ICAI Notes- Concept and Accounting of Depreciation- 3 - CA Foundation PDF Download

SUMMARY:-  

• Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. 
• Objectives for providing depreciation are:     

1. Correct income measurement     
2. True position statement     
3. Funds for replacement     
4. Ascertainment of true cost of production. 

• Factors in the measurement of depreciation:     

1. Cost of asset     
2.  Estimated useful life of the asset
3. Estimated scrap value (if any) at the end of useful life of the asset. 

• Methods for providing depreciation:     

1. Straight line method     
2. Reducing balance method     
3. Sum of years of digits method     
4. Annuity method     
5. Sinking fund method     
6. Machine hour method     
7. Production units’ method     
8. Depletion method 

• The resulting profit or loss on sale of the tangible asset is ultimately transferred to profit and loss account. 
• The depreciation method residual value & useful life 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, on account of the above, they should be changed to reflect the changed pattern. 
• Whenever there is a revision in the estimated useful life of the asset, the unamortised depreciable amount should be charged to the asset over the revised remaining estimated useful life of the asset. 
• Whenever the depreciable asset is revalued, the depreciation should be charged on the revalued amount on the basis of the remaining estimated useful life of the asset.

TEST YOUR KNOWLEDGE:-
Multiple Choice Questions:-
Ques 1: Original cost = ₹12,60,000; Salvage value = Nil; Useful life = 6 years. Depreciation for the first year under sum of years digits method will be 
(a) ₹3,60,000
(b) ₹1,20,000
(c) ₹1,80,000
Ans: (a)

Ques 2: Obsolescence of a depreciable asset may be caused by:
I. Technological changes.
II. Improvement in production method.
III. Change in market demand for the product or service output.
IV. Legal or other restrictions.
(a) Only (I) above
(b)  Both (I) and (II) above
(c)  All (I), (II), (III) and (IV) above
Ans: (c)

Ques 3: The number of production of similar units expected to be obtained from the use of an asset by an enterprise is called as
(a) Unit life
(b) Useful life
(c) Production life
Ans: (b)

Ques 4: If a concern proposes to discontinue its business from March 2015 and decides to dispose of all its plants within a period of 4 months, the Balance Sheet as on March 31, 2015 should indicate the plants at their
(a) Historical cost
(b) Net realizable value
(c) Cost less depreciation
Ans: (b)

Ques 5: In the case of downward revaluation of a plant which is for the rst time revalued, the account to be debited is
(a)  Plant account
(b)   Revaluation Reserve
(c)  Profit & Loss account
Ans: (c)

Ques 6: The portion of the acquisition cost of the tangible asset, yet to be allocated is known as
(a) Written down value
(b)   Accumulated value
(c)   Realisable value
Ans: (a)

Ques 7: The main objective of providing depreciation is to
(a) Create secret reserve
(b) Reduce the book value of assets  
(c) Allocate cost of the assets
Ans: (c)

Ques 8: Original cost of a machine was ₹25,20,000 salvage value was ₹1,20,000, useful life was 6 years.  Annual  depreciation under Straight Line Method
(a) ₹4,20,000
(b) ₹4,00,000
(c) ₹3,00,000
Ans: (b)

Ques 9: The cost of a machine is ₹20,00,000. Two years later the book value is ₹10,00,000. The Straight-line percentage depreciation is
(a) 50%
(b) 33-1/3%
(c) 25%
Ans: (c)

Ques 10: Original cost ₹13,00,000, Salvage value ₹40,000, Useful life 6 years. Depreciation for the first year under sum-of-years digit methods will be
(a) ₹60,000
(b) ₹1,20,000
(c) ₹3,60,000
Ans: (c)

Ques 11: Which of the following assets does not depreciate?
(a) Machinery and equipment
(b) Patents
(c) Land
Ans: (c)

Ques 12: A company purchased a machinery on April 01, 2010, for ₹15,00,000. It is estimated that the machinery will have a useful life of 5 years after which it will have no salvage value. The depreciation charged during the year 2014-15 was
(a) ₹5,00,00
(b) ₹4,00,000
(c) ₹3,00,000
Ans: (c)

Ques 13: If the equipment account has a balance of  ₹22,50,000 and the accumulated depreciation account has a balance of  ₹14,00,000, the book value of the equipment is
(a)  ₹36,50,000
(b)  ₹8,50,000
(c)  ₹14,00,000
Ans: (b)

Theory Questions:-
Ques 1: Distinguish between  Straight line method of depreciation and Written down value method of depreciation.
Ans: Under straight line method an equal amount is written off each year throughout the working life of the depreciable tangible asset so as to reduce the cost of the asset to nil or to its scarp value at the end. Under reducing balance method, a fixed percentage is charged on the diminishing balance of the asset each year so as to reduce the value of the asset to its scarp value at the end of useful life. The basic distinction between these two methods are as follows:
Under straight line method, annual depreciation charge is equal throughout the life of the asset; but under reducing balance method, depreciation charge is reduced over the years as the asset grows old.
Under straight-line method, the asset can be fully depreciated but under reducing balance method asset can never be fully depreciated.
Under straight line method the charge for depreciation is constant while repair charges increase with the life of the asset, so the total charge throughout the life of the asset will not be uniform. To the contrary, under reducing balance method, depreciation charges become high in the initial years but generally repair remains low. As the asset grows old depreciation charge reduces but repair expenses increase. Thus under reducing balance method depreciation and repairs are more or less evenly distributed throughout the life of the asset.

