NCERT Solutions Class 11 Accountancy Chapter 7 Depreciation Provisions and Reserves

Question 1. What is ‘Depreciation’?
Answer: Depreciation represents the continuous decline in the recorded book value of a depreciable fixed asset. This decrease occurs due to several factors:
1. Wear and tear from regular use
2. The passage or efflux of time
3. Becoming outdated or obsolete
4. Accidental damage

As an illustration, consider a piece of machinery purchased for Rs. 1,00,000 with an expected working life of 10 years. The annual charge is calculated as:
Annual Depreciation = \( \frac{\text{Cost of Asset} - \text{Estimated Scrap Value}}{\text{Expected Life of Asset}} \)
Annual Depreciation = \( \frac{\text{Rs. 1,00,000}}{10} = \text{Rs. 10,000} \)
In simple words: Depreciation is the drop in the value of an asset as it gets older and is used in the business.

Exam Tip: Remember that depreciation is non-cash in nature, meaning it reduces reported profit but does not cause an immediate outflow of cash.

 

Question 2. State briefly the need for providing depreciation.
Answer: The essential reasons for charging depreciation in accounts are:
1. Determining accurate net profit or loss: To find the true earnings of a business, all expenses and losses related to earning revenue must be charged against the Profit and Loss Account. Since fixed assets help generate revenue, their consumption cost is charged as depreciation.
2. Displaying a true and fair view of financial position: Without depreciation, fixed assets would appear in the balance sheet at their historical cost rather than their actual depreciated value, leading to an overstated financial health.
3. Calculating correct production costs: For manufacturing concerns, the depreciation of factory machinery is part of the cost of production. Omitting this underestimates the product cost, which can lead to low pricing and lower profits.
4. Accumulating funds for asset replacement: Unlike typical operating costs, depreciation is a non-cash expense. The amount debited is retained in the business, helping to accumulate funds to replace the asset at the end of its life.
5. Compliance with legal requirements: Charging depreciation is mandatory under various laws, including the Companies Act and the Income Tax Act.
In simple words: We charge depreciation to know the exact profits, show the real value of our assets, and save up money to buy new assets when old ones wear out.

Exam Tip: In descriptive questions about the necessity of depreciation, always highlight "true and fair view of financial statements" and "matching principle of accounting" as key terms.

 

Question 3. What are the causes of depreciation?
Answer: Depreciation occurs due to several primary factors:
1. Ongoing asset usage: Continuous use of a fixed asset leads to physical wear and tear, which naturally reduces its value.
2. Expiry of time: Even if an asset remains idle, its remaining useful life decreases simply with the passage of time.
3. Technological obsolescence: Innovations, new inventions, and technological advancements can make existing assets outdated and inefficient.
4. Accidental damage: Unforeseen events like fire, theft, or natural disasters can cause a permanent loss in an asset's value.
In simple words: Assets lose value because they get worn out from use, get older over time, become outdated due to new technology, or get damaged in accidents.

Exam Tip: Clearly distinguish between internal causes (like wear and tear) and external causes (like obsolescence and efflux of time) when listing these factors.

 

Question 4. Explain basic factors affecting the amount of depreciation.
Answer: The primary determinants that influence the annual depreciation charge are:
1. Historical cost of the asset: This represents the total acquisition cost, which includes the purchase price plus any expenses incurred to make the asset ready for operation, such as freight, delivery, and installation costs.
Total Cost = Purchase Price + Freight Charges + Installation Expenses
2. Expected useful life: This is the estimated period during which the asset will be economically productive for the enterprise, measured in years or production units. It reflects commercial utility rather than physical life. For instance, if an asset can physically last for 20 years but becomes economically unviable after 15 years, its useful life is taken as 15 years.
3. Estimated residual value: Also known as scrap value, this is the expected net realizable amount from selling the asset at the end of its useful life. It is deducted from the total cost to find the depreciable amount. For example, if furniture is bought for Rs. 1,30,000 with a 10-year useful life and a scrap value of Rs. 10,000:
Annual Depreciation = \( \frac{\text{Rs. 1,30,000} - \text{Rs. 10,000}}{10\text{ years}} = \text{Rs. 12,000} \)
In simple words: The amount we depreciate depends on how much the asset cost to buy and set up, how long we can use it, and what we can sell it for at the end.

Exam Tip: Remember that installation charges and transit insurance are added to the purchase price to calculate the original cost of the asset.

 

Question 5. Distinguish between straight line method and written down value method of calculating depreciation.
Answer:

In simple words: Under the straight line method, we charge the same amount of depreciation every year. Under the written down value method, the depreciation amount keeps decreasing year after year.
Exam Tip: WDV is highly favored by tax authorities and is more realistic for assets like vehicles and machinery that have high maintenance costs as they age.

 

Question 6. “In case of a long term asset, repair and maintenance expenses are expected to rise in later years than in earlier year”. Which method is suitable for charging depreciation if the management does not want to increase burden on profits and loss account on account of depreciation and repair.
Answer: The Written Down Value (WDV) method is highly suitable in this scenario. Under this approach, the depreciation charge is higher in the initial years and progressively decreases as the asset ages. Conversely, repair and maintenance costs are lower at the start and increase over time. By combining a declining depreciation charge with rising maintenance expenses, the total annual burden on the Profit and Loss Account remains relatively stable, preventing an unfair strain in the asset's later years.
In simple words: Using the written down value method helps balance out costs because the high depreciation in early years drops just as the repair costs start to go up.

Exam Tip: For assets like plant, machinery, and vehicles, the WDV method is ideal as it equalizes the total charge of depreciation and repairs on the P&L account.

 

Question 7. What are the effects of depreciation on profit and loss account and balance sheet?
Answer: The impacts of recording depreciation on the financial statements are described below:

On the Profit and Loss Account:
1. Depreciation is treated as an operating expense and is debited to this account, which directly reduces the net profit of the business.
2. It increases the total expenses of the business, altering the balance between revenues and expenses.

On the Balance Sheet:
1. It reduces the book value of the respective fixed asset.
2. Consequently, the total value of non-current assets and the overall balance sheet total are decreased.
In simple words: Depreciation reduces the net profit shown on the income statement and lowers the recorded value of the assets shown on the balance sