Depriciation

depreciation• Decrease in the value of a fixed assets due to use,

passage of time, obsolescence etc.• Permanent and continuous decrease in the value

of assets• Def. “ depreciation represents that part of cost of

a fixed assets to its owner which is not recoverable when the assets is finally out of use by him. Provision against this loss of capital is an integral cost of conducting the business during the effective commercial life of the assets and is not dependent on the amount of profit earned”

• Def. “ depreciation accounting is a system of accounting which aims to distribute cost on the basic value of tangible capital assets less salvage value ( if any) over the estimated useful life of the assets in a systematic and rationale manner. It is a process of allocation and not of valuation.”

Need for charging depreciation

• To ascertain true results of operation• To present true and fair view of the financial

position• To ascertain the true cost of production• To comply with legal requirement• To accumulate funds for replacement of

assets

Factors affecting the amount of depreciation

• Historical cost• Expected useful life• Estimated residual value

Methods of recording depreciation

• By charging to assets account• By creating provision for depreciation a/c

Charging to assets A/cdate particulars LF debit credit

Assets a/c Dr To cash/ bank( for purchasing assets)Depreciation a/c Dr To Assets A/c( for changing depreciation)P&L a/c Dr To Depreciation( for closing Deprecation)Cash/ Bank a/c Dr To Asset a/cAssets A/c Dr To P&L a/c(Transfer of profit)P&L a/c Dr To assts(transfer of Loss)

Creating provision for depreciationdate particulars LF Debit Credit

Creating provision for depreciationdate particulars LF Debit Credit

Assets A/c Dr To cash( for purchasing assets)Depreciation A/c Dr To provision for depreciation(for charging depreciation)Asset disposal A/c Dr To Assets( for selling assets at original cost)Provision for depreciation A/c Dr To assets disposal A/c( transfer of accumulated depreciation)Cash/ Bank a/c Dr To assets disposal a/c

Creating provision for depreciationdate particulars LF Debit Credit

Assets disposal A/c Dr To P&L a/c( in case of profit)P&L a/c Dr To assets disposal A/c( in case of loss)

problem

• Mr X purchased a Machine on 1/4/2010 for Rs 90000 and spend Rs 10000 for its transporting and erecting. On 31/3/2011 he sold the Machine for Rs 82000. Record the following transaction in the books of Mr X assuming the depreciation rate is 20 % per annum. Record this by both the methods and prepare the ledgers.

Method of charging depreciation

• Straight line method (SLM)• Original cost – residual value / expected useful

life of the assets• Original cost 100000, residual value 10000,

useful life 10 years then rate of depreciation is 9 %

Advantages of this method

• Easy to understand• Easy to calculate

disadvantages

• Not scientific: initial stages depreciation is more

problemPurchase price

Erection cost

Residual value

Expected life in years

Date of purchase

Machine A 100000 10000 15000 10 1/10/2010

Machine B 50000 5000 7000 5 1/1/2011

Calculate depreciation on Machine A and B for the year 2010-11

problem

• On 1/10/2008 X purchased a new machine for Rs 50000 and spend Rs 20000 for its installation. The useful life of the machine is 5 years and its residual value is expected to be Rs 10000. On 1/7/2010 the machine was sold for Rs 55000. Prepare the machine A/c for the year 2008-09, 9-10 and 10-11 by charging to assets a/c method.

Written down value (WDV)

• Rate of depreciation remains the same but depreciation is charged on the written value every year.

• This method is more scientifically as later years repairs is more

• As the assets gets old the depreciation decreases

disadvantages

• More difficult to calculate ( i.e. the rate )• It takes a lot of years to write off an assets• It does not provide for the replacement of the

assets

problem

• On 1/10/2008 X purchased a truck for 500000 and spend 200000 for making its body. On 1/10/2010 the truck was sold for Rs 300000. Prepare the truck A/c for the year 2008-09,9-10, 10-11. depreciation is to be charged @ 20 % on written down value.

problem

• Previous problem prepare all the ledgers. Method to be followed is by creating provision for depreciation a/c.

Bills of exchange

• Cash sales: not always possible• Credit sales: fund gets blocked, higher risk of

bad debts, tendency of finding faults i.e.. Goods are defective

definition

• “ a bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of a certain person or to the bearer of the instrument” Negotiable Instrument Act

features

• The terms and conditions are specified• The amount of money cannot be altered • The date of payment is certain• Drawee is the person on whom bill is raised. If

he accepts it he is bound to make the payment

• Payee: the payee makes the payment. Generally the Drawee and payee are the same

Advantage of bill of exchange

• Planning: the drawer and Drawee knows when the payment is due so better planning is possible.

• Proof of debt: the receiver of money is secure about his payment.

• Liquidity is maintained: the drawer cab discount the bill and receive payment immediately.

• Easy transferability: can be transferred from one person to another

Basic terms

• Bills receivable: if payment is receivable • Bills payable : if payment is payable• Due date of bill of exchange: the date on

which the payment is to be paid

journal

• A sells Rs 10000 worth of goods to B on 1/4/2011. On 2/4/2011 A draws a bill for 10000 on B which B accepts. The due date for the same is 2/6/2011. On the due date B makes the payment. Pass the journal entries

In the books of Adate particulars LF Debit Credit

1/4/2011

2/4/2011

2/6/2011

B a/c debit To sales a/c

Bills receivable a/c Debit To B a/c( on raising the Bill)Bank A/c Debit To bills receivable A/c( on receiving payment)

10000

10000

10000

10000

10000

10000

In the books of Bdate particulars LF Debit Credit

1/4/2011

2/4/2011

2/6/2011

Purchase A/c Debit To A A/c

A a/c Debit To Bills Payable( on accepting the Bill)Bills Payable A/c Debit To Bank A/c ( on making the payment)

10000

10000

10000

10000

10000

10000

Discounting with the bankdate particulars LF Debit Credit

Bank A/c DebitDiscount on Bills a/c Debit To Bills receivable

Endorsing the bill in favour of a third party

date particulars LF Debit Credit

C A/c Debit To Bills receivable a/c( on endorsement)

Bank A/c Debit To C A/c( on receipt of payment)

Dishonor of billdate particulars LF Debit Credit

B A/c Debit To bills receivable A/c

If a had discounted the bill or endorsed the bill

B A/c Debit To Bank/ To C A/c

Noting chargesdate particulars LF Debit Credit

B a/c Debit to cash( if paid by A)

B A/c Debit To Bank( if discounted by the bank)

B A/c Debit To C A/c( if endorsed to C and C pays for it)

Insolvencydate particulars LF Debit Credit

B A/c Debit To Bills receivable/ Bank/ C

Bank a/c DebitBad debts A/c Debit To B A/c( the amount not received is treated as bad debts)

problem

journaldate particulars LF Debit Credit