Test: Depreciation Provisions And Reserves - 2 - Commerce MCQ

The cost of a fixed asset refers to the initial cost incurred to acquire or construct the asset. On the other hand, accumulated depreciation expenses represent the total depreciation incurred on the fixed asset over its useful life. To find the book value of a fixed asset, we need to subtract the accumulated depreciation expenses from the cost of the fixed asset.
Therefore, the detailed solution is as follows:
1. Cost of a fixed asset: This refers to the initial cost incurred to acquire or construct the asset.
2. Accumulated depreciation expenses of the fixed asset: This represents the total depreciation incurred on the fixed asset over its useful life.
3. Book value of fixed asset: This is the remaining value of the fixed asset after deducting the accumulated depreciation expenses from the cost of the asset. It represents the net value of the asset on the company's balance sheet.
4. Historical cost of a fixed asset: This is another term for the cost of a fixed asset. It refers to the original cost incurred to acquire or construct the asset.
5. Recoverable amount of a fixed asset: This refers to the amount that can be obtained from the disposal or sale of the fixed asset. It is based on the estimated market value or the net selling price of the asset.
6. Market value of fixed asset: This refers to the current value of the fixed asset in the open market. It represents the price at which the asset could be sold in the market.
Answer: The correct answer is A. Book value of fixed asset.

An increase in the value of fixed asset is referred to as Appreciation. Appreciation, in general terms, is an increase in the value of an asset over time. The increase can occur for a number of reasons, including increased demand or weakening supply, or as a result of changes in inflation or interest rates.

The term _____ is generally used for the depreciation of natural resources

The correct answer is B: Depletion

Explanation:

Depreciation is a term used to describe the decrease in value of an asset over time. In the case of natural resources, such as oil, minerals, or forests, the term used for their depreciation is depletion. Depletion refers to the exhaustion or reduction of these resources due to extraction, consumption, or other forms of utilization.

Here is a breakdown of the options:

• Appreciation: This term refers to the increase in value of an asset over time, which is the opposite of depreciation. It is not applicable in the context of natural resource depreciation.


• Depletion: This is the correct term used for the depreciation of natural resources.


• Disposal value: Disposal value refers to the estimated worth of an asset at the end of its useful life or when it is sold or disposed of. It is not specifically related to the depreciation of natural resources.


• Amortization: Amortization refers to the gradual reduction or repayment of debt over a period of time. It is not directly related to the depreciation of natural resources.

In conclusion, the term depletion is generally used for the depreciation of natural resources.

Asset Disposal Account
The correct answer is option C: Asset disposal account. When an asset is disposed of, it is necessary to record the procedure in a separate account called the asset disposal account. This account helps in accurately reflecting the disposal of the asset and its impact on the financial statements. Here is a detailed explanation:
1. Definition: An asset disposal account is a separate account that is used to record the disposal of an asset. It is created when an asset is sold, scrapped, or otherwise disposed of.
2. Purpose: The asset disposal account serves several purposes, including:
- Keeping track of the proceeds received from the disposal of the asset.
- Recording any gains or losses realized on the disposal.
- Separating the disposal transactions from the regular operating activities of the business.
- Providing a clear audit trail for the disposal of assets.
3. Recording the disposal: When an asset is disposed of, the following entries are typically recorded in the asset disposal account:
- Debit: Accumulated Depreciation (to remove the accumulated depreciation associated with the asset).
- Debit: Asset Disposal Account (to record the cost of the asset being disposed of).
- Credit: Asset Account (to remove the asset from the books).
- Credit: Gain/Loss on Asset Disposal (to record any gains or losses realized on the disposal).
4. Example: Let's say a company sells a piece of equipment for $10,000, which originally had a cost of $15,000 and accumulated depreciation of $5,000. The entry in the asset disposal account would be as follows:
- Debit: Accumulated Depreciation ($5,000)
- Debit: Asset Disposal Account ($15,000)
- Credit: Equipment ($20,000)
- Credit: Gain/Loss on Asset Disposal ($10,000)
5. Impact on financial statements: The asset disposal account helps in accurately reflecting the disposal of the asset in the financial statements. The gain or loss recorded in the asset disposal account is eventually transferred to the income statement, which affects the company's net income and retained earnings.
In conclusion, when an asset is disposed of, the procedure is recorded in a separate account called the asset disposal account. This account helps in accurately reflecting the disposal of the asset and its impact on the financial statements.

