1. 06/10/2015DEPRECIATION,PROVISIONS AND RESERVES1

3. 1 CONCEPT OF DEPRECIATION 2 CAUSES OF DEPRECIATION 3 NEED OF DEPRECIATION 4 BASIC FACTORS 5 METHODS OF DEPRECIATION 6 PROVISION AND RESERVES 06/10/2015DEPRECIATION,PROVISIONS AND RESERVES3

4. DEFINITION Depreciation is the permanent decrease in the value of an asset due to use and /or the lapse of the time. CLMA, LONDON 06/10/2015 4 DEPRECIATION,PROVISIONS AND RESERVES

5. CAUSES OF DEPRECIATION Physical depreciation Economic factors Time factors Depletion Accident

6. 06/10/2015DEPRECIATION,PROVISIONS AND RESERVES6 NEED FOR CHARGING DEPRECIATION To calculation the profit. True and fair view in balance sheet. Replacement of asset. Saving in income tax. Accurate ascertainment of cost.

7. BASIC FACTORS AFFECTING DEPRECIATION Cost of asset. Estimated working life. Salvage/Residual/Scrap value. Legal provisions Additions to assets

8. METHODS OF DEPRECIATION CHANGE MACHINE HOUR RATE DEPLETION REVALUATION INSURANCE POLICY DEPRECIATION FUND ANNUITY

9. STRAIGHT LINE METHOD Under this method,a fixed asset in written off annually so that,by the time asset is worn out,its proportion cost of the value in the book is reduced to zero. FORMULA FIXED ASSET- ESTIMATED SCRAP VALUE ESTIMATED LIFE OF ASSET 06/10/2015DEPRECIATION,PROVISIONS AND RESERVES9

10. MERITS AND DEMERITS 06/10/2015DEPRECIATION,PROVISIONS AND RESERVES10 MERITS- 1. Simple. 2. Asset is fully written off. 3. Knowledge of total depreciation charged. 4. Suitable for fixed life assets. DEMERITS- 1. Interest on capital. 2. Reairs and maintenance 3. Income tax

11. QUESTION:- A trader bought machinery on 1 st jan, 2001 for Rs. 125000 whose useful life has been estimated 5 years. After the expiry of useful life, the scrap will realise Rs 25000. ANNUAL DEPRECIATION 125000-25000 =5000 5

12. MACHINERY ACCOUNT DATEPARTICULARSAMTDATEPARTICULA RS AMT 2001 Jan 1 To bank a\c1250002001 Dec 31 By depreciation a\c 20000 Dec 31By bal c\d105000 125000 2002 Jan 1 To bal b\d1050002002 Dec 31 By depreciation a\c 20000 Dec 31By bal c\d85000

13. 105000 2003 Jan 1 To bal b\d850002003 Dec 31 By depreciation a\c 20000 Dec 31By bal c\d65000 85000 2004 Jan 1 To bal b\d650002004 Dec 31 By depreciation a\c 20000 By bal c\d45000 65000 2005 Jan 1 To bal b\d450002005 Dec 31 By depreciation a\c 20000 Dec 31By bal c\d25000 45000

14. DIMINISHING BALANCE METHOD Depreciation is calculated at a certain percentage each year on the balance of the asset which is brought forward from the previous year. The amount of depreciation charged in each period is not fixed but it goes on decreasing gradually as the beginning balance of the asset in each year will reduce.

15. MERITS & DEMERITS MERITS 1. Fresh calculation of depreciation are not necessary as and when additions are made. 2. this method is recognized by the income tax authorities in India. DEMERITS 1.Its difficult to determine the suitable rate of depreciation. 2. the original cost of the asset is altogether lost sight of in subsequent years and the asset can never be reduced to zero.

16. QUESTION:- A company bought machinery for Rs.400000, including a shaft Rs. 40000. The machinery is subject to dep at 10% by reducing instalment method. In the beginning of the fifth year, the shaft became obsolete and instalment method. In the beginning of the fifth year, the shaft become obsolete and was sold for Rs. 8000.Write up the machinery account for five years.

17. MACHINERY ACCOUNT DAT E PARTICULARSAMTDATEPARTICULARSAMT 1 ST YrTo bank a\c4000001 ST Yr.By depreciation a\c 40000 By bal c\d360000 400000 2 ND Yr To bal b\d3600002 ND Yr By depreciation a\c @10% ON 360000 36000 By bal c\d324000

18. 360000 3 RD Yr.To bal b\d3240003 rd Yr.By depreciation@10%ON Rs.324000 32400 By bal c\d291600 324000 4 TH Yr.To bal b\d2916004 TH Yr.By depreciation@10%ON Rs.291600 29160 By bal c\d262440 291600 5 th Yr.To bal b\d2624405 TH Yr.By bank a\c8000 By profit & loss [Loss on sale of shaft] 18244 By depreciation@10%ON Rs 236196 23620

19. By bal c\d212576 262440

20. SUM OF THE DIGITS METHOD This is a variant of the reducing instalment or diminishing balance method.

21. QUESTION:-Suppose machinery was purchased for Rs. 60000 on 1 st jan,2003 and depreciation was charged following the sum of the digits method assuming its useful life to be 3 years. Depreciation for three years will be calculated as under : DEPRECIATION FOR THE FIRST YEAR = 3 Rs.60000 =Rs.30000 3+2+1 SECOND YEAR = 2 Rs.60000=Rs.20000 6 THIRD YEAR = 1 Rs.60000 =Rs.10000 6

22. ANNUITY METHOD Under this,amount spent on purchase of an asset is regarded as an investment which is assumed to earn interest at a certain rate. The amount to be written off as depreciation is calculated from annuity table, an extract of which is given below : Years3%3 1% 2 4%4 1% 2 5% 30.3535300.3596340.3603490.3637730.367209 40.2690270.2722510.2754900.2787440.282012 50.2183550.2214810.2246270.2277920.230975

23. QUESTION:- A firm purchases a 5 yr lease for Rs.40,000 on 1 st jan. It decides to write off depreciation on annuity method,presuming the rate of interest to be 5% per annum. The annuity tables show that a sum of Rs. 9,239 should be written off every year. Show the lease account for five yr.calculation are to be made to the nearest – rupee.

24. DATEPARTICULARSAMTDATEPARTICULARSAMT 1 st yr Jan 1 To cash400001 st yr Dec 31 By depreciation a\c 9239 Dec 31To interest2000Dec 31By bal c\d32761 42000 2 nd yr Jan 1 To bal b\d327612 nd yr Dec 31 By depreciation a\c 9239 Dec 31To interest1638Dec 31By bal c\d25160 34399 LEASE ACCOUNT

25. 3 rd yr Jan 1 To bal b\d251603 rd yr Dec 31 By depreciation a\c9239 Dec 31 To interest1258Dec 31By bal c\d17179 26418 4 th yr Jan 1 To bal b\d171794 th yr Dec 31 By depreciation a\c9239 Dec 31 To interest859Dec 31By bal c\d8799 18038 5 th yr Jan 1 To bal b\d87995 th yr Dec 31 By depreciation a\c9239 Dec 31 To interest440 9239

26. DEPRECIATION FUND METHOD This method is implies that the amount written off as depreciation should be kept aside and invested in readily saleable securities. The securities accumulate and when the life of asset expires, the securities are sold and with the sale proceeds a new asset is purchased. The rate of interest which is easily calculated from sinking fund tables, an extract of given below :

27. years3%3 1% 2 4%4 1% 2 5% 30.3235400.3219340.3203490.3187730.317208 40.2390270.2372510.2354900.2337410.232012 50.1883500.1864810.1846270.1827920.180975 SINKING FUND TABLE

28. QUESTION:- A company purchased a 3 years lease on January 1,2007 for Rs. 25000. It is decided to provide for the replacement of lease at the end of 3 years by setting up a depreciation fund.It is expected that the investments will fetch interest at 5%. Sinking fund table show that to provide the requisite sum at 5% at the end of 3 years an investment of Rs 7932 is required every year. Investment are made to the nearest rupee. On 31 st Dec,2009 the investments were sold for Rs. 15250. on 1 st January,2010, the same lease was renewed for a further period of 3 years by payment of Rs. 30000.

29. DEPRECIATION FUND ACCOUNT 2007 Jan 1 To bal c\d79322007 Dec 31 By depreciation a\c7932 2008 Dec 31 To bal c\d162612008 Jan 1 By bal b\d7932 Dec 31 By bank397 Dec 31 By depreciation a\c7932 16261 2009 Dec 31 To depreciation Fund investment a\c 10112009 Jan 1 By bal b\d16261

30. Dec 31 To lease a\c25000Dec 31By bank [interest]813 Dec 31By depreciation a\c7932 Dec 31By profit & loss a\c1005 26011

31. DEPRECIATION FUND INVESTMENT ACCOUNT 2007 Dec 31 To bank79322007 Dec 31 By bal c\d7932 2008 jan 1 To bal b\d79322008 Dec 31 By bal c\d16261 Dec 31To bank8329 16261 2009 jan 1 To bal b\d162612009 Dec 31 By bank15250 Dec 31By depreciation fund a\c [loss transferred] 1011 16261

32. INSURANCE POLICY METHOD This method is similar to the depreciation fund method but instead of making investment, arrangement are made with an insurance company which will receive premiums annually and pay at the end of the fixed period the required amount. Premiums have to be paid at the beginning of each year.

