NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

Accountancy Class 11

Commerce : NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

The document NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev is a part of the Commerce Course Accountancy Class 11.
All you need of Commerce at this link: Commerce

Page Number : 282
Short answers : 
Q1 : What is Depreciation?
Answer : Every business acquires fixed assets for its use in the business over a period of time. As the benefits of these assets can be availed over a long period of time, thus, due to their regular use,there occurs continuous wear and tear and consequently fall in their value. This fall in the value of fixed assets, due to their regular use or expiry of time is termed as depreciation.
A machinery costing Rs 1,00,000 and its useful life is 10 years; so, depreciation is calculated as:

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

Q2 :State briefly the need for providing depreciation.
Answer : The needs for providing depreciation are given below.
1. To ascertain true net profit or net loss- Correct profit or loss can be ascertained when all the expenses and losses incurred for earning revenues are charged to Profit and Loss Account. Assets are used for earning revenues and its cost is charged in form of depreciation from Profit and Loss Account.
2. To show true and fair view of financial statements- If depreciation is not charged, assets are shown at higher value than their actual value in the Balance Sheet; consequently, the Balance Sheet does not reflect true and fair view of financial statements.
3. For ascertaining the accurate cost of production- Depreciation on plant and machinery and other assets, which are engaged in production, is included in the cost of production. If depreciation is not included, cost of production is underestimated, which will lead to low sale price and thus leads to low profit.
4. Distribution of dividend out of profit- If depreciation is not charged, which leads to overestimating of profit and consequently more profit is distributed as dividend, out of capital instead of the profit. This leads to the flight of scarce capital out of the business.
5. To provide funds for replacement of assets- Unlike other expenses, depreciation is not a cash expense. So, the amount of depreciation charged will be retained in the business and will be used for replacement of fixed assets after its useful life.
6. Consideration of tax- If depreciation is charged, then Profit and Loss Account will disclose lesser profit as to when the depreciation is not charged. This depicts reduced profit and thus the business will be liable for lesser tax amount.

Q3 : What are the causes of depreciation?
Answer :

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

1. Constant use - Due to constant use of the fixed assets there exists normal wear and tear that leads to fall in the value of fixed assets.
2. Expiry of time - With the passage of time, whether assets are used or not, its effective life decreases. The natural forces like rain, weather, etc. lead to deterioration of the fixed assets.
3. Obsolescence - Due to the fast technological innovations and inventions today's assets may be outdated by tomorrow's sophisticated assets. This leads to the obsolescence of fixed assets.
4. Expiry of legal rights - If an asset is acquired for a specific period of time, then, whether the asset is put to use ornot, its value becomes zero at the end of its useful life. For example, if a land is acquired for Rs 1,00,000 for 25 years on lease, then each year its value depreciates by NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev of its gross value. At the end of the 25th year, the value of the lease will be zero.
5. Accident - An asset may lose its value and damage may happen to it due to mishaps such as a fire accident, theft or a natural calamity. The loss due to accident is permanent in nature.
6. Permanent fall in value - Generally, we do not record fluctuations in the market price of the fixed assets in the books. However, if the fall in market price is permanent, it is accounted, which leads to a fall in the value of fixed assets in the books.

Q4 : Explain basic factors affecting the amount of depreciation.
Answer :

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev


1. Total cost of asset - The total cost of an asset is taken into consideration for ascertaining the amount of depreciation. The expenses incurred in acquiring, installing and constructing asset and bringing the asset to its usable condition are included in the total cost of asset.
2. Estimated useful life - Every asset has its useful life other than its physical life (in terms of number of years, units, etc.), used by a business. The useful life of an asset is considered to estimate the effective life of a fixed asset. For example, land has indefinite life; however, if business acquiress a piece of land on lease for 25 years, then the useful life of the piece of land is considered to be 25 years.
3. Estimated scrap value - It is estimated as the net realisable value or sale value of an asset at the end of its effective life. It is deducted from the total cost of an asset. For example, furniture is acquired at Rs 50,000 and its effective life is 10 years.
After 10 years, the furniture will be sold at Rs 10,000. So, depreciation is charged as:

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

Q5 : Distinguish between straight line method and written down value method of calculating depreciation.
Answer :

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

Q6 :  In case of a long term asset, repair and maintenance expenses are expected to rise in later years than in earlier year. Which method is suitable for charging depreciation if the management does not want to increase burden on profits and loss account on account of depreciation and repair.
Answer : If the management does not want to exert undue burden on the profits due to high depreciation and repair costs in the latter years of the assets, then 'written down method' should be a preferred method to provide depreciation. This is because the cost of depreciation reduces; whereas, repair and maintenance expenses increase in the latter years. However, on the whole, it does not exert increasing burden on profits.