Limitation of the Written Down Value Method:
There are several limitations of the Written Down Value (WDV) method, but the specific limitation mentioned in the question is:
A. The value of the asset can never be zero:
- Under the WDV method, the value of the asset is gradually reduced over time by deducting depreciation. However, the asset's value can never be reduced to zero, even if it becomes obsolete or unusable. This limitation can result in an overvaluation of assets on the company's balance sheet.
Other limitations of the Written Down Value method include:
B. Suitable for fixed assets that last long:
- The WDV method is more suitable for fixed assets that have a long lifespan. It may not be appropriate for assets with short lifespans, as the depreciation expenses may not accurately reflect the asset's value over time.
C. Acceptance by Income Tax Act:
- This limitation mentioned in the question is incorrect. The Income Tax Act may or may not accept the WDV method for tax purposes. The acceptance of the method depends on the specific tax regulations of each country.
D. Reduction of loss due to obsolescence:
- Under the WDV method, a larger portion of the asset's cost is written off in earlier years. This can result in a reduction of loss due to obsolescence, as the asset's value is already significantly reduced. However, this can also lead to an overvaluation of assets on the balance sheet if the asset's value does not accurately reflect its true worth.
In conclusion, the correct limitation of the Written Down Value method is that the value of the asset can never be reduced to zero, even if it becomes obsolete or unusable.

Provisions Except Examples:

• Provision for depreciation: This provision is made to account for the decrease in value of an asset over time. It is used to allocate the cost of an asset over its useful life.


• Provision for taxation: This provision is made to account for the future tax liabilities of a company. It is used to estimate and set aside funds for paying taxes in the future.


• Provision for bad and doubtful debts: This provision is made to account for potential losses from non-payment or delayed payment of debts. It is used to estimate the amount of doubtful debts and set aside funds to cover these potential losses.

Provision for Liability:
This provision is not an example of a provision. It is a general term that refers to the act of setting aside funds to cover potential liabilities or obligations of a company. It can include provisions for various types of liabilities such as legal claims, warranties, or contingent liabilities.
In the given options, provision for liability does not fit into the category of provisions with specific examples provided. Therefore, the correct answer is D.

Obsolescence means decrease in assets
Obsolescence refers to the decrease in the value or usefulness of assets over time. It can occur due to various factors such as technological advancements, changing customer preferences, and market conditions. Let's break down the given options to determine the most accurate definition of obsolescence:
A: Assets become out of fashion
- This option suggests that obsolescence occurs when assets go out of fashion.
- While changing trends and preferences can contribute to obsolescence, it is not the only factor.
- Assets can become obsolete even if they are not related to fashion or style.
B: Due to its use in business operations
- This option implies that obsolescence is a result of the asset's use in business operations.
- While obsolescence can be influenced by how an asset is used, it is not the sole cause.
- Obsolescence can occur even if an asset is not actively used in business operations.
C: Both
- This option suggests that obsolescence can occur due to assets becoming out of fashion and their use in business operations.
- While both factors can contribute to obsolescence, neither one exclusively defines it.
- Obsolescence is a broader concept that encompasses various causes.
D: None
- This option states that obsolescence does not lead to a decrease in assets.
- This is incorrect as obsolescence directly relates to the decrease in the value or usefulness of assets.
Answer: A
- The most accurate definition of obsolescence from the given options is that it refers to assets becoming out of fashion.
- While this definition is not comprehensive, it captures one aspect of obsolescence.
- Obsolescence can be caused by various factors, including changing trends, technological advancements, and market conditions.

Depreciation is a process of
Definition:
Depreciation refers to the systematic allocation of the cost of an asset over its useful life. It is a method used to account for the wear and tear, obsolescence, and decrease in value of an asset over time.
Explanation:
Depreciation is an important concept in accounting and finance. It helps in accurately representing the value of assets on a company's financial statements.
Key points:
- Valuation of assets: Depreciation helps in determining the accurate value of assets by allocating the cost of the asset over its useful life.
- Allocation of cost: Depreciation allows companies to allocate the cost of an asset over its useful life, rather than expensing the entire cost in the year of purchase.
- Valuation of charge: Depreciation is not directly related to the valuation of charge.
- Valuation of profit: Depreciation indirectly affects the valuation of profit by reducing the value of assets and increasing expenses, thereby reducing the profit.
Conclusion:
Depreciation is the process of allocating the cost of an asset over its useful life. It helps in accurately valuing assets and determining the profit of a company. The correct answer is option C: Allocation of cost.

Explanation:

If the amount of any known liability cannot be determined with accuracy, the appropriate accounting treatment is to make a provision. A provision is a liability of uncertain timing or amount, and it is recognized when there is a present obligation that arises from past events, and it is probable that an outflow of resources will be required to settle the obligation.

Reasoning:

In this scenario, since the amount of the liability cannot be determined accurately, it means there is uncertainty regarding the timing or amount of the liability. Therefore, a provision should be made to account for this uncertainty and reflect the potential obligation in the financial statements.

Key Points:

• If the amount of any known liability cannot be determined accurately, a provision should be made.


• A provision is a liability of uncertain timing or amount.


• A provision is recognized when there is a present obligation arising from past events, and it is probable that an outflow of resources will be required to settle the obligation.

Therefore, the correct answer is C: A provision should be made.

Secret Reserve:
Secret reserve refers to the practice of keeping a portion of profits hidden from the financial statements. It is a conservative accounting technique employed by some companies to create a cushion for future uncertainties or to manipulate financial results.
Statements regarding Secret Reserve:
D. All of these are true relating to Secret Reserve.
1. Appropriation of profit: Secret reserves are created by appropriating a portion of the profit and keeping it undisclosed. This means that the company intentionally hides a portion of its earnings, which could have otherwise been distributed as dividends or used for other purposes.
2. Not shown in the balance sheet: Secret reserves are not disclosed in the balance sheet or any other financial statement. They remain hidden from the public and only known to the management of the company. This allows the company to present a more conservative financial position to external stakeholders.
3. Profits are shown by less amount than actual: By creating secret reserves, companies can understate their profits in the financial statements. This can be done by inflating expenses, understating revenues, or manipulating various accounting entries. The purpose is to create a buffer for future contingencies or to manage expectations of investors and stakeholders.
It is important to note that while secret reserves may be legal, they can raise ethical concerns and may not be in line with generally accepted accounting principles. They can mislead investors and stakeholders by presenting a distorted financial picture of the company's true performance.
In conclusion, secret reserves involve the appropriation of profit, are not shown in the balance sheet, and result in the understatement of actual profits.

Dividend equalization reserve is termed as reserves
The correct answer is B: Created out of profits.
Explanation:
Dividend equalization reserve is a type of reserve that is created by a company to equalize the amount of dividends paid to shareholders. It is used to maintain a consistent level of dividend payments even in times of fluctuating profits.
Here is a detailed explanation of why the answer is B:
- Reserves: Reserves are funds that are set aside by a company for specific purposes. They are created to ensure the financial stability and sustainability of the company.
- Dividend equalization reserve: Dividend equalization reserve is a specific type of reserve that is created to equalize the amount of dividends paid to shareholders.
- Created out of profits: Dividend equalization reserve is created out of profits. This means that the reserve is funded by the company's profits. When a company has higher profits, it can set aside a portion of those profits into the dividend equalization reserve to ensure that it can continue to pay consistent dividends to shareholders even during periods of lower profits.
- Purpose: The purpose of creating a dividend equalization reserve is to maintain a stable dividend payment to shareholders. It helps to smooth out fluctuations in profits and ensures that shareholders receive a consistent return on their investment.
- Accounting treatment: Dividend equalization reserve is shown as a liability on the company's balance sheet. It is deducted from the company's profits and is not available for distribution as dividends to shareholders.
In conclusion, dividend equalization reserve is a reserve that is created out of profits to maintain a consistent level of dividend payments to shareholders. It helps to ensure financial stability and sustainability for the company.

