Depreciation, Provision And Reserves - Class 11 Commerce Accountancy - Extra Questions

Whether installation, freight and transport expenses will be added to the cost of the asset or treated as revenue expenses?

It is very clear from the concepts of accounting that all the incidental expenses incurred to procure any assets should be added to the cost of assets. More simply, till the plant gets installed and operational, all such expenses to be added to the acquisition cost. 

For example, a machine is purchased for Rs.80000. Transportation charges for bringing the machine to the installation place is Rs.10000, cost of installation is Rs.5000 and other misc charges are  Rs.5000. 
In the above example, acquisition cost of machine would be Rs.80000+Rs.10000+Rs.5000+Rs.5000.


State briefly the need for providing depreciation.

In accounting, depreciation is needed because of conceptual, legal and practical business consideration.


What are the causes of depreciation?

There are generally two main causes of depreciation; first is normal cause such as normal wear and tear due to usage or passage of time, expiration of legal right in case of some assets and obsolescence due to technological advancement and second is abnormal cause such as accidents due to fire, earthquake, floods etc.


Question : What are 'provisions'? How are they created? Give accounting treatment in case of provision for doubtful debts.

Provision can be explained as an arrangement for certain types of expenses/losses which are related to the current accounting period but amount of which is not known with certainty because they are not yet incurred. It is necessary to make provision for such items for ascertaining true net profit.

E.g. A trader who sells on credit basis knows that some of the debtors of the current period would default and would not pay or would pay only partially.
It is necessary to take into account such an expected loss while calculating true and fair profit/loss according to the principle of Prudence or Conservatism.

Therefore, the trader creates a provision for doubtful debts to take care of expected loss at the time of realization from debtors. In a similar way, provision for repairs and renewals may also be created to provide for expected repair and renewal of the fixed assets. Examples of provisions are
(i) Provision for depreciation
(ii) Provision for bad and doubtful debts
(iii) Provision for taxation
(iv) Provision for discount on debtors
(v) Provision for repairs and renewals

Accounting Treatment for Doubtful Debts : First of all the amount of expected bad debts is ascertained which is posted in the debit side of P & L Account as new provision for doubtful debts is greater than new one, it will be shown in the credit side of P & L account and if the new provision is greater than the old one, the balance amount will be shown in the debit side of the P & L account. After that the amount of new provision will be deducted from the debtors figure in assets side of the balance sheet.



State whether the following statements are True or False:
Depreciation increases the value of an asset.

This statement is false. The monetary value of asset decreases over time due to use, wear and tear or obsolescence. This decrease in value of asset is termed as Depreciation.


Question : 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 : In straight line method of depreciation a fixed and an equal amount is charged as depreciation in every accounting period during the lifetime of an asset. The amount annually charged as depreciation is such that it reduces the original cost of the asset to its scrap value, at the end of its useful life.
In this case, depreciation amount is also calculated by dividing depreciable cost by the estimated life of the assets. It is also Fixed installment method because the amount of depreciation remains constant from year to year over the useful life of the asset.
Written Down Value Method : In written down value method, the depreciation is calculated at a fixed percentage of written down value of the asset. The method assumes that benefit acquiring to business by utilization of asset keeps on decreasing as the asset gets old. As the value of asset goes on decreasing from year to year, the amount of depreciation charged to different accounting years decreases with the passage of time.
                    


    Difference Between Straight line Method and Written Down Value Method.                          

Straight Line MethodWritten Down Value Method
(i) Depreciation is charged on original cost of assets.(i) Depreciation is charged on Written down value of assets.
(ii) Amount of the depreciation remains fixed every year.(ii) Amount of depreciation keeps on decreasing from year to year.
(iii) It is not recognized by Income Tax Law.(iii) It is recognized by Income Tax Law
(iv) Rate of depreciation can be calculated easily.(iv) It is complicated in calculation.

Suitability of Straight Line Method : This method depreciation is suitable to assets in which the repair charges are less and the possibility of obsolescence is less and expiration of cost depends upon time period involved.

Suitability of Written Down Value Method : This method of depreciation is suitable for assets which are affected by technological changes; require more repairs with passage of time.


Question : Explain the determinants of the amount of depreciation.

Answer : The determination of depreciation depends on three parameters, viz, cost, estimated useful life and probable salvage value.

