ICAI Notes- Concept and Accounting of Depreciation- 2 - CA Foundation PDF Download

ILLUSTRATION  5:- On 1st April, 2013, Z Limited purchased the lease of property for ₹10,00,000. The lease would expire on 31st March, 2016. Z Ltd., decided to set up a sinking fund. The Sinking Fund was to be credited (or debited) with an annual contribution from profit, the interest on the investments and any profits (or losses) made on the realisation of the sinking fund investments. The sinking fund was to be represented by specific investment, and any sums made available to the sinking fund were to be immediately invested, except at the termination of the fund.
During the three years following transactions took place:-
2014 31^st March: A contribution from profits of  ₹3,20,000 was made and this sum was invested.
2014 13^th Oct.: Investments which originally costed ₹1,10,000 were sold for ₹1,20,000 and the proceeds of sale were re-invested.
2015 31^st March: A contribution from profits of ₹3,20,000 was made; interest on investments of ₹16,000 was received and these amounts were reinvested.
2015 9^th August: Investments which originally costed ₹2,10,000 were sold at a profit of ₹20,000 and proceeds of sale were re-invested.
2016 31^st March: Interest on investments ₹48,000 was received which was not invested. All existing investments were sold for ₹6,60,000. A contribution from profit of an amount required to make up the sinking fund to ₹10,00,000 was made and this amount was not invested.
Required:- Prepare Sinking Fund and Sinking Fund Investment Account for the years 2013-14, 2014-15, 2015-16.

SOLUTION:- 
Sinking Fund Account:-

Sinking Fund Investment Account:-

ILLUSTRATION 6:- On the basis of the data given in the illustration 5,
Required:- Prepare Lease Account and Depreciation Account for the years 1st April, 2013 to 31st March, 2016.

SOLUTION:- 


3.6 Machine Hour Method:- Where it is practicable to keep a record of the actual running hours of each machine, depreciation may be calculated on the basis of hours that the concerned machine worked. The machine hour rate of the depreciation, is calculated after estimating the total number of hours that machine would work during its whole life; however, it may have to be varied from time to time, on a consideration of the changes in the economic and technological conditions which might take place, to ensure that the amount provided for depreciation corresponds to that considered appropriate in the changed circumstances. It would be observed that the method is only a slight variation of the Straight Line Method under which depreciation is calculated per year. Under this method it is calculated for each hour the machine works.
Schedule II to the Companies Act 2013, prescribes estimated useful life of different assets for companies, also recognizes this method to some extent. It prescribes that depreciation should be charged using estimate useful life suggested in it, however, in certain category of plant and machinery it prescribes to charge higher amount of depreciation if these assets are used for 2 shifts or 3 shifts. In a way, schedule II combines straight line method and machine hour method.

ILLUSTRATION 7:- A machine was purchased for ₹30,00,000 having an estimated total working of 24,000 hours. The scrap value is expected to be ₹2,00,000 and anticipated pattern of distribution of effective hours is as follows:
Year
1 – 3 3,000 hours per year
4 - 6   2,600 hours per year
7 - 10 1,800 hours per year
Required:- Determine Annual Depreciation under Machine Hour Rate Method.

SOLUTION:- Statement of Annual Depreciation under Machine Hours Rate Method

3.7 Production Units Method:- Under this method depreciation of the asset is determined by comparing the annual production with the estimated total production. The amount of depreciation is computed by the use of following method:
Depreciation for the period = Depreciable Amount X
The method is applicable to machines producing product of uniform specifications.

ILLUSTRATION 8:- A machine is purchased for ₹20,00,000. Its estimated useful life is 10 years with a residual value of ₹2,00,000. The machine is expected to produce 1.5 lakh units during its life time. Expected distribution pattern of production is as follows:

Required:- Determine the value of depreciation for each year using production units method.

SOLUTION:- Statement showing Depreciation under Production Units Method

3.8 Depletion Method:- This method is used in case of mines, quarries etc. containing only a certain quantity of product. The depreciation rate is calculated by dividing the cost of the asset by the estimated quantity of product likely to be available. Annual depreciation will be the quantity extracted multiplied by the rate per unit.

ILLUSTRATION 9:- M/s Surya took lease of a quarry on 1-1-2013 for ₹1,00,00,000. As per technical estimate the total quantity of mineral deposit is 2,00,000 tonnes. Depreciation was charged on the basis of depletion method. Extraction pattern is given in the following table:

Required:- Show the Quarry Lease Account and Depreciation Account for each year from 2013 to 2015.

SOLUTION:-  



4. PROFIT OR LOSS ON THE SALE/DISPOSAL OF PROPERTY, PLANT AND EQUIPMENT:- Whenever any depreciable asset is sold during the year, depreciation is charged on it for the period it has been used in the sale year. The written down value after charging such depreciation is used for calculating the profit or loss on the sale of that asset. The resulting profit or loss on sale of the asset is ultimately transferred to profit and loss account.
For example:- The book value of the asset as on 1st January, 2015 is ₹50,00,000. Depreciation is charged on the asset @10%. On 1st July 2015, the asset is sold for ₹32,00,000. In such a situation, profit or loss on the sale will be calculated as follows:

 ILLUSTRATION 10:- A firm purchased on 1st January, 2015 certain machinery for ₹5,82,000 and spent ₹18,000 on its erection. On July 1, 2015 another machinery for  ₹2,00,000 was acquired. On 1st July, 2016 the machinery purchased on 1st January, 2015 having become obsolete was auctioned for ₹3,86,000 and on the same date fresh machinery was purchased at a cost of  ₹4,00,000.
Depreciation was provided for annually on 31st December at the rate of 10 per cent p.a. on written down value.
Required:- Prepare machinery account.