Q7 : What are the effects of depreciation on profit and loss account and balance sheet?
Answer : The effects of depreciation on Profit and Loss Account are given below.
1. Depreciation increases the debit side of profit and loss account and hence reduces net profit.
2. Depreciation increases the total expenses, leading to an excess of debit over credit balance.
The effects of depreciation on Balance Sheet are given below.
1. It reduces the original cost or book value of the concerned asset.
2. It reduces the overall balance of asset's column in the balance sheet.

Q8 : Distinguish between provision and reserve.
Answer :
NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

Q9 : Give four examples each of provision and reserves.
Answer :
Four examples of provision are given below.
1. Provision for bad and doubtful debts
2. Provision for discount on debtors
3. Provision for depreciation
4. Provision for taxation
Four examples of reserve are given below.
1. General reserve
2. Capital reserve
3. Dividend equalisation reserve
4. Debenture redemption reserve

Q10 : Distinguish between revenue reserve and capital reserve.
Answer : 

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

Q11 : Give four examples each of revenue reserve and capital reserves.
Answer :
1. Four examples of revenue reserve are given below.
    1. General Reserve
    2. Retained Earnings
    3. Dividend Equalisation Reserve
    4. Debenture Redemption Reserve
2. Four examples of capital reserve are given below.
    1. Issues of shares at premium
    2. Profit or issue of shares
    3. Sale of fixed assets
    4. Profit on redemption of debentures

Q12 : Distinguish between general reserve and specific reserve.
Answer :

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev 

Q13 : Explain the concept of secret reserve.
Answer :
Reserves that are created by overstating liabilities or understating assets are known as secret reserves. They are notshown in the balance sheet. These reduce tax liabilities, as the liabilities are overstated. It is created by management to avoid competition by reducing profit. Creation of secret reserve is not allowed by Companies Act, 1956 that requires full disclosure of all material facts and accounting policies while preparing final statements.

Page Number : 283
Long answers : 
Q1 : Explain the concept of depreciation. What is the need for charging depreciation and what are the causes of depreciation?
Answer : Every business acquires fixed assets for its use in the business over a period of time. As the benefits of these assets can be availed over a long period of time (due to their regular use), there exists continuous wear and tear and consequently fall in their value. This fall in the value of fixed assets (due to regular use or expiry of time) is termed as depreciation. A machinery that costs Rs 1,00,000 and its useful life of 10 years, its depreciation will be calculated as:

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

1. To ascertain true net profit or net loss - Correct profit or loss can be ascertained when all the expenses and losses incurred for earning revenues are charged to profit and loss account. Assets are used for earning revenues and its cost is charged in form of depreciation from profit and loss account.
2. To show true and fair view of financial statements - If depreciation is not charged, assets are shown at higher value than their actual value in the balance sheet; consequently, the balance sheet does not reflect true and fair view of financial statements.
3. For ascertaining the accurate cost of production - Depreciation on plant and machinery and other assets, which are engaged in production, is included in the cost of production. If depreciation is not included, cost of production is underestimated, which will lead to low sale price and thus leads to low profit.
4. Distribution of dividend out of profit - If depreciation is not charged, which leads to overestimating of profit and consequently more profit is distributed as dividend, out of capital instead of the profit. This leads to the flight of scarce capital out of the business.
5. To provide funds for replacement of assets - Unlike other expenses, depreciation is not a cash expense. So, the amount of depreciation charged will be retained in the business and will be used for replacement of fixed assets after its useful life.
6. Consideration of tax - If depreciation is charged, then profit and loss account will disclose lesser profit as to when the depreciation is not charged. This depicts reduced profit and thus the business will be liable for lesser tax amount.
Below are given the causes for depreciation.