(i) Cost of Asset : Cost of an asset includes invoice price and other costs, which are necessary to put the asset in use for working condition. Besides the purchase price, it includes freight and transportation cost, transit insurance, installation cost, registration cost, commission paid on purchase of asset items such as software etc. In case of purchase of a second hand asset, it includes initial repair cost to put the asset in workable condition. In such condition, repair also become capital expenditure.
Estimated Useful Life : Useful life of an asset is the estimated economic or commercial life of the asset. Physical life is not important for this purpose because an asset may still exist physically but may not be capable of commercially viable production.
Estimated Net Residual Value : Net residual value (also known as Scrap value or Salvage value for accounting purpose) is the estimated net realizable value (or sale value) of the asset at the end of its useful life The net residual value is calculated after deducting the expenses necessary for the disposal of the asset.



Question : Explain the concept of depreciation. What is the need for changing depreciation and what are the causes of depreciation?

Answer : Concept of Depreciation : In simple words, Depreciation is a gradual reduction in the value of assets. In this way, depreciation may be defined as the permanent continuous diminution in the quality, quantity or value of assets.
According to Institute of Cost and Management accounting, London (ICMA) Terminology.. " The depreciation is the diminution in intrinsic value of the asset due to use and / or lapse time.
Need for changing Depreciation : In accounting, depreciation is needed because of conceptual, legal and practical business consideration. More over it is needed.
(i) To allocate depreciable cost
(ii) To ascertain true and fair profit or loss
(iii) To reveal true and fair financial position
(iv) To provide funds for replacement
Causes of Depreciation : There are generally two main causes of depreciation first is normal case such as normal wear and tear due to usage or passage of time, expiration of legal right in case of some assets and obsolescence due to technological advancement and second are abnormal causes such as accidents due to fire, earthquake, floods etc.



What are the effects of depreciation on profit and loss account and balance sheet?

Depreciation is charged as expenditure in Profit and Loss account and the depreciation figure is deducted from the value of concerned assets in the assets side of the balance sheet.
In that case, it reduces the profit of the concern; 
On the other hand, it reduces the assets side in the balance sheet. 
Here, it is worth mentioning that Depreciation is a non - cash expenditure.


What is meant by Reserve?

Reserve is an appropriation of the Profit. It is that amount which is set aside from the profits of the business. It helps in strengthening the business.
The amount of reserves is used to purchase plants or Machinery or  to repay debts or for expansions, bonuses, and dividend repayments.
There are three types of reserves
 1. Capital Reserve
2. Revenue Reserve
3. Specific Reserve


Explain the purpose of providing depreciation.

The purpose of providing depreciation on fixed asset is to ascertain true value of an asset, to replace asset, to ascertain correct profit or loss on sale of asset and to compute correct tax liability, etc.


What is meant by provision?

The term 'Provisions' refers to writing off some amount of Profit and Loss Account and retaining such amount in the business for future well being of the business.


Why is depreciation charged even there is loss to the business?

Fixed assets are used even in the year of loss and use of fixed asset reduces it value and hence depreciation is charged even in the year of loss.


What are the Reserves created out of capital profits known as?

Reserves created out of capital profit are known as capital reserves. Capital reserves are not available for distribution as profit. In case of companies, following are the examples of capital profits :
  • Profit prior to incorporation
  • Premium on issue of debentures and shares
  • Profit on reissue of forfeited shares.
  • Profit on redempltion of debentures
  • Profit on sale of fixed assets
  • Profit on revaluation of fixed asset
  • Profit on sale of whole undertaking or a part of it.


What is the total amount whatsoever received by selling used or obsolete asset or its spare parts known as?

Total amount whatsoever received by selling used or obsolete asset or its spare parts is known as scrap value or salvage value or residual value.
Salvage value of depreciable asset implies the value expected to be realised on its sale or exchange on the expiry of its useful life.


What is meant by cost of asset?

The sum total of purchase price of fixed asset and its installation charges are called cost of asset.


Why depreciation is charged?

Depreciation on fixed asset is charged to ascertain the correct profit or loss on its sale, to show asset at correct value in the Balance Sheet and to provide for its replacement.


State with reasons whether following statements are True or False:
Depreciation is an amortised expenditure.

This statement is false. Depreciation is used for tangible assets and amortization is used for intangible assets. Amortization is a method of spreading the cost of an intangible assets over a specific period of time, which is usually its useful life. 
Depreciation is a method of spreading the cost of a tangible assets over a specific period of time which is usually its useful life. 


State with reasons whether following statements are True or False:
Depreciation ensures sufficient cash for asset replacement

This statement is false. Depreciation does not mean money set aside for the future replacement of asset. It is provided to match the use of asset, its deterioration and obsolescence with the income it generates. Depreciation is neither a source nor use of funds. The original investment of the asset should be fully recovered into the product cost during the economic life of an asset. 


State with reasons whether following statements are True or False:
Depreciation is cash expenditure like normal expenses.