33. QUESTION:-On 1 st jan. 2006,a lease of premises is purchased for four years for Rs.50000 and it is decided to make provision for the replacement of the lease by means of an insurance policy purchased for an annual premium of Rs.12000. show the necessary ledger account for four years assuming that the renewal of the lease costs Rs.50000 on 1-1 2010.

34. LEASE ACCOUNT 2006 Jan 1 To bank a\c500002006 dec31 By bal c\d50000 2007 jan 1 To bal b\d500002007 dec31 By bal c\d50000 2008 jan 1 To bal b\d500002008 dec31 By bal c\d50000 2009 jan 1 To bal b\d500002009 dec31 By bal c\d50000

35. DEPRECIATION RESERVE ACCOUNT 2006 Dec 31 To bal c\d120002006 Dec 31 By profit and loss a\c 12000 2007 Dec 31 To bal c\d240002007 Jan 1 By bal b\d12000 Dec 31By profit and loss a\c 12000 24000 2008 Dec 31 To bal c\d360002008 Jan 1 By bal b\d24000 Dec 31By profit and loss a\c 12000

36. 36000 2009 Dec 31 To lease a\c500002009 jan 1 By bal b\d36000 Dec 31By profit and loss a\c 12000 Dec 31By depreciation insurance policy a\c [profit on the realisation of policy] 2000 50000

37. REVALUATION METHOD Under this, the asset is revalued at the end of the accounting year and this value is compared with the value of the asset at the beginning of the year. The difference is treated as depreciation.this method is used in case of bottles, corks, crates or etc

38. QUSETION:- A company manufactures loose tools for its own use.At the end of each year, depreciation is charged on revaluation method. From the following particulars show the loose tools account : Year ended 31-12-2006-loose tools manufactured Rs.5000 [revalued on 31-12-2006:Rs.4100]

39. Year ended 31-12-2007-loose tools manufactured :Rs. 2700 [revalued on 31-12-2007:Rs5700] Year ended 31-12-2008-loose tools manufactured :Rs.1000 [revalued on 31-12-2009:Rs.6000] Year ended 31- 12-2009-loose tools manufactured :Rs.1500 [revalued on 31-12-2009: Rs.5100]

40. LOOSE TOOLS ACCOUNT 2006TO COST OF PRODUCTION A\C 50002006BY DEP A\C [Bal.fig.] 900 BY BAL C\D4100 5000 2007TO BAL B\D41002007BY DEP A\C [Bal.fig.] 1100 TO COST OF PRODUCTION A\C 2700BY BAL C\D5700

41. 6800 2008To bal b\d57002008By depreciation a\c700 To cost of production a\c 1000By bal c\d6000 6700 950 250 1200

42. DEPLETION METHOD This method is mostly used in case of mine, quarries; etc. from which certain quantity of output is expected to be obtained. The value of mine depends only upon quantity of minerals that can be obtained.when the whole quantity is taken,the mine loses its value.the rate of depreciation is worked out only so much per tonne. It is simply dividing the cost of the mine by the total quantity of the minerals expected to be available.

43. QUESTION:-A mine was acquired at a cost of Rs.20,00,000 on 1 st July 2007. It was expected it would yield 2,00,000 tons of minerals in all. The actual output was 2007- 10,000 tons,2008-40,000 tons and 2009- 32,000 tons. Write up the mine account for the above years using depletion method of charging depreciation. Rate of depreciation =Rs.10 per ton

44. MINE ACCOUNT 2007 July 1 To bank a\c20000002007 Dec 31 By depreciation a\c 100000 Dec3 1 By bal c\d1900000 2000000 2008 Jan 1 To bal b\d19000002008 Dec3 1 By depreciation a\c 400000 Dec3 1 By bal c\d15000000

45. 1900000 2009 Jan 1 To bal b\d15000002009 Dec 31 By depreciation a\c 320000 Dec 31By bal c\d1180000 1500000 2010 Jan 1 To bal b\d1180000

46. MACHINE HOUR RATE METHOD This method is useful in case of machines.The life of machine is fixed in terms of hours. Hourly rate of depreciation is worked out by dividing the cost of the machine by the total number of hours for which the machine is expected to be used.depreciation to be written off in a year will be ascertained by multiplying the hourly rate of depreciation by the number of hours that the machine actually runs in the year.

