Description
Depreciation, Reserve & Provision
Depreciation means a fall in the value of an asset. Every Fixed Asset is liable to lose its value ,once it begin to be used for production purpose Accounting Concept of Depreciation
Accounting concept of depreciation means to distribute the cost of fixed asset over its estimated life in a reasonable manner.
Depreciation
Depletion
Amortization
Plant Assets
Natural Resources
Intangible Assets
Causes of Depreciation
1. Wear and tear
wearing out of the asset on account of its constant use is called wear & tear. 2. Lapse of time With passage of time there is reduction in the value of fixed assets . 3. Obsolescence Due to acquisition of an improved model which is more economic and works more quickly then the existing machine will become obsolete.
Objective of Charging Depreciation
1. To Ascertain the Profit or Loss Properly 2. To show the Asset at its proper Value 3. To Retain out of Profit Funds for Replacement
Basic Factors Consider for calculating the Depreciation
1. Original cost of the Asset 2. Scrap Value at the End of its Life 3. Estimated effective or Commercial life or legal life which ever is shorter
Methods of Depreciations
1. 2. 3. 4. 5. 6. 7.
Straight Line Method or Fixed installment Method Diminishing Balance or Written Down Value Method Annuity Method Sinking Fund Method Sum of the Digits Method Insurance policy Method Revaluation Method
Straight Line Method
Under this method, an equal portion (amount) of the cost of the Asset is allocated as Depreciation to each accounting year over a period of its effective life. This is done so to reduce the value of the asset equal to zero or its salvage or scrap value
This method is based on the assumption that depreciation is the Function of Time Rather than of use and service potential of the Asset
The Annual depreciation charge will be computed as follows
Annual Depreciation = Cost of Asset + Erection charges – Scrap Value Estimated life of the Asset
Illustration 1: A machine is purchased for Rs 50000 & Rs 5000 is incurred as erection charges. The machine has a life of 5 years with a salvage value of Rs 10,000. Compute the annual depreciation. Illustration 2: A firm bought a machinery for Rs 38000 on 1st January 2009 and its life was Estimated to be 8 years. Its estimated scrap value at the end of the period was Rs 6000. Calculate the amount of depreciation.
Question1. Ram & Sons acquired a machine on 1st July 2008 at a cost of Rs 14000 and spent Rs 1000 on its installation. The firm write off depreciation at 10% on the original Cost every year. The Books are closed on 31st December every year. Show the Machinery Account & Depreciation Account for three years. Question 2 On 1st January 2000, Z Ltd purchased a plant costing Rs 41000 and spent Rs 4000 On its erection. The estimated effective life of the plant is 10 year with scrap value of Rs 5000. Calculate depreciation on the SLM for three years.
Advantages of Fixed installment method • It is easily understandable & is simply to apply. • Amount of depreciation does not vary from year to year. • Under this method the book value of asset is reduced either to zero or scrap value as the case may be.
Disadvantages of fixed installment method
• It does not reflect correct charge on a/c of depreciation where effective utilization of asset varies from year to year. • It does not recognize the reality that as an asset becomes older the amount spent for repairs. • Sometime in this method, book value of asset become zero but yet the assets are used in the business.
Written Down Value Method
Under this Method depreciation is charged at fixed rate on the reducing balance (i.e. cost less depreciation) every year.
Advantages of diminishing balance method
•Simple to understand •Easy to follow •Ensures a fairly even charge to profit and loss A/c Disadvantages
•Value of an asset cannot be brought down to zero •There is a difficult task to ascertain the proper rate of depreciation
Provisions
According to The Indian Companies Act,”provision can be defined as any amount. written off or retained by way of providing for depreciation , renewal diminution in the value of assets or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy”.
Provisions
1. It is created by debiting the profit and loss account.
2. It is created to meet a known liability or a specific contingency, e.g.. provision for bad and doubtful debts, or provision for depreciation etc.
3. A provision is created irrespective of whether there is profit or loss in the business. 4. It is not available for distribution as dividend among shareholders. 5. A provision is made for a definite amount and, therefore, a definite sum is set aside every year to meet the known contingency. 6. Making of a provision is a must to meet known liability or contingency.
