(For realization of scrap value) (For realization of scrap value)

1,000 1,000

D

Drr. . DDeepprreecciiaattiioon n AAccccoouunnt t CCrr.. D

Daattee PPaarrttiiccuullaarr LLFF AAmmoouunntt DDaattee PPaarrttiiccuullaarr LLFF AAmmoouunntt

Dec.31, Dec.31, 1990 1990

T

Too, , MMaacchhiinne e aa//cc 33,,000000 DDeecc..3311,, 1990 1990 B Byy, , PP//L L aa//cc 33,,000000 3 3,,000000 33,,000000 Dec.31, Dec.31, 1991 1991 T

Too, , MMaacchhiinne e aa//cc 33,,000000 DDeecc..3311,, 1991 1991 B Byy, , PP//L L aa//cc 33,,000000 3 3,,000000 33,,000000

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Dec.31, Dec.31, 1992 1992

T

Too, , MMaacchhiinne e aa//cc 33,,000000 DDeecc..3311,, 1992 1992 B Byy, , PP//L L aa//cc 33,,000000 3 3,,000000 33,,000000 D

Drr.. MMaacchhiinnee AAccccoouunntt CCrr.. D

Dec.31, Dec.31, 1990 1990

T

Too, , BBaannk k aa//cc 1100,,000000 DDeecc..3311,, 1990 1990

By, Dep. a/c By, Dep. a/c By, Bal c/d By, Bal c/d 3,000 3,000 7,000 7,000 1 100,,000000 1100,,000000 Dec.31, Dec.31, 1991 1991 T Too, , BBaal l bb//dd 77,,000000 DDeecc..3311,, 1991 1991

By, Dep. a/c By, Dep. a/c By, Bal c/d By, Bal c/d 3,000 3,000 4,000 4,000 7 7,,000000 77,,000000 Dec.31, Dec.31, 1992 1992 T Too, , BBaal l bb//dd 44,,000000 DDeecc..3311,, 1992 1992

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

3,000 3,000 1,000 1,000 4 4,,000000 44,,000000 Problem Problem

A trader bought machinery on 1

A trader bought machinery on 1stst January, 1993 for Rs.1,25,000 whose useful life has beenJanuary, 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 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 machinery account and depreciation account, charging depreciation by fixed installment method for 5 years. Also pass necessary journal entries.

for 5 years. Also pass necessary journal entries.

Addition and sale of assets during the year Addition and sale of assets during the year

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

amount of depreciation at the end of the period.

Addition of asset Addition of asset

The

The deprdeprecieciatiation on for for the the addadditiitional onal assassets ets purpurchachased sed durduring ing the the accaccountounting ing perperiod iod may may bebe provided on either of the

provided on either of the following two basis:following two basis: 1.

1. DeprDeprecieciatiation may on may be provibe provided for a ded for a yeayear for the r for the addadditiitional assonal assets irrets irrespespectective of useive of use period. That is, depreciation may be provided for a year even if assets are added in period. That is, depreciation may be provided for a year even if assets are added in

middle or near to end of accounting period. middle or near to end of accounting period. 2.

2. DeDeprprececiaiatition on mamay y be be prprovovidided ed on on asassesets ts adaddeded d fofor r ththe e ususe e pepeririod od ononlyly. . ThThat at isis,, de

deprprececiaiatition on shshouould ld be be prproviovideded d fofor r ththe e perperioiod d of of ththe e datdate e of of purpurchachase se to to enend d of of accounting period, i.e., for use period only.

accounting period, i.e., for use period only.

Note:

Note: If date of addition and method of charging deprecation is given in the problem, then 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.

depreciation on additional assets should be provided for use period only.

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

machinery: O

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O

On n JJuully y 11, , 11999966 MMaacchhiinne e ccoossttiinng g RRss..2200,,000000 O

On n AApprriil l 11, , 11999977 MMaacchhiinne e ccoossttiinngg RRss..1100,,000000

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

account for 1996 and 1997.

Solution: Solution:

Y

Yeeaarr PPaarrttiiccuullaarr MMaacchhiinnee TToottaall Depreciation Depreciation 1 1 22 33 1 1999966 CCoosstt Depreciation Depreciation 30,000 30,000 3,000 3,000 20,000 20,000 1,000 1,000 ---- 44,,000000 1 1999977 BBaal l bb//dd Depreciation Depreciation 27,000 27,000 3,000 3,000 19,000 19,000 2,000 2,000 10,000 10,000 7 75500 55,,775500 B Baallaannccee 2244,,000000 1717,,000000 99,,225500 Note:

Note: - Depreciation for 1- Depreciation for 1stst_{machine is provided for a year in 1996 and 1997.}_{machine is provided for a year in 1996 and 1997.} - Depreciation on 2

- Depreciation on 2ndnd_{machine is provided only for 6}_{machine is provided only for 6 months in 1996 and for a}_{months in 1996 and for a year in}_{year in} 1997.

1997.

- Depreciation on 3

- Depreciation on 3rdrd_{machine is provided for 9 months in 1997.}_{machine is provided for 9 months in 1997.}

D

Drr. . MMaacchhiinneerry y AAccccoouunnt t CCrr.. D

Jan 1, Jan 1, 1996 1996 July 1, July 1, 1996 1996

To, Bank a/c To, Bank a/c To, Bank a/c To, Bank a/c

30,000 30,000 20,000 20,000 Dec.31, Dec.31, 1996 1996

By, Dep. a/c By, Dep. a/c By, Bal c/d By, Bal c/d 4,000 4,000 46,000 46,000 5 500,,000000 5500,,000000 Jan 1, Jan 1, 1997 1997 April 1, April 1, 1997 1997 To, Bal b/d To, Bal b/d To, Bank a/c To, Bank a/c

46,000 46,000 10,000 10,000 Dec.31, Dec.31, 1991 1991

By, Dep. a/c By, Dep. a/c By, Bal c/d By, Bal c/d 5,750 5,750 50,250 50,250 5 566,,000000 5566,,000000 Problem Problem On

On 11stst _{January 1999 a company purchased a plant and machinery costing Rs.1,00,000. It is}_{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

estimated that the working life of the plant is 10 years after which its break up value 10 years after which its break up value will be zero.will be zero. Additions are made on 1

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

at 5 years and scrap value at the end of life is Rs.10,000.at the end of life is Rs.10,000. More additions are made on 1

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

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 It was decided to write off depreciation by Straight Line Method. The accounts are closed on 31stst December each year.

December each year.

Required:

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Sale of assets Sale of assets

During the accounting period, the firm may sell its partial or whole assets due to various reasons During 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 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 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.

depreciation) or at a profit or at loss. The gain or loss should be accounted accordingly.

Clinton maintains his books of accounts on calendar year basis. He purchased on 1.1.94 a Clinton 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 1

machine for Rs.40,000. He purchased another machine on 1stst_{October 1994 for Rs.20,000 and on}_{October 1994 for Rs.20,000 and on} 1

1stst _{July 1995 for Rs.10,000. On 1}_{July 1995 for Rs.10,000. On 1}stst _{July, 1996 one fourth of the machine installed on 1}_{July, 1996 one fourth of the machine installed on 1}stst _January,_January, 1994 became obsolete and was sold for Rs.6,800.

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 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

fixed installment method. Depreciation is to be charged at 10% per annum.at 10% per annum.

Solution: Solution:

Y

Yeeaarr PPaarrttiiccuullaarr MMaacchhiinnee TToottaall Depreciation Depreciation 1 1 22 33 1 1999944 CCoosstt Depreciation Depreciation 40,000 40,000 4,000 4,000 20,000 20,000 500 500 ---- 44,,550000 1

1999955 BBaallaanncce e & & ccoosstt Depreciation Depreciation 36,000 36,000 4,000 4,000 19,500 19,500 2,000 2,000 10,000 10,000 5 50000 66,,550000 1 1999966 BBaallaannccee Depreciation Depreciation 32,000 32,000 3000+500 3000+500 17,500 17,500 2,000 2,000 9,500 9,500 1 1,,000000 66,,550000 D

1.1.94 1.1.94 1.10.94 1.10.94

To, Bank a/c To, Bank a/c To, Bank a/c To, Bank a/c

40,000 40,000 20,000 20,000

3

31.1.1122..9944 BByy, D, Depep. a. a//cc By, Bal c/d By, Bal c/d 4,500 4,500 55,500 55,500 6 600,,000000 6600,,000000 1.1.95 1.1.95 1.7.96 1.7.96 To, Bal b/d To, Bal b/d To, Bank a/c To, Bank a/c

55,500 55,500 10,000 10,000

3

31.1.1122..9955 BByy, D, Depep. a. a//cc By, Bal c/d By, Bal c/d 6,500 6,500 59,000 59,000 6 655,,550000 6655,,550000 1

1..11..9966 TToo, , BBaal l bb//dd 5599,,000000 3311..1122..9966 BByy, , BBaannk k aa//cc By, Dep. sold By, Dep. sold machine machine By, P/L a/c By, P/L a/c (loss) (loss)

By, Dep. a/c By, Dep. a/c By, Bal c/d By, Bal c/d 6,800 6,800 500 500 700 700 6,000 6,000 45,000 45,000 5 599,,000000 5599,,000000 Problem Problem

A machine was purchased for Rs.10,000 on 1

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the rate of 10% on original cost method. On 1

the rate of 10% on original cost method. On 1stst _{July, 1989 another machinery was purchased for}_{July, 1989 another machinery was purchased for} Rs.20,000. On 1

Rs.20,000. On 1stst JanJanuaruary, y, 1990 the 1990 the macmachinhinery bought on ery bought on 11stst JanJanuaruary, y, 1998 was 1998 was solsold d for for Rs.8,500.

Rs.8,500.

Prepare machinery account for 3 years, assuming that the books are closed on 31

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

each year.

(Ans: Profit on sale of machinery Rs.500; Balance on machinery account on 31

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

Rs.17,000).

Written Down Method Written Down Method

This method is also known as Diminishing Balance method, Reducing Balance method. Under This 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 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 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 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 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 years of use than later years because the maximum loss of an asset occurs in the early years of use.

use.

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

obtained by following formula –

n n asset asset o of f cost cost e e Depreciabl Depreciabl Value Value Scrap Scrap --1 1 o onn Depreciati Depreciati o of f Rate Rate ==

Where, n = Estimated useful life of the asset Where, n = Estimated useful life of the asset

Example Example

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

down value method.