Ques 2:  Write short notes on:
(i) Depletion method of depreciation
(ii) Sinking fund method.
Ans: (i) Natural resources include physical assets like mineral deposits, oil and gas resources and timber. These natural resources exhaust by exploitation.  
Depletion per unit is calculated as  = Acquisition cost-Residual value/ Estimated life in terms of production units
(ii) Sinking fund method of providing depreciation is used where the aim is not only to charge depreciation but also to replace the asset. In case a large sum of money is required for the replacement of an asset at the end of its effective life, it may not be advisable to leave in the amount of depreciation set apart annually, for it may or may not be available in the form of concern itself the readily realisable assets at the time it is required. To safeguard this position, the amount annually provided for depreciation may be placed to the credit of the Sinking Fund account, and at the same time an equivalent amount may be invested in government securities. The book value of the old asset, at the time, is transferred to the Sinking Fund Account. Any amount realised on sale of the old asset, as well as the profit or loss on sale of securities, is transferred to the Sinking Fund Account and it is closed off by transfer of the balance to the profit and loss account or general reserve.
Ques 3: What factors are considered for calculation of depreciation of a plant?
Ans:  The factors considered for calculation of depreciation are as:
(i) Cost of asset including expenses for installation, commissioning, trial run etc.
(ii) Estimated useful life of the asset  and
(iii) Estimated scrap value (if any) at the end of useful life of the asset.

Practical Questions:-
Ques 1: A firm’s plant and machinery account at 31^st December, 2015 and the corresponding depreciation provision account, broken down by year of purchase are as follows:

Depreciation is at the rate of 10% per annum on cost. It is the Company’s policy to assume that all purchases, sales or disposal of plant occurred on 30th June in the relevant year for the purpose of calculating depreciation, irrespective of the precise date on which these events occurred.  
During 2015 the following transactions took place:
1. Purchase of plant and machinery amounted to ₹15,00,000
2. Plant that had been bought in 2004 for  ₹170,000 was scrapped.
3. Plant that had been bought in 2005 for ₹90,000 was sold for ₹5,000.
4. Plant that had been bought in 2006 for ₹2,40,000 was sold for ₹15,000.
You are required to:-
Calculate the provision for depreciation of plant and machinery for the year ended 31st December, 2015. In calculating this provision you should bear in mind that it is the company’s policy to show any profit or loss on the sale or disposal of plant as a completely separate item in the Profit and Loss Account. You are also required to prepare the following ledger accounts during 2015.  
(i) Plant and machinery at cost;
(ii) Depreciation provision;
(iii) Sales or disposal of plant and machinery.
Ans: Calculation of provision for depreciation of plant and machinery for the year ended 31st December, 2015.

Plant and Machinery Account (for 2015) at Cost

Depreciation Provision Account (for 2015)


Ques 2: The Machinery Account of a Factory showed a balance of ₹19,00,000 on 1^st January, 2015. Its accounts were made up on 31^st December each year and depreciation is written off at 10% p.a. under the Diminishing Balance Method.
On 1st June 2015, a new machinery was acquired at a cost of  ₹2,80,000 and installation charges incurred in erecting the machine works out to ₹8,920 on the same date. On 1^st June, 2015 a machine which had cost ₹4,37,400 on 1st January 2013 was sold for ₹75,000. Another machine which had cost ₹4,37,000 on 1^st January, 2014 was scrapped on the same date and it realised nothing.
Write a plant and machinery account for the year 2015, allowing the same rate of depreciation as in the past calculating depreciation to the nearest multiple of a Rupee.
Ans:

Working Note:-



Ques 3: The LG Transport company purchased 10 trucks at ₹45,00,000 each on 1st April 2014. On October 1st, 2016, one of the trucks is involved in an accident and is completely destroyed and ₹27,00,000 is received from the insurance in full settlement. On the same date another truck is purchased by the company for the sum of ₹50,00,000. The company write off 20% on the original cost per annum. The company observe the calendar year as its financial year.  
Give the motor truck account for two year ending 31 Dec, 2017.
Ans: 

Working Note: 
1. To find out loss on Profit on settlement of truck