Provisions
Thus provisions are the amounts set aside out of profits and other surpluses to provide for:1. Depreciation, Renewals or diminution in the value of assets 2. Any known liability of which the amount cannot be determined with substantial accuracy.
Provisions
Provisions are generally created for the following:1. Provision for Depreciation 2. Provision for Bad and Doubtful Debts 3. Provision for Discount on Debtors 4. Provision for taxation 5. Provision for Repairs and Renewals
Reserves
This term means amount set aside out of profits and other surplus which are not designed to meet any liability or diminution in value of assets known to exist at the date of B/S.
Reserves Basic purpose of creating a reserve is to provide for unexpected losses in future and also retain profits within business to provide funds for expansion of the business.
Reserves
1. It is created by debiting the profit and loss appropriation account. 2. It is created to meet an unknown liability, or to strengthen the financial position of the company or for equalization of dividends etc. 3. A reserve is created only when there is profit in the business. 4. It can be distributed among shareholders as dividend. 5. The reserve is created without taking into consideration the actual amount required except in the case of redemption of debentures when a definite sum is set aside. 6. Creation of reserve depends upon the financial policy of the business and discretion of its management.
Reserve Fund
The term ‘ Reserve Fund ‘ is used for the amount of reserve which has been invested in outside securities. Examples of Reserve Fund are employees welfare fund, pension fund, gratuity fund etc. Profit set aside and used in the business is a reserve. But profit set aside and invested outside the business is a reserve fund. Thus, the use of the term 'fund' indicates investment of reserve outside the business.
Distinction between provision and Reserve Provision 1. It is made to meet a known liability for depreciation of assets. 2. The amount set aside is used only to meet the specific purpose for which provision was made. 3. It is to be made even if there are no profits. Reserve 1. These are created to meet unexpected contingencies likely to arise in future. 2. Amount can be used for any liability or loss. 3. It is created only when there are sufficient profits.
doc_879769277.pptx
Depreciation, Reserve & Provision
Depreciation means a fall in the value of an asset. Every Fixed Asset is liable to lose its value ,once it begin to be used for production purpose Accounting Concept of Depreciation
Accounting concept of depreciation means to distribute the cost of fixed asset over its estimated life in a reasonable manner.
Depreciation
Depletion
Amortization
Plant Assets
Natural Resources
Intangible Assets
Causes of Depreciation
1. Wear and tear
wearing out of the asset on account of its constant use is called wear & tear. 2. Lapse of time With passage of time there is reduction in the value of fixed assets . 3. Obsolescence Due to acquisition of an improved model which is more economic and works more quickly then the existing machine will become obsolete.
Objective of Charging Depreciation
1. To Ascertain the Profit or Loss Properly 2. To show the Asset at its proper Value 3. To Retain out of Profit Funds for Replacement
Basic Factors Consider for calculating the Depreciation
1. Original cost of the Asset 2. Scrap Value at the End of its Life 3. Estimated effective or Commercial life or legal life which ever is shorter
Methods of Depreciations
1. 2. 3. 4. 5. 6. 7.
Straight Line Method or Fixed installment Method Diminishing Balance or Written Down Value Method Annuity Method Sinking Fund Method Sum of the Digits Method Insurance policy Method Revaluation Method
Straight Line Method
Under this method, an equal portion (amount) of the cost of the Asset is allocated as Depreciation to each accounting year over a period of its effective life. This is done so to reduce the value of the asset equal to zero or its salvage or scrap value
This method is based on the assumption that depreciation is the Function of Time Rather than of use and service potential of the Asset
The Annual depreciation charge will be computed as follows
Annual Depreciation = Cost of Asset + Erection charges – Scrap Value Estimated life of the Asset
Illustration 1: A machine is purchased for Rs 50000 & Rs 5000 is incurred as erection charges. The machine has a life of 5 years with a salvage value of Rs 10,000. Compute the annual depreciation. Illustration 2: A firm bought a machinery for Rs 38000 on 1st January 2009 and its life was Estimated to be 8 years. Its estimated scrap value at the end of the period was Rs 6000. Calculate the amount of depreciation.