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

1. Constant use - Due to constant use of the fixed assets there exists normal wear and tear that leads to fall in the value of fixed assets.
2. Expiry of time - With the passage of time, whether assets are used or not, its effective life decreases. The natural forces like rain, weather, etc. lead to deterioration of the fixed assets.
3. Obsolescence - Due to the fast technological innovations and inventions today's assets may be outdated by tomorrow's sophisticated assets. This leads to the obsolescence of fixed assets.
4. Expiry of legal rights - If an asset is acquired for a specific period of time, then, whether the asset is put to use ornot, its value becomes zero at the end of its useful life. For example, if a land is acquired for Rs 1,00,000 for 25 years on lease, then each year its value depreciates by NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev of its gross value. At the end of the 25th year, the value of the lease will be zero.
5. Accident - An asset may lose its value and damage may happen to it due to mishaps such as a fire accident, theft or a natural calamity. The loss due to accident is permanent in nature.
6. Permanent fall in value - Generally, we do not record fluctuations in the market price of the fixed assets in the books. However, if the fall in market price is permanent, it is accounted, which leads to a fall in the value of fixed assets in the books.

Q2 : Discuss in detail the straight line method and written down value method of depreciation. Distinguish between the two and also give situations where they are useful.
Answer : Straight Line method
It is a simple method of charging depreciation. Under this method, depreciation is charged on the original cost of an asset, at a fixed rate of percentage. In this method, amount of depreciation remains same from year to year and asset's value becomes zero at the end of its useful life.
Amount of depreciation is calculated as under:

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev
Advantages of Straight Line Method
1. It is simple to calculate.
2. Asset can be completely written off, i.e., asset can be depreciated until the net scrap value is zero.
3. Same amount of depreciation is charged every year. Therefore, it helps in easy comparison of Profit and Loss Account for different years.
4. It is used for assets that have low repairs and maintenance expenses and are continuously used over a period of time.
Limitations of Straight Line Method
1. Burden of deprecation is more on profit and loss account in the later years, when repair and maintenance costs increase, as asset becomes older.
2. Value of asset becomes zero in the books even if asset is still in usable condition in business.
Uses of Straight Line Method
1. This method is useful where repairs and maintenance expenses on asset are low.
2. It is also useful when an asset is continuously used from one year to another.
3. It is useful when the value of assets, such as patent, copyright, goodwill, etc., becomes zero
Written Down Value Method
This method is applicable where depreciation is charged on the diminishing balance, i.e., book value of the asset. In this method, asset's value goes on diminishing year after year and the amount of depreciation declines.
Rate of depreciation is calculated as follows:

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

Where,
R represents rate of depreciation
n represents expected useful life of the asset
s represents the scrap value
c represents the cost of the asset
Advantages of Written Down Value Method
1. It is based on the logical assumption that asset is used more in the earlier years, so more cost is charged in form of depreciation.
2. It is suitable for the assets where repairs are more in the later years, as depreciation is lesser and on a whole the combined burden of depreciation and repairs exerts equal pressure on the net profit over years.
3. This method is accepted by the income tax authorities.
4. As more depreciation is charged in the earlier years, so the loss due to obsolescence of the asset is reduced.
Limitations of Written Down Value Method
1. It is difficult to calculate and is a time consuming process.
2. The value of an asset cannot be zero, thus the asset cannot be completely written off.
3. There arises shortage of funds for replacement of new asset. This happens due to the fact that the amount of depreciation is retained and used in the business. Consequently, at the end of the useful life of an old asset, business finds it difficult to arrange funds for its replacement.
Uses of  Written Down Value Method
1. It is useful when assets have long life.
2. It is useful for those assets that require more repair and maintenance costs in the later years.
3. It provides easy calculation to provide depreciation of additional asset purchased during a year. 

Difference between Straight Line Method and Written Down Value MethodNCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

Q3 : Describe in detail two methods of recording depreciation. Also give the necessary journal entries.
Answer :
The two methods of recording depreciation are diagrammatically presented below.