How secret reserve can be created:
Creating secret reserves is a practice that involves manipulating financial statements to hide profits or assets. While it is not considered ethical or legal, here are some methods that are commonly used to create secret reserves:
1. Charging capital expenditure to revenue:
- Capital expenditures are typically long-term investments in assets that benefit a company over a period of time.
- By charging these expenses to revenue, a company can understate its profits, creating a secret reserve.
2. Under-Valuating Stock:
- By intentionally undervaluing the stock on the balance sheet, a company can create a secret reserve.
- This can be done by undervaluing the cost of production or using a lower market value for the stock.
3. Making Excessive Provisions:
- Provisions are made for potential liabilities or losses that a company might face in the future.
- By intentionally making excessive provisions, a company can overstate its expenses, thus reducing its profits and creating a secret reserve.
4. All of These:
- It is important to note that creating secret reserves can involve a combination of these methods or other similar manipulations.
Creating secret reserves is generally discouraged and is considered unethical. It can mislead stakeholders, investors, and regulators, leading to a loss of trust in the company. Companies should strive for transparency and accuracy in their financial reporting to ensure fair and reliable information for all stakeholders.

Capital Reserves are created out of capital gain.
Explanation:
- Capital reserves are created by setting aside a portion of the capital gains earned by a company.
- Capital gains are the profits made from the sale of long-term assets such as property, stocks, or bonds.
- These reserves are not available for distribution as dividends to shareholders and are retained by the company for specific purposes.
- The purpose of creating capital reserves is to strengthen the financial position of the company and provide a cushion for future needs.
- Capital reserves can be used for various purposes, such as funding future expansion projects, repaying debts, or acquiring new assets.
- It is important to note that capital reserves are different from revenue reserves, which are created out of the company's profits from its regular operations.
- Examples of capital reserves include the share premium account, revaluation reserve, and reserve for contingencies.
In conclusion, capital reserves are created out of capital gains and serve as a financial buffer for the company's future needs.

Answer:
Good debt
A: Those whose collection of credit is uncertain
B: Who have paid the whole amount
C: Who have good characters
D: Those whose collection of credit is certain
Explanation:
Good debt refers to debts that are considered positive or beneficial for an individual or organization. These debts are typically used for investments or purchases that have the potential to generate long-term value or income. Here is a detailed explanation of each option:
A: Those whose collection of credit is uncertain:
- This option suggests that good debt is associated with individuals or organizations whose ability to repay the debt is uncertain. However, this is incorrect. Uncertain credit collection does not define good debt.
B: Who have paid the whole amount:
- This option suggests that good debt is associated with individuals or organizations who have already paid off the entire debt amount. However, this is incorrect. Good debt does not necessarily imply that the debt has been fully repaid.
C: Who have good characters:
- This option suggests that good debt is associated with individuals or organizations who have good characters. However, character is not necessarily a determining factor for good debt. Good debt is primarily based on the potential for generating long-term value.
D: Those whose collection of credit is certain:
- This option correctly identifies good debt as being associated with individuals or organizations whose collection of credit is certain. This means that there is a high likelihood of the debt being repaid on time and in full. Good debt is often backed by collateral or supported by a strong credit history.
Therefore, the correct answer is option D, which states that good debt is associated with those whose collection of credit is certain.

False Statement about Depreciation:
The false statement about depreciation is as follows:
A: It increases the book value of fixed assets.
Explanation:
Depreciation is a process that involves the gradual decrease in the value of an asset over time. It is important to note that the book value of fixed assets, such as machinery or equipment, decreases as depreciation is recorded. Therefore, statement A is false.
Correct Statements about Depreciation:
To provide a comprehensive understanding of depreciation, here are the correct statements:
B: It includes loss of value due to efflux ion of time, usage, or obsolescence.
Depreciation accounts for the decline in value that occurs as a result of the passage of time, usage of the asset, or obsolescence. These factors contribute to the decrease in the asset's worth over its useful life.
C: It is a continuing process.
Depreciation is an ongoing process that is recorded over the useful life of the asset. It is not a one-time occurrence but rather a recurring expense that is recognized in the financial statements over time.
D: It is an expired cost and must be deducted before calculating taxable profit.
Depreciation is considered an expired cost because it is associated with the consumption of the asset's value over its useful life. It is deducted from the revenue generated by the asset before calculating taxable profit. This deduction helps to reflect the true economic value of the asset.
In conclusion, statement A is false as depreciation decreases the book value of fixed assets over time.

Depreciation arise due to:

Depreciation refers to the decrease in the value of an asset over time. It can occur due to various factors, including:

• Normal wear and tear: Assets undergo physical deterioration and lose value over time due to regular usage, exposure to the environment, or aging. This is known as physical depreciation and is a common cause of depreciation.



• Fall in the value of money: Depreciation can also occur due to inflation or a decrease in the purchasing power of money. When the value of money decreases, it takes more money to purchase the same goods or services. This affects the value of assets, leading to depreciation.



• Fall in the market value: Changes in market conditions, demand, and supply can impact the market value of assets. If the market value of an asset falls below its original cost, depreciation occurs.



• Obsolescence: Technological advancements and changes in consumer preferences can make certain assets obsolete. When an asset becomes outdated or no longer useful, its value decreases, resulting in depreciation.



• Accumulated depreciation: Over time, the wear and tear or other factors mentioned above accumulate, leading to a gradual decrease in the value of an asset.

Conclusion: Depreciation can arise due to normal wear and tear, fall in the value of money, fall in the market value, obsolescence, and accumulated depreciation. It is important for businesses to account for depreciation when calculating the value of their assets and determining their financial performance.

Under which depreciation method the amount of depreciation expenses remain same throughout the useful life of a fixed asset?

The correct answer is Straight line method.

Explanation:

The straight line method is a common and simple depreciation method used to allocate the cost of a fixed asset evenly over its useful life. In this method, the amount of depreciation expense remains the same throughout the useful life of the asset.

Here are some key points about the straight line method:

• The straight line method is based on the assumption that the asset depreciates by an equal amount each year.


• The formula to calculate the annual depreciation under the straight line method is:




• Depreciation Expense = (Cost of Asset - Salvage Value) / Useful Life




• The cost of the asset is the initial purchase price or the historical cost.


• The salvage value is the estimated value of the asset at the end of its useful life.


• The useful life is the estimated number of years that the asset will be productive and generate economic benefits.


• The depreciation expense is the amount that is recorded as an expense on the income statement each year to reflect the reduction in the value of the asset.


• By using the straight line method, the same amount of depreciation expense is recognized each year, resulting in a consistent allocation of the asset's cost over its useful life.

Therefore, the straight line method is the depreciation method where the amount of depreciation expenses remains the same throughout the useful life of a fixed asset.

Credit balance is the normal balance of an accumulated depreciation account. Accumulated depreciation has a credit balance, because it aggregates the amount of depreciation expense charged against a fixed asset.

Deprecation amount Residential value of a fixed asset:
The residential value of a fixed asset can be determined by considering the deprecation amount. The deprecation amount is the reduction in the value of the asset over time due to wear and tear, obsolescence, or other factors. To calculate the residential value of a fixed asset, the deprecation amount needs to be taken into account.
The correct option for the residential value of a fixed asset is B: Cost of the fixed asset. The cost of the fixed asset represents the original purchase price or acquisition cost of the asset. This cost is used as the basis for calculating depreciation and determining the residential value of the asset.
Here is a breakdown of the options:
A: Accumulated depreciation - This represents the total deprecation amount accumulated over the life of the fixed asset. It is not directly related to the residential value of the asset.
B: Cost of the fixed asset - This is the original purchase price or acquisition cost of the asset and is used as the basis for calculating depreciation. It directly contributes to determining the residential value of the asset.
C: Depreciation expenses - This represents the amount of deprecation recognized in a particular accounting period. While it is related to deprecation, it does not directly represent the residential value of the asset.
D: Future economic benefits of a fixed asset - This refers to the potential benefits or value that the asset will provide in the future. It is not directly related to the residential value, which focuses on the current value of the asset.
In conclusion, the residential value of a fixed asset is determined by considering the cost of the asset, which represents the original purchase price or acquisition cost. Accumulated depreciation, depreciation expenses, and future economic benefits are not directly related to the residential value.

The element of the machine's cost that is not included is the refundable tax. The other elements, such as import duty and purchase price of the machine, are part of the machine's cost. Here is the breakdown:
Import duty:
- Import duty is a tax imposed on imported goods.
- It is calculated as a percentage of the value of the imported goods.
- Import duty is incurred when the machine is brought into the country.
Purchase price of the machine:
- The purchase price of the machine refers to the amount of money paid to acquire the machine.
- It includes the cost of the machine itself, as well as any additional fees or charges associated with the purchase.
Refundable tax:
- Refundable tax refers to a tax that can be refunded under certain conditions.
- This type of tax is not typically included in the cost of a machine, as it can be reclaimed or refunded at a later date.
Conclusion:
The element of the machine's cost that is not included is the refundable tax. Import duty and the purchase price of the machine are both part of the machine's cost.