SOLUTION:-

Working Note:-

5. CHANGE IN THE METHOD OF DEPRECIATION:- The depreciation method applied to an asset should be reviewed at least at each financial year-end and, if there has been a significant change in the expected pattern of consumption of the future economic benefits embodied in the asset, the method should be changed to reflect the changed pattern. Whenever any change in depreciation method is made.  Such change in method is treated as change in accounting estimate as per Accounting Standards. Its effect needs to be quantified and disclosed. A change in an accounting estimate may affect the current period only or both the current period and future periods.
Example:-
 

The company charges depreciation on straight line method for the first two years and thereafter decides to adopt written down value method by charging depreciation @ 25%.  (calculated based on useful life).  You are required to calculate depreciation for the 3rd year.
Depreciation already charged for the first 2 years as per straight line method is ₹2,00,000.  Therefore, WDV for 2nd   year is ₹8,50,000
Therefore in the profit and loss account of the 3rd year, the depreciation of ₹2,12,500 (25% of ₹850,000) should be debited. 

ILLUSTRATION 11:- M/s Anshul commenced business on 1st January 2011, when they purchased plant and equipment for ₹7,00,000. They adopted a policy of charging depreciation at 15% per annum on diminishing balance basis and over the years, their purchases of plant have been:

On 1-1-2015 it was decided to change the method and rate of depreciation to straight line basis. On this date remaining useful life was assessed as 6 years for all the assets purchased before 1.1.2015 and 10 years for the asset purchased on 1.1.2015 with no scrap value.
Calculate the difference in depreciation to be adjusted in the Plant and Equipment Account for the year ending 31st December, 2015.

SOLUTION:-

6. REVISION OF THE ESTIMATED USEFUL LIFE OF PROPERTY, PLANT AND EQUIPMENT:- The residual value and the useful life of an asset should be reviewed at least at each financial year-end and, if expectations differ from previous estimates, the change(s) should be accounted for as a change in an accounting estimate in accordance with Accounting Standards.
Whenever there is a revision in the estimated useful life of the asset, the unamortised depreciable amount should be charged over the revised remaining estimated useful life of the asset.

ILLUSTRATION 12:- A Machine costing ₹6,00,000 is depreciated on straight line basis, assuming 10 years working life and Nil residual value, for three years. The estimate of remaining useful life after third year was reassessed at 5 years.
Required:- Calculate depreciation for the fourth year.

SOLUTION:- 
Depreciation per year = ₹6,00,000 / 10 = ₹60,000
Depreciation on SLM charged for three years = ₹60,000 x 3 years = ₹1,80,000
Book value of the computer at the end of third year = ₹6,00,000 – ₹1,80,000 = ₹4,20,000.
Remaining useful life as per previous estimate = 7 years
Remaining useful life as per revised estimate = 5 years
Depreciation from the fourth year onwards = ₹4,20,000 / 5 = ₹84,000 per annum

7. REVALUATION OF PROPERTY, PLANT AND EQUIPMENT:- If there is an upward revision in the value of asset for the first time, then the amount of appreciation is debited to Asset Account and credited to Revaluation Reserve Account. If there is downward revision in the value of asset then Profit and Loss Account is debited and Asset Account is credited. If an asset was earlier revalued downward and later on revalued upward then the appreciation to the extent of earlier downfall is credited to profit and loss account. If an asset was earlier revalued upward and then later on it was revalued downward then the downfall to the extent of earlier appreciation is debited to Revaluation Reserve Account. In case the revaluation has a material effect on the amount of depreciation, the same should be disclosed separately in the year in which revaluation is carried out.

ILLUSTRATION 13:- A machine of cost ₹12,00,000 is depreciated straight-line assuming 10 year working life and zero residual value for three years. At the end of third year, the machine was revalued upwards by ₹60,000 the remaining useful life was reassessed at 9 years.
Required:- Calculate depreciation for the fourth year.

SOLUTION:- 
Depreciation per year charged for three years = ₹12,00,000 / 10 = ₹1,20,000
WDV of the machine at the end of third year = ₹12,00,000 – ₹1,20,000 × 3 = ₹8,40,000.
Depreciable amount after revaluation = ₹8,40,000 + ₹60,000 = ₹9,00,000
Remaining useful life as per previous estimate = 7 years
Remaining useful life as per revised estimate = 9 years
Depreciation for the fourth year onwards = ₹9,00,000 / 9 = ₹1,00,000.

8. PROVISION FOR REPAIRS AND RENEWALS:- Expenditure incurred for repairs, renewals and maintenance on plant and machinery may vary over the years during the working life. Thus, for equalising the charge of repairs and renewals, sometimes a Provision for Repairs and Renewals Account is opened. Total of such expenses that may be incurred over the working life is estimated beforehand. Average of this expenditure is debited to Profit and Loss Account and credited to Provision for Repairs and Renewals Account irrespective of actual expenses incurred. Every year Provision for Repairs and Renewals Account is debited and Repairs Account is credited for actual expenses incurred. The balance in provision for Repairs and Renewals Account is carried forward and in the end or on sale of the asset, the account is closed by transfer to the Asset Account for any balance left.

ILLUSTRATION 14:- The following particulars are available from the books of a public company having a large fleet of vehicles:

The company makes an annual provision of ₹4,00,000 on repairs and renewals.
Required:- Draw up the Provision for Repairs and Renewals Account for the years 2015-2016 and 2016-2017.

SOLUTION:-