Required:

Required: Rate of DepreciationRate of Depreciation

Solution: Solution: n n asset asset o of f cost cost e e Depreciabl Depreciabl Value Value Scrap Scrap --1 1 o onn Depreciati Depreciati o of f Rate Rate == 3 3 2,16,000 2,16,000 27,000 27,000 --1 1 o onn Depreciati Depreciati o of f Rate Rate == = 50% = 50% Advantages Advantages 1.

1. The amounThe amount t of depreof depreciaciatition on decrdecreaseases conties continuonuouslusly with the y with the gragradual decrdual decreasease e in thein the service potential of asset.

service potential of asset. 2.

2. When addiWhen additions ations are made to tre made to the assethe asset, fres, fresh calculh calculation of dation of depreciepreciation is ation is not requinot required.red. 3.

3. UndeUnder this methr this method largod larger amouner amount of t of deprdeprecieciatiation is on is proprovidvided in ed in earearlielier r yeayears and thusrs and thus method minimizes the impact of obsolescence.

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1.

1. Amount of deAmount of deprecipreciation expeation expenses decrnses decreases eveeases even if the effin if the efficiencciency of asset is my of asset is maintaaintainedined by way of repairs and maintenance.

by way of repairs and maintenance. 2.

2. Heavy deHeavy deprecipreciation expeation expenses wilnses will be chargl be charged to profied to profit and lost and loss account is account in earlien earlier yearsr years.. 3.

3. Even aftEven after becomer becoming obsing obsoleteolete, the book , the book value of value of asset asset can never can never be zero.be zero.

Illustration Illustration

An asset was purchased for Rs.50,000 on 1

An asset was purchased for Rs.50,000 on 1stst _{January, 1998. Assuming annual depreciation to be}_{January, 1998. Assuming annual depreciation to be} 10%, show the asset account for 3 years under written down value method.

10%, show the asset account for 3 years under written down value method.

Solution: Solution:

Calculating depreciation for 3 years Calculating depreciation for 3 years

Y

Yeeaarr BBaallaanncce e oof f aasssseett DDeeppreciationreciation

1 1 5500,,000000 55,,000000 2 2 4455,,000000 44,,550000 3 3 4400,,550000 44,,005500 Asset Account Asset Account D

1

1..11..11999988 TToo, , BBaannk k aa//cc 5500,,000000 3311..1122..9988 BByy, , DDeepp. . aa//cc By, Bal c/d By, Bal c/d 5,000 5,000 45,00 45,00 5 500,,000000 5500,,000000 1

1..11..9988 TToo, , BBaal l bb//dd 4455,,000000 3311..1122..9988 BByy, , DDeepp. . aa//cc By, Bal c/d By, Bal c/d 4,500 4,500 40,500 40,500 4 455,,000000 4455,,000000 1

1..11..9988 TToo, , BBaal l bb//dd 4400,,550000 3311..1122..9988 BByy, , DDeepp. . aa//cc By, Bal c/d By, Bal c/d 4,050 4,050 36,450 36,450 4 400,,550000 4400,,550000 D

Drr. . DDeepprreecciiaattiioon n AAccccoouunnt t CCrr.. D

3 311..1122..9988 TToo, , AAsssseett 55,,000000 3131..1122..9988 BByy, , PP//L L aa//cc 55,,000000 5 5,,000000 55,,000000 3 311..1122..9988 TToo, , AAsssseett 55,,000000 3131..1122..9988 BByy, , PP//L L aa//cc 55,,000000 5 5,,000000 55,,000000 3 311..1122..9988 TToo, , AAsssseett 55,,000000 3131..1122..9988 BByy, , PP//L L aa//cc 55,,000000 5 5,,000000 55,,000000 Problem Problem

A firm purchased plant and machinery on 1

A firm purchased plant and machinery on 1stst _{April 1993 for Rs.50,000. Depreciation is written-}_{April 1993 for Rs.50,000. Depreciation is} written-off at the rate of 10% per annum. Show 5 years plant and machinery account and depreciation 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 31

account under reducing balance method. The firm closes its books on 31ststDecember each year.December each year. [Ans: Balance 30,344]

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Purchases of asset Purchases of asset Illustration

Illustration

A

A mamachchinine e wawas s bouboughght t fofor r RsRs.4.40,00,000 00 wiwith th an an esestitimamateted d lilife fe of of 10 10 yeyearars. s. WrWritite e ofoff f 1010%% depreciation each on diminishing balance system and show the ledger account for the first five 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.

years. At the commencement of third year a new machine worth Rs.5,000 was added.