This statement is false. Depreciation is a non cash accounting charge and does not have a direct impact on the amount of cash flow generated by a company. Since, depreciation was taken out while calculating net income and is not a cash outlay, depreciation is added back in profits, while creating the cash flow statement. 


What is Reserves?

Reserves – also known as retained earnings – are portions of a business’s profits which have been set aside to strengthen the business's financial position.Reserves are often used to purchase fixed assets; to repay debts; or to fund expansions, bonuses, and dividend repayments.

Although the IFRS Standards sometimes call provisions a 'reserve', they are not the same thing - a provision is an upcoming liability without a confirmed date or cost.

There are two main kinds of reserves: revenue reserves and capital reserves. They are taken from different sources of income and are usually set aside for different purposes.




Distinguish between 'Provision'  and 'Reserve'.

Difference between Provision and Reserve
Basis of DifferenceProvisionReserve
Basic NatureCharge against profitAppropriation of profit.
PurposeIt is created for a known liability or expense pertaining to current accounting period, the amount of which is not certain.It is made for strengthening the financial position of the business. Some reserves are also mandatory under law.
Effect on taxable profitsIt reduces taxable profits.It has no effect on taxable profit.
Presentation in financial statementsIt is shown in the liabilities side along with current liabilities. As it is a liability against some specified thing.It is shown in balance sheet liabilities side after capital amount.
UsesIt can be used for specified purpose and cannot used for dividend distribution.It can be used for dividend distribution.


Question : You are looking at the profit and loss account of the business enterprises. You find the term depletion in first case and amortization in third case. What is the type of business the two enterprises are into?

In the first case, the enterprises must be involved in business related in extraction of natural resources like mines, quarries etc. 
On the other hand in second case, the enterprise must be involved in certain specific contractor business where there is use of intangible assets like patents, copyright, trademarks etc.


Distinguish between 'Revenue reserve' and 'Capital reserve'.

 Revenue Reserve Capital Reserve
 It is formed out of revenue profit which is earned from normal activities of business operations. It is formed of capital profit which is a gain from other than normal activities of business operations, such as sale of fixed assets.
 It can be used for distribution of dividend. It cannot be used for distribution of dividend.
 It is created for increasing the financial position of the business. It is created for the purpose of the Companies Act.


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

 Straight line method Written down value method
Depreciation is calculated on the original cost of an asset.Depreciation is calculated on the reducing balance, i.e., the book value of an asset.
Equal amount of depreciation is charged each year over the useful life of the asset.Diminishing amount of depreciation is charged each year over the useful life of the asset.
 Book value of the asset becomes zero at the end of its effective life. Book value of the asset can never be zero.
 It is suitable for the assets such as patents, copyright, land and buildings which have lesser possibility of obsolescence and lesser repair charges. It is suitable for assets which needs more repair in the later years such as plant and machinery, car.
 As depreciation remains same over the years but repair cost increases in the later years, there will be unequal effect over the life of the asset. As depreciation cost is high and repairs are less in the initial years but in the later years the repair costs increase and depreciation cost decreases, there will be equal effect over the life of the asset.
 It is not recognized under the income tax act. It is recognized under the income tax act.


Question : Saraswati Ltd purchased a machinery costing Rs$$10,00,000$$ on January 1,A new machinery was purchased on 01, May, 2002 for Rs $$15,00,000$$ and another on July 1, 2004 for Rs $$12,00,000$$. A part of the machinery which originally cost Rs $$2,00,000$$ in 2001 was sold for Rs.$$75,000$$ on October 31,Show the Machinery account, Provision for depreciation account and Machinery disposal account for 2001 toIf depreciation is provided at $$10\%$$ per annum on original cost and account are closed on December 31st, every year.

Answer :
Dr                                                   Machinery Account                            Cr
DateParticularsJFAmt.(Rs)DateParticularsJFAmt.(Rs)
2001 Jan 1To Bank A/c M1 $$(8,00,000 + 2,00,000)$$10,00,000$$2001 Dec 31By Balance c/d$$10,00,000$$
$$10,00,000$$$$10,00,000$$
2002 Jan 1To Balance b/d (M1)$$10,00,000$$2002 Dec 31By Balance c/d$$25,00,000$$
May 1To Bank A/c (M2)$$15,00,000$$
$$25,00,000$$$$25,00,000$$
2003 Jan 1To Balance b/d$$25,00,000$$2003 Dec 31By Balance c/d$$25,00,000$$
$$25,00,000$$$$25,00,000$$
2004 Jan 1To Balance b/d$$25,00,000$$2004 Oct 31By Machinery Disposal A/c$$2,00,000$$
Jul 1To Bank A/c (M3)$$12,00,000$$Dec 31By Balance c/d
M1 = $$ (10,00,000 - 2,00,000)$$
M2 = $$15,00,000$$
M3 = $$12,00,000$$