47. QUESTION:- A machine was acquired on 1 st April,2008 at a cost of Rs 90,000, the cost of installation being Rs. 10000. It is expected that its total life will be 20,000 hours. During 2008 it worked for 5,000 hours and during 2009 for 8,000 hours. Write up the machinery account for 2008 & 2009. Machine hour rate= Rs 5 per hour

48. MACHINERY ACCOUNT 2007 Ap 1 To bank a\c [cost and installation charges] 100000Dec 31By depreciation a\c 25000 Dec31By bal c\d75000 100000 2009 Jan 1 To bal b\d750002009 Dec31 By depreciation a\c 40000 Dec31By bal c\d35000 75000 2010 Jan 1 To bal b\d35000

49. CHANGE OF METHOD Sometimes the method is changed either from straight line method to diminishing balance method or from diminishing balance method to straight line method with effect from the current year or with retrospective effect.if the change is from current year then there will be no problem but simply to change the method of depreciation.

50. QUESTION:- Plant and machinery account of a company had a debit balance of Rs. 1,47,390 on 1 st jan,2009.The company was incorporated in 2006 and has been following the practice of charging full year, depreciation every year on diminishing balance system @15%. In 2009 it was, however decided to change the method from reducing system to straight line with retrospection effect from 2006 and to give effect of the change while preparing the final accounts for the year ended 31 st dec,2009, the rate of depreciation remaining same as before. In 2009, new machineries were purchased at a cost of Rs.50,000. All the other machineries were acquired in 2006. Show Plant and machinery account from 2006 to 2009.

51. PLANT AND MACHINERY ACCOUNT 2006 Jan 1 TO BANK A\C2400002006 Dec31 BY DEP A\C [15% on Rs 240000] 36000 Dec31BY BALC\D204000 240000 2007 Jan 1 TO BAL B\D2040002007 Dec31 BY DEP A\C [15% on Rs204000 30600 Dec31BY BAL C\D173400

52. 204000 2008 Jan 1 To bal b\d1734002008 Dec 31 By depreciation a\c [15% on Rs173400 26010 Dec 31 By bal c\d147390 173400 2009 Jan 1 To bal b\d1473902009 Dec 31 By profit and loss a\c [additional dep] 2 15390 Jan 1To bank a\c [Additions] 50000Dec3 1 By depreciation a\c [15%on 240000+50000] 43500

53. Dec 31By bal c\d138500 197390

54. PROVISIONS AND RESERVES MEANING OF PROVISIONS The term “provision” means any amount written off or retained by way of providing depreciation,renewals or diminution in the value of assets or retained by way of providing for any know liability the amount of which may not be determined with substantial accuracy

55. Question:- A firm desires to debit its profit and loss account with a uniform figure every year in respect of repairs and renewals. It expects that considering the life of the asset in question Rs.10,000 will be the average amount to spent per year. Actual repairs are Rs.1,000 in the first year, Rs.2,300 in the second year and Rs.3,700 in the third year. Show the provision for repairs and renewals account.

56. FOR REPAIRS AND RENEWALS ACCOUNT YEAR 1 To bank [Repairs]1000YEAR 1 By profit and loss a\c 10000 To bal c\d9000 10000 2To bank [Repairs]23002By bal b\d9000 To bal c\d16700By profit and loss a\c 10000 19000

57. 3To bank [Repairs]37003By bal b\d16700 To bal c\d23000By profit and loss a\c 10000 26700

58. MEANING OF RESERVE Any sum which is appropriated out of profit and loss appropriation account and is not meant to cover up liability,contingency,commitment,or reduction in the value of an asset is a reserve.

59. QUESTION:- Show the distinction between sinking fund to repay a liability and sinking fund to replace a wasting asset by the operation of ledger account at the end of five years in the following cases: 1. sinking fund to replace leasehold property valued Rs. 900000 at the end of five years. 2. sinking fund to repay Rs. 900000 debentures at the end of five years.

60. To old lease a\c [transfer] 900000By bal b\d900000 1. Sinking fund [to replace an asset at the end of five years] OLD LEASE ACCOUNT To bal b\d900000By sinking fund a\c [transfer] 900000 To bank a\c900000 NEW LEASE ACCOUNT 2. Sinking fund [to repay a liability at the end of five years] To reserve fund [transfer] 900000By bal b\d900000 DEBENTURES ACCOUNT To bank a\c900000By bal b\d900000