Solution: Solution:

Journal Entries Journal Entries

D

Daattee PPaarrttiiccuullaarr LLFF DDeebbiitt CCrreeddiitt

1

1stst_y_yeeaarr _M_Maacch_hiin_ne_e_aa//cc _D_Drr.. To, bank a/c

To, bank a/c

(Being purchase of machine) (Being purchase of machine)

40,000 40,000 40,000 40,000 At the end At the end of 1 of 1ststyear year D

To, Machine a/c

(Being depreciation charged at 10%) (Being depreciation charged at 10%)

4,000 4,000

4,000 4,000 P

Prrooffiit t & & LLoosss s aa//cc DDrr.. To, Dep. a/c

To, Dep. a/c (Be

(Being ing trtransansfer fer of of depdeprecreciatiation ion toto P/L a/c) P/L a/c) 4,000 4,000 4,000 4,000 At the end At the end of 2 of 2ndnd_year_year D

To, Machine a/c

3,600 3,600

3,600 3,600 P

To, Dep. a/c (Be

(Being ing trtransansfer fer of of depdeprecreciatiation ion toto P/L a/c) P/L a/c) 3,600 3,600 3,600 3,600 In the beg. In the beg. of 3 of 3rdrdyear year M

Maacchhiinne e aa//cc DDrr.. To, Bank a/c

To, Bank a/c

(Being purchase of new machinery) (Being purchase of new machinery)

5,000 5,000 5,000 5,000 At the end At the end of 3 of 3rdrd_year_year D

To, Machine a/c

3,740 3,740

3,740 3,740 P

To, Dep. a/c (Be

(Being ing trtransansfer fer of of depdeprecreciatiation ion toto P/L a/c) P/L a/c) 3,740 3,740 3,740 3,740 At the end At the end of 4 of 4thth_year_year D

To, Machine a/c

3,366 3,366

3,366 3,366 P

To, Dep. a/c (Be

(Being ing trtransansfer fer of of depdeprecreciatiation ion toto P/L a/c) P/L a/c) 3,366 3,366 3,366 3,366

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At the end At the end

of 5

of 5ththyear year D

To, Machine a/c

3,029 3,029

3,029 3,029 P

To, Dep. a/c (Be

(Being ing trtransansfer fer of of depdeprecreciatiation ion toto P/L a/c) P/L a/c) 3,029 3,029 3,029 3,029 D

1

1stst_y_yeeaarr _T_To_o,_,_B_Baan_nk_k ₄₄₀_0,,0₀₀₀₀₀ ₁₁stst_y_yeeaarr _B_By_y,_{, D}_Deep_p._{. aa//cc} By, Bal c/d By, Bal c/d 4,000 4,000 36,000 36,000 4 400,,000000 4400,,000000 2

2ndnd yyeeaarr TToo, , BBaal l bb//dd 3366,,000000 22ndnd yyeeaarr BByy, , DDeepp. . aa//cc By, Bal c/d By, Bal c/d 3,600 3,600 32,400 32,400 3 366,,000000 3366,,000000 3 3rdrd _y_yeeaarr _T_To_o,_{, B}_Baal_{l b}_b//d_d To, Bank To, Bank 32,400 32,400 5,000 5,000 3

3rdrd_y_yeeaarr _B_By_y,_{, D}_Deep_p._{. aa//cc} By, Bal c/d By, Bal c/d 3,740 3,740 33,660 33,660 3 377,,440000 3377,,440000 4

4thth_y_yeeaarr _T_To_o,_,_B_Baal_l_b_b//d_d ₃₃₃_3,,6₆₆₆₀₀ ₄₄thth_y_yeeaarr _B_By_y,_{, D}_Deep_p._{. aa//cc} By, Bal c/d By, Bal c/d 3,366 3,366 30,294 30,294 3 333,,666600 3333,,666600 5

5thth_y_yeeaarr _T_To_o,_,_B_Baal_l_b_b//d_d ₃₃₀_0,,2₂₉₉₄₄ ₅₅thth_y_yeeaarr _B_By_y,_{, D}_Deep_p._{. aa//cc} By, Bal c/d By, Bal c/d 3,029 3,029 27,265 27,265 3 300,,229944 3300,,229944 6 6thth_y_yeeaarr _T_To_o,_,_Baal_B _l_b_b//d_d ₂₂₇_7,,2₂₆₆₅₅ Sale of assets Sale of assets

On January 1991 a company acquired machinery for Rs.120,000 and on June 30

On January 1991 a company acquired machinery for Rs.120,000 and on June 30thth_{, 1992 it}_{, 1992 it} purchased additional machinery at cost of Rs.20,000. On March 31, 1993 one of the original 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 machines which cost Rs.5,000 was found to have become obsolete and was sold as scrap for Rs.

Rs.500500. . On On thathat t datdate e it it purpurchachased a sed a new machinew machine ne coscostinting g Rs.Rs.8,08,000. Deprec00. Depreciatiation is ion is to to bebe provided at the rate of 15% per annum on written down value on December 31

provided at the rate of 15% per annum on written down value on December 31stst _{of each year.}_{of each year.} You are asked to write up

You are asked to write up machinery account for four years.machinery account for four years. [Ans: Balance Rs.7,932]

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Depreciation Fund Method Depreciation Fund Method

Under this method, a fixed amount of depreciation is transferred to a fund called Depreciation Under 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 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 invested into easily realizable securities. This method takes into account the time value of money. It is based on the concept of present value.

money. It is based on the concept of present value.

Under this method, a fund is created by debiting Depreciation account and crediting Sinking 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 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 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 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 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 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 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

to be less than the replacement cost of the asset.cost of the asset. The asset is shown in balance

The asset is shown in balance sheet every year, at its original value. Sinking fund sheet every year, at its original value. Sinking fund is shown on theis shown on the liabilities side and sinking fund investment is shown on the asset side of the balance sheet. At 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 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 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 account. It should be noted that profit or loss on sale of investment is also transferred to the Sinking fund account.

Sinking fund account.