$$35,00,000$$
$$37,00,000$$$$37,00,000$$
2005 Jan 1To Balance b/d 
M1 = $$8,00,000$$
M2 = $$15,00,000$$
M3 = $$12,00,000$$

$$35,00,000$$2005 Dec 31By Balance c/d
M1 = $$8,00,000$$
M2 = $$15,00,000$$
M3 = $$12,00,000$$

$$35,00,000$$
                                              $$35,00,000$$                         $$35,00,000$$

Dr                        Provision for Depreciation Account                         Cr
DateParticularsJFAmt.(Rs)DateParticularsJFAmt.(Rs)
2001 Dec 31To Balance c/d$$1,00,000$$2001 Dec 31By Depreciation A/c$$1,00,000$$
$$1,00,000$$$$1,00,000$$
2002 Dec 31To Balance c/d$$3,00,000$$2002 Jan 1By Balance b/d$$1,00,000$$
Dec 31By Depreciation A/c M1 = $$1,00,000$$
M2 = $$1,00,000$$
(Dep on M2 is for 8 months)

$$2,00,000$$
$$3,00,000$$$$3,00,000$$

DateParticularsJFAmt. (Rs)DateParticularsJFAmt.(Rs)
2003 Dec 31To Balance b/d$$5,50,000$$2003 Jan 1By Balance b/d$$3,00,000$$
Dec 31By Depreciation A/c
M1= $$1,00,000$$
M2= $$1,50,000$$

$$2,50,000$$
$$5,50,000$$$$5,50,000$$
2004 Jan 31To Machinery Disposal A/c$$76,667$$2004 Jan 1By Balance b/d$$5,50,000$
Dec 31To Balance c/d$$7,80,000$$Oct 31By Depreciation A/c$$16,667$$
By Depreciation A/c 
M1 = $$8,00,000$$
M2 = $$1,50,000$$
M3 = $$60,000$$

$$2,90,000$$
$$8,56,667$$$$8,56,667$$
2005 Dec 31To Balance c/d$$11,30,000$$2005 Jan1By Balance b/d$$7,80,000$$
Dec 31By Depreciation A/c
M1 = $$80,000$$
M2 = $$1,50,000$$
M3 = $$1,20,000$$

$$3,50,000$$
$$11,30,000$$$$11,30,000$$


Dr                            Machinery Disposal Account                                 Cr
DateParticularsJFAmt.(Rs)DateParticularsJFAmt.(Rs)
2004 Oct 31To Machinery A/c$$2,00,000$$2004 Oct 31By Depreciation A/c$$76,667$$
Oct 31By Bank A/c (Sales Proceed)$$75,000$$
Oct 31By Profit & Loss A/c (Loss on Sale)$$48,333$$
$$2,00,000$$$$2,00,000$$

Working Note
Computation of Profit or Loss on Disposal
Total Dep charged on Machine till Oct 1,2004
(2001)$$20,000$$ + (2002) $$20,000$$ + (2003) $$20,000$$ + (2004 Oct) + $$16,667$$ = $$Rs.76,667$$
 Value of Machine on Oct 1, 2004 = $$2,00,000$$ - $$76,667$$ = $$Rs. 1,23,333$$
Loss on Sale of Machine = $$[1,23,333 - 75,000] = Rs.48,333$$ (Loss)


What are the reserves created for specific purpose known as?

It is known as specific reserve. A specific reserve is one, which is created for some specific purpose by debiting profit and loss appropriation account. It is available for the purpose for which it is created. Some examples of specific reserves are - 
1. Dividend equalization reserve.
2. Investment Fluctuation Reserve.
3. Debenture Redemption Reserve.


Discuss the factors taken into consideration for calculation of depreciation.

There are four main factors to consider when calculating depreciation : 
The cost of the asset. The estimated salvage of the asset. Salvage value (or residual value) is the amount of money the company expects to recover , less disposal costs on the date the asset is scrapped , sold or traded in. 

Estimated useful life of the asset. Useful life refers to the window of time that a company plans to use an asset. Useful life can be expressed in years , months , working hours , or units produced. 

Obsolescence should be considered when determining an asset's useful life and will affect the calculation of depreciation. For example, a machine capable of producing units for $$20$$ years may be absolute in six years; therefore the asset's useful life is six years.  


Class 11 Commerce Accountancy Extra Questions