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev
1. Charging depreciation to Asset Account- Under this method, depreciation is directly credited to the asset account and no separate account is prepared for provision of depreciation. Under this method, the original cost of an asset and the total amount of depreciation cannot be determined from the Balance Sheet, as the Asset Account appears at its written down value.
Journal entries for depreciation are given below.
When depreciation is charged to Assets Account
Depreciation A/c
                 To Assets A/c
(Depreciation charged to Assets Account)
Closing of Depreciation Account
Profit and Loss A/c
                 To Depreciation A/c
(Depreciation transferred to Profit and Loss Account)
2. Creating Provision for Depreciation Account- Under this method, depreciation is not credited to the Assets Account; in fact, it is credited to the provision for Depreciation Account. At the year end, asset is shown at the original cost in the Balance Sheet and total depreciation up to the date of Balance Sheet is shown as Provision for Depreciation Account.
NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev
When the asset is sold, the accumulated depreciation on that asset is credited to the Asset Account by passing the following Journal entry:

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

 Q4 : Explain determinants of the amount of depreciation.
Answer :

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev
1. Total cost of asset - The total cost of an asset is taken into consideration for ascertaining the amount of depreciation. The expenses incurred in acquiring, installing and constructing of assets and bringing the assets to their usable condition are included in the total cost of asset.
2. Estimated useful life - Every asset having it's useful life other than it's physical life, in terms of number of years, units, etc. are considered to estimate the effective life of a fixed asset. For example, land has indefinite life; however, if business acquires a piece of land on lease for 25 years, it's useful life is considered to be 25 years.
3. Estimated scrap value - It is estimated as the net realisable value or sale value of an asset at the end of it's effective life. It is deducted from the total cost of an asset. For example, furniture is acquired at Rs 50,000 with it's effective life of 10 years.
After 10 years, furniture will be sold at Rs 10,000. So, depreciation is charged as:

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev

 

Q5 : Name and explain different types of reserves in details.
Answer : Reserves- Reserves are created for strengthening the financial positions and future growth. It is created out of profit earned by business.
The broad classification of reserve is diagrammatically presented below.

NCERT Solution (Part - 1) - Depreciation, Provisions and Reserves Commerce Notes | EduRev
1. Revenue Reserve- It is created out of revenue profit, i.e., revenue earned from normal activities of the business. It can be used for either general purpose or specific purpose. It is of two types:
a. General Reserve- When the reserve is created without any specified purpose, then the
reserve is called general reserve. It is a free reserve and so can be used for any purpose. It can also be used for future growth and expansion. For example, reserve funds, retained earnings, contingencies reserves, etc.
b. Specific Reserve- When reserve is created for some specific purpose, then the reserve is called specific reserve.
Examples of specific reserve are given below.
i. Debenture Redemption Reserve
ii. Investment Fluctuation Reserve
iii. Dividend Equalisation Reserve
iv. Workmen Compensation Fund
2. Capital Reserve- It is created out of capital profit, i.e., gain from other than normal activities of business operations, such as sale of fixed asset, etc. It is created to meet the capital loss. It cannot be distributed as dividend. The example of capital reserves are given below.
i. Premium on issue of shares
ii. Premium on issue of debentures
iii. Profit on redemption of debentures
iv. Profit on sale of fixed assets
v. Profit on reissue of forfeited shares
vi. Profit prior to incorporation
3. Secret Reserves- Reserves that are created by overstating liabilities or understating assets are known as secret reserves. They are not shown in the Balance Sheet. These reduce tax liabilities, as the liabilities are overstated. It is created by management to avoid competition by reducing profit.
Creation of secret reserve is not allowed by Companies Act, 1956, which requires full disclosure of all materials facts and accounting policies, while preparing final statements.

Q6 :  What are provisions? How are they created? Give accounting treatment in case of provision for doubtful Debts.
Answer : Provisions are the amount that is created against profit to meet the known liability; however, the amount of liability is uncertain. It is created for specific liability. Creation of provision is compulsory even if, there is no profit. The underlying principle behind creation of provision is conservatism, viz., to prepare for future loss. The main rationale for making provisions is to provide cushion to the future business performance against the uncertain and unforeseen losses that may arise from the past transactions. A few examples of provisions are given below.
1. Provision for bad and doubtful debts
2. Provision for depreciation
3. Provision for taxation
4. Provision for discount on debtors
Provisions are made by debiting the Profit and Loss Account on estimate basis. The provisions are created on the basis of past experiences. Every year, a business may experience common losses, such as depreciation of fixed assets, taxation, etc., which are although known; however, their exact amount of future period is unknown. Thus, business creates provision of certain percentage every year, which is truly based on the intuitions and past experiences. These unascertained liabilities in form of provisions are kept aside, which help future business activities, undisturbed from the future losses.
Accounting treatment for provision for doubtful debts is:

Profit and Loss A/c
               To Provision for Doubtful Debts
(Provision for doubtful debt made)

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