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
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/c date 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/c Assets A/c Dr To P&L a/c (Transfer of profit) P&L a/c Dr To assts (transfer of Loss)
Creating provision for depreciation date particulars LF Debit Credit
Creating provision for depreciation date 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 depreciation date 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)
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
Not scientific: initial stages depreciation is more
problem Calculate depreciation on Machine A and B for the year 2010-11 Purchase 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
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
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
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.
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
“ 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
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
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
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 A date 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 B date 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 bank date particulars LF Debit Credit Bank A/c Debit Discount 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 bill date 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 charges date 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)
Insolvency date particulars LF Debit Credit B A/c Debit To Bills receivable/ Bank/ C Bank a/c Debit Bad debts A/c Debit To B A/c ( the amount not received is treated as bad debts)