Advantages Advantages

1.

1. This metThis method of deprechod of depreciatiiation assison assists the busits the business to provness to provide funds fide funds for the replor the replacement of acement of asset when it gets worn out.

asset when it gets worn out. 2.

2. As As ththe e amamouount nt eqequal to ual to dedeprprececiaiatition on is inveis investsted ed ououtstsidide e ththe e bubusisinesness, s, it it reresusultlts s inintoto generation of extra income on account of interest received.

generation of extra income on account of interest received. 3.

3. As the amAs the amount of annuount of annual depreal depreciaticiation remaion remains the samns the same thus each ye thus each year’s pear’s profit arofit and lossnd loss account is burdened uniformly.

account is burdened uniformly.

1.

1. Each yearEach year’s depr’s depreciateciation is reqion is required to be iuired to be investenvested in purchasd in purchase of investe of investmentsments, intere, interest isst is required to be collected and in the last year of life of asset these investments are to be 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.

sold, all these activities involve lot of time and labour cost. 2.

2. If the maIf the market prirket price of invesce of investment ftment fallsalls, it will r, it will result iesult in loss to tn loss to the businhe business.ess. 3.

3. In order tIn order to purchao purchase invesse investmenttments each years each year, funds ar, funds are require required to be arred to be arranged.anged. 4.

4. From acFrom accounticounting point of ving point of view also thew also this metis method is quihod is quite time cote time consuminsuming and complng and complex.ex.

Amount of Depreciation Amount of Depreciation

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

can be calculated as follows: Amount

Amount of of Depreciation Depreciation = = Original Original cost cost – – Scrap Scrap valuevalue Future value of Annuity of Re.1 for

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For e.g.: For e.g.:

ABC Co. purchased a machine costing Rs.13500 with an estimated scrap value of Rs.1000. The ABC Co. purchased a machine costing Rs.13500 with an estimated scrap value of Rs.1000. The esti

estimated life of mated life of the machine is the machine is 5 years. The 5 years. The rate of rate of inteinterest on rest on the investmthe investment is ent is 4%. Calculat4%. Calculatee the amount of depreciation to be charged each year.

the amount of depreciation to be charged each year.

Sol: Sol:

O

Orriiggiinnaal l ccoosstt = = RRss..1133550000 Less:

Less: Scrap ValueScrap Value = Rs.1000= Rs.1000 D

Deepprreecciiaabblle e vvaalluuee = = RRss..1122550000 Amount

Amount of of depreciation depreciation = = Depreciable Depreciable valuevalue FVIFA4%,5yrs FVIFA4%,5yrs = Rs.12500 = Rs.12500 5.4163 5.4163 = Rs.2307.88 = Rs.2307.88 Journal Entries Journal Entries 1.

1. At At the the enend od of tf the he firfirst st yeayearr a.

a. For For settsetting ing asidaside the the ree requirquired aed amoumount nt

D

Deepprreecciiaattiioon n aa//cc DDrr.. To, Dep. fund a/c

To, Dep. fund a/c

b.

b. For For trantransfersferring ring depdeprecireciatioation to Pn to P/L a/L a/c/c

P

Prrooffiit t aannd d LLoosss s aa//cc DDrr.. To, Depreciation a/c

c.

c. FoFor inr inveveststining thg the ame amouount nt

D

Deepp. . FFuunnd d IInnvveessttmmeennt t aa//cc DDrr.. To, Bank a/c

To, Bank a/c

2.

2. SecSeconond and and sud subsbsequequenent yet yearsars a.

a. For For intintereerest ost on in invenvestmstment ent

B

Baannk k aa//cc DDrr..

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

IInntteerreesst t oon n DDeepp. . FFuunnd d IInnvveessttmmeennt t aa//cc DDrr.. To, Dep. Fund a/c

To, Dep. Fund a/c

b.

b. For For setsettinting asg asidide the the ae amomount unt

D

Deepp. . aa//cc DDrr.. To, Dep. Fund a/c

To, Dep. Fund a/c

c.

c. For trFor transfansferrierring Deng Deprecpreciatiiation to Pon to Profirofit and Lt and Loss a/oss a/cc

D

Deepp. . aa//cc DDrr.. To, P/L a/c

(15)

d.

d. For inFor investvesting (aming (amounount of deprt of depreciaeciation ption plus intlus intereserest)t)

D

Deepp. . FFuunnd d IInnvveessttmmeennt t aa//cc DDrr.. To, Bank a/c

To, Bank a/c

3

3.. LLaasst Yt Yeeaarr a.

a. For For intintereerest ost on in invenvestmstment ent

B

Baannk k aa//cc DDrr..

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

To, Dep. Fund a/c

b.

b. For For setsettinting asg asidide the the ae amomount unt

D

Deepp. . aa//cc DDrr.. To, Dep. Fund a/c

To, Dep. Fund a/c

c.

c. FoFor sr salale oe of if invnvesestmtmenent t

B

Baannk k aa//cc DDrr.. To, Dep. Fund Investment a/c To, Dep. Fund Investment a/c

d.

d. For trFor transfansferrierring prong profit or lfit or loss on saoss on sale of inle of investvestmenment t (i)

(i) For ProfitFor Profit

D

Deepp. . FFuunnd d IInnvveessttmmeennt t aa//cc DDrr.. To, Dep. Fund a/c

To, Dep. Fund a/c

(ii) For Loss (ii) For Loss

D

Deepp. . FFuunnd d aa//cc DDrr.. To, Dep. Fund Investment a/c To, Dep. Fund Investment a/c

e.

e. FoFor sr salale oe of sf scrcrapap

B

Baannk k aa//cc DDrr.. To, Asset a/c

To, Asset a/c

f.

f. FoFor cr closlosining Dg Depep. F. Funund ad accccouountnt

D

Deepp. . FFuunnd d aa//cc DDrr.. To, Asset a/c

To, Asset a/c

g.

g. FoFor cr closlosining Ag Asssset et acaccocountunt

If there is any balance in the asset account, it is transferred to Profit & Loss If there is any balance in the asset account, it is transferred to Profit & Loss account.

account.

Illustration Illustration

Sanjay Bros. bought a machine whose estimated life was 5 years. The date of purchase was 1 Sanjay Bros. bought a machine whose estimated life was 5 years. The date of purchase was 1stst January 1990 and its cost was Rs.13500, with a scrap value of Rs.1000. They decided to 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 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 annum. At the end of 1994 the investments realized Rs.9700. Show the entries and prepare necessary accounts.

necessary accounts.

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

years. years.

Solution: Solution:

C

Coosst t oof f mmaacchhiinnee RRss..1133550000 L

Leessss: : SSccrraap p VVaalluuee RRss..11000000 A

Ammoouunnt t tto o bbe e wwrriitttteenn--ooffff RRss..1122550000 An

Annunual al amamouount nt of of dedeprprececiaiatition = on = 0.0.181846463 X R3 X Rs.s.1212505000 = Rs= Rs.2.230307.7.8888 Journal Entries

Journal Entries

At the time of machine purchase At the time of machine purchase

1

1..11..9900 MMaacchhiinne e aa//cc DDr r To, Bank To, Bank (Purchase of machine) (Purchase of machine) Rs.13500 Rs.13500 Rs.13500 Rs.13500

At the end of first year At the end of first year

3

311..1122..9900 DDeepp. . aa//cc DDrr.. To, Dep. Fund a/c

To, Dep. Fund a/c (A

(Annunnual al depdeprereciciatatioion n crcrediediteted d toto Dep. Fund a/c)

Dep. Fund a/c)

2307.88 2307.88

3

311..1122..9900 PPrrooffiit t & & LLoosss s aa//cc DDrr.. To, Dep. a/c

To, Dep. a/c

(Depreciation charged to PL a/c) (Depreciation charged to PL a/c)

2307.88 2307.88

2307.88 2307.88 3

311..1122..9900 DDeepp. . FFuunnd d IInnvveessttmmeennt t aa//cc DDrr.. To, Bank a/c

To, Bank a/c (Investment purc

(Investment purchased)hased)

2307.88 2307.88 2307.88 2307.88 Second years Second years 3 311..1122..9911 BBaannk k aa//cc DDrr.. To, Interest on Dep. Fund

To, Interest on Dep. Fund Investment a/c Investment a/c (Interest received) (Interest received) 92.32 92.32 92.32 92.32 3

311..1122..9911 IInntteerreesst t oon n DDeepp. . FFuunnd d IInnvv. . aa//cc DDrr.. To, Dep. Fund a/c

To, Dep. Fund a/c

(Interest credited to Dep. Fund a/c) (Interest credited to Dep. Fund a/c)

92.32 92.32 92.32 92.32 3 311..1122..9911 DDeepp. . aa//cc DDrr.. To, Dep. Fund a/c

To, Dep. Fund a/c

(Depreciated credited to Dep. Fund (Depreciated credited to Dep. Fund a/c) a/c) 2307.88 2307.88 2307.88 2307.88 3

To, Dep. a/c

(Depreciation debited to PL a/c) (Depreciation debited to PL a/c)

2307.88 2307.88

2307.88 2307.88 3

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To, Bank a/c To, Bank a/c

(Investment purchased) (Investment purchased) 2400.20 2400.20 Third year Third year 3 311..1122..9922 BBaannk k aa//cc DDrr.. To, Interest on Dep. Fund

To, Dep. Fund a/c

To, Dep. a/c

2307.88 2307.88

2307.88 2307.88 3

To, Bank a/c

(Investment purchased) (Investment purchased) 2496.20 2496.20 2496.20 2496.20 Fourth year Fourth year 3 311..1122..9933 BBaannk k aa//cc DDrr.. To, Interest on Dep. Fund

To, Dep. Fund a/c

To, Dep. a/c

2307.88 2307.88

2307.88 2307.88 3

To, Bank a/c

(Investment purchased) (Investment purchased) 2596.04 2596.04 2596.04 2596.04 Fifth year Fifth year 3 311..1122..9944 BBaannk k aa//cc DDrr.. To, Interest on Dep. Fund

To, Interest on Dep. Fund Investment a/c Investment a/c (Interest received) (Interest received) 392.01 392.01 392.01 392.01

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3

To, Dep. Fund a/c

To, Dep. a/c

2307.88 2307.88

At the sale of Investment At the sale of Investment

3

311..1122..9944 BBaannk k aa//cc DDrr.. To, Dep. Fund Investment a/c To, Dep. Fund Investment a/c (Investment sold) (Investment sold) 9700.00 9700.00 9700.00 9700.00 3 311..1122..9944 DDeepp. . FFuunnd d aa//cc DDrr.. To, Dep. Fund Investment a/c To, Dep. Fund Investment a/c

((LLoosss s oon n ssaalle e oof f IInnvveessttmmeenntt transferred to Dep. Fund a/c)

transferred to Dep. Fund a/c)

100.32 100.32 100.32 100.32 3 311..1122..9944 BBaannk k aa//cc DDrr.. To, Machine a/c

To, Machine a/c

(Scrap value of machine) (Scrap value of machine)

1000.00 1000.00 1000.00 1000.00 3 311..1122..9944 DDeepp. . FFuunnd d aa//cc DDrr.. To. Machine a/c

To. Machine a/c

(Balance of Dep. Fund transferred to (Balance of Dep. Fund transferred to Machine a/c) Machine a/c) 12500.00 12500.00 12500.00 12500.00 3

311..1122..9944 PPrrooffiit t & & LLoosss s aa//cc DDrr.. To, Machine a/c

To, Machine a/c

(Balance of machine a/c transferred (Balance of machine a/c transferred to PL a/c) to PL a/c) 100.11 100.11 100.11 100.11 Problem 1 Problem 1

A company purchased a plant for Rs.11000. It estimated the turn in value Rs.1000 and useful life A 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 8 years. It decided to make provision for depreciation by means of sinking fund. Show necessary le

ledgedger r acaccoucountnts s fofor r ththe e fifirsrst t ththreree e yeyearars. s. It It is is asascecertrtaiainened d frfrom om sisinkinking ng fufund nd tatablble e ththatat Re.0.10472181 invested annually at 5% per annum at compound interest will provide Re.1 a the Re.0.10472181 invested annually at 5% per annum at compound interest will provide Re.1 a the end of 8 years.

end of 8 years.

[Ans: Annual depreciation Rs.1047.22; Balance at the end to 3

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Question Question Objective Type Questions:

Objective Type Questions: 1.

1. StatState whice which of the fh of the folloollowing awing alterlternatinatives is coves is correrrectct

a.

a. The maThe main objin objectective of prive of proviovidinding deprg deprecieciatiation ison is i.

i. To cTo calalcuculalate tte trurue pre profofitit ii.

ii. To sTo show thow true frue financiinancial poal positisition in on in the bthe balance alance sheetsheet ii

iii.i. To To rereduduce ce tatax bx bururdedenn iv.

iv. To prTo provide ovide funds funds for for replacreplacement ement of fiof fixed asxed assetssets

b.

b. DeprDepreciaeciation tion arisarises es becabecause use of:of:

i.

i. FalFall in l in the mthe markarket vet valualue of ae of an asn assetset ii

ii.. PhPhysysicical al wewear ar anand td teaear r ii

iii.i. FaFall ill in thn the vae valulue of me of mononeyey

c.

c. UndeUnder the strar the straight liight line metne method of chhod of chargarging deping deprecreciatiiation, it:on, it:

i.

i. InIncrcreaeaseses s eveevery ry yeyear ar ii

ii.. DeDecrcreaseases es eveverery yy yeaear r ii

iii.i. Is cIs cononststant ant eveverery yy yeaear r

d.

d. Under Under the dimthe diminishing inishing balance balance method, method, deprecidepreciation is ation is calculacalculated on:ted on:

i.

i. ThThe oe oririgiginanal cl cosostt ii

ii.. WrWrititteten don down vwn valalueue ii

iii.i. ThThe se scrcrap ap vavaluluee

e.

e. A A didimmininisishihing ng babalalancnce e memeththod od of of prprovovididining g fofor r dedeprprececiaiatition on is is onone,e, according to which:

according to which:

i.

i. The amoThe amount on whicunt on which deprech depreciatiation is calion is calculculateated, is reducd, is reduced from yeed from year toar to year

year ii

ii.. ThThe e rarate per cent declte per cent declinines from yeaes from year r to yeato year, at r, at whwhicich h depdeprereciciatatioion n isis charged

charged iii.

iii. The raThe rate per te per cent as cent as well well as amas amount rount reduces educes every every year year

f.

f. The amThe amount oount of deprf deprecieciatioation charn charged on mged on machachinerinery will be dy will be debitebited toed to

i.

i. MaMachchininerery ay accccouountnt ii

ii.. DeDeprprececiaiatition on acaccocountunt iiiii.i. CaCassh ach accocoununtt

g.

g. Loss on Loss on the salthe sale of pe of plant alant and macnd machinery hinery should should be wrbe written oitten of againf against:st:

i.

i. ShSharare pe preremimium um acaccocountunt ii

ii.. DeDeprprececiaiatition fuon fund acnd accoucountnt

h.

h. DeprDepreciaeciation on the dimtion on the diminisinishing bahing balanclance methoe method on a d on a macmachinehinery of Rs.200ry of Rs.20000 at the rate of 10% per annum after three years will be:

at the rate of 10% per annum after three years will be:

ii.. RRss..11440000 iiii.. RRss..114455..88 iiiiii.. RRss..554422 iv

iv.. NoNone ne of of ththe ae aboboveve

i.

i. DeDeprprececiaiatition ion is prs prococesess ofs of::

ii.. VVaalluuatatiioonn iiii.. AlAlllococatatiionon ii

iii.i. BotBoth vah valualuatiotion ann and ald alloclocatiationon iiv.v. NoNone ne of of ththesesee

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j.

j. If the cosIf the cost of t of the asthe asseset is t is RsRs.21.2100000 and the scr0 and the scrap valap value is Rs.ue is Rs.1001000 then th0 then thee am

amounount t of of depdeprereciaciatiotion n @1@10% 0% p.ap.a. . fofor r the the yeyear ar unundeder r the the ststraraighight t linlinee method would be:

method would be:

ii.. RRss..22110000 iiii.. RRss..22000000 iiiiii.. RRss..22220000

2.

2. FiFill ll up up ththe be blalanknks:s:

a.

a. DeprecDepreciatiiation refeon refers trs to ……o ……… in … in the vthe value alue of asof assets.sets. b.

b. When deprWhen depreciateciation is chion is charged, aarged, asset acsset account icount is …………s ……… an……… and deprecd depreciatioiationn account is ………

account is ……… c.

c. DeprDeprecieciatiation is proon is providvided on ………ed on ……… ass… assetsets.. d.

d. The salThe sales values value of an ase of an asset afset after it ter it becomebecomes usels useless is ess is callecalled …………d ……… e.

e. DiscarDiscarding thding the old mace old machinerhinery due to ny due to new invenew invention ition is calls called ………ed ……… 3.

3. Short Questions:Short Questions:

a.

a. WhaWhat is dt is depreprecieciatiation? Won? What ahat are itre its caus causesses?? b.

b. How does diHow does diminiminishing balshing balance metance method diffhod differ from fer from fixed insixed installtallment metment method?hod? c.

c. What iWhat is Depres Depreciaticiation Fund meon Fund method? Wthod? What are hat are the objethe objectivectives of this of this meths method?od? d.

d. Is it comIs it compulsorpulsory to proviy to provide deprecde depreciatiiation on fixed ason on fixed assets in a ssets in a sole traole trading concding concern?ern? e.

e. What aWhat are the re the factofactors to rs to be consbe considereidered whild while calce calculatiulating depreng depreciatciation?ion?

4.

4. PrPracactiticacal Prl Proboblelemsms:: a.

a. StStraraigight Lht Linine Me Metethohodd

i.

i. A compA company purany purchachased a plansed a plant for Rs.t for Rs.40004000. The usef. The useful liful life of the plane of the plant ist is 10 years and the estimated scrap value is Rs.400. Determine the rate of 10 years and the estimated scrap value is Rs.400. Determine the rate of depreciation when the management wants to depreciation it by straight depreciation when the management wants to depreciation it by straight line method.

line method. [Ans. 9%] [Ans. 9%]

iiii.. OOn n 11stst _{January, 1990 an asset was purchased for Rs.35000. The estimated}_{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 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 only. Prepare the asset account for the first three years, by straight line method assuming that the books are closed on 31

method assuming that the books are closed on 31stst_December._December. [Ans: Balance of machinery account 31

[Ans: Balance of machinery account 31ststDec. 1992, Rs.19500]Dec. 1992, Rs.19500]

b.

b. WrWrititteten Don Down Mwn Metethohodd

i.

i. The oriThe originginal cost of fural cost of furnitniture and fixture and fixtureures amouns amounted to Rs.4ted to Rs.4000 and it is000 and it is divided to write off 5% on the diminishing value of asset as depreciated at 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 end of the each year. Show the ledger account as it will appear during the first four years.

the first four years.

[Ans: Balance of machinery account after four

[Ans: Balance of machinery account after four years, Rs.3258.03]years, Rs.3258.03] ii.

ii. A planA plant is put is purchaserchased for Rd for Rs.25600s.25600. Depre. Depreciaticiation is to on is to be provibe provided at 25ded at 25%% pa. on written down value method. The turn in value of plant at the end of 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 its economic life of 4 years is expected to be Rs.8100. You are required to show plant account for 4

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

c.

c. DepDeprereciaciatiotion n FuFund nd MeMethothodd

i.

i. A comA companpany pury purchachased a lsed a leasease for e for Rs.Rs.300030000 on 10 on 1stst _{January 1989. It is to be}_{January 1989. It is to be} renewed at the end of three years. For this purpose a depreciation fund is renewed at the end of three years. For this purpose a depreciation fund is established. The depreciation fund investments will realize 5%. Sinking established. The depreciation fund investments will realize 5%. Sinking fund table shows that Re.0.317208 must be invested each year to obtain fund table shows that Re.0.317208 must be invested each year to obtain Re.1 at the end o

Re.1 at the end of 3 years, the rate of interest being 5%.f 3 years, the rate of interest being 5%. On 31

On 31stst _{Dec., 1991, the}_{Dec., 1991, the invest}_{investments were realize}_{ments were realized}_{d Rs.1940}_{Rs.19400. A}_{0. A new lease}_{new lease} was purchased on the same date for Rs.35000. The balance at the bank 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 before realization of investments was Rs.20000. Give journal entries in the books of the company.

books of the company.

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

End of the Chapter End of the Chapter

Accountig for Fixed Assets

Accounting for Fixed Assets

Accounting for Fixed Assets

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