Question1. Ram & Sons acquired a machine on 1st July 2008 at a cost of Rs 14000 and spent Rs 1000 on its installation. The firm write off depreciation at 10% on the original Cost every year. The Books are closed on 31st December every year. Show the Machinery Account & Depreciation Account for three years. Question 2 On 1st January 2000, Z Ltd purchased a plant costing Rs 41000 and spent Rs 4000 On its erection. The estimated effective life of the plant is 10 year with scrap value of Rs 5000. Calculate depreciation on the SLM for three years.
Advantages of Fixed installment method • It is easily understandable & is simply to apply. • Amount of depreciation does not vary from year to year. • Under this method the book value of asset is reduced either to zero or scrap value as the case may be.
Disadvantages of fixed installment method
• It does not reflect correct charge on a/c of depreciation where effective utilization of asset varies from year to year. • It does not recognize the reality that as an asset becomes older the amount spent for repairs. • Sometime in this method, book value of asset become zero but yet the assets are used in the business.
Written Down Value Method
Under this Method depreciation is charged at fixed rate on the reducing balance (i.e. cost less depreciation) every year.
Advantages of diminishing balance method
•Simple to understand •Easy to follow •Ensures a fairly even charge to profit and loss A/c Disadvantages
•Value of an asset cannot be brought down to zero •There is a difficult task to ascertain the proper rate of depreciation
Provisions
According to The Indian Companies Act,”provision can be defined as any amount. written off or retained by way of providing for depreciation , renewal diminution in the value of assets or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy”.
Provisions
1. It is created by debiting the profit and loss account.
2. It is created to meet a known liability or a specific contingency, e.g.. provision for bad and doubtful debts, or provision for depreciation etc.
3. A provision is created irrespective of whether there is profit or loss in the business. 4. It is not available for distribution as dividend among shareholders. 5. A provision is made for a definite amount and, therefore, a definite sum is set aside every year to meet the known contingency. 6. Making of a provision is a must to meet known liability or contingency.
Provisions
Thus provisions are the amounts set aside out of profits and other surpluses to provide for:1. Depreciation, Renewals or diminution in the value of assets 2. Any known liability of which the amount cannot be determined with substantial accuracy.
Provisions
Provisions are generally created for the following:1. Provision for Depreciation 2. Provision for Bad and Doubtful Debts 3. Provision for Discount on Debtors 4. Provision for taxation 5. Provision for Repairs and Renewals
Reserves
This term means amount set aside out of profits and other surplus which are not designed to meet any liability or diminution in value of assets known to exist at the date of B/S.
Reserves Basic purpose of creating a reserve is to provide for unexpected losses in future and also retain profits within business to provide funds for expansion of the business.
Reserves
1. It is created by debiting the profit and loss appropriation account. 2. It is created to meet an unknown liability, or to strengthen the financial position of the company or for equalization of dividends etc. 3. A reserve is created only when there is profit in the business. 4. It can be distributed among shareholders as dividend. 5. The reserve is created without taking into consideration the actual amount required except in the case of redemption of debentures when a definite sum is set aside. 6. Creation of reserve depends upon the financial policy of the business and discretion of its management.
Reserve Fund
The term ‘ Reserve Fund ‘ is used for the amount of reserve which has been invested in outside securities. Examples of Reserve Fund are employees welfare fund, pension fund, gratuity fund etc. Profit set aside and used in the business is a reserve. But profit set aside and invested outside the business is a reserve fund. Thus, the use of the term 'fund' indicates investment of reserve outside the business.
Distinction between provision and Reserve Provision 1. It is made to meet a known liability for depreciation of assets. 2. The amount set aside is used only to meet the specific purpose for which provision was made. 3. It is to be made even if there are no profits. Reserve 1. These are created to meet unexpected contingencies likely to arise in future. 2. Amount can be used for any liability or loss. 3. It is created only when there are sufficient profits.
doc_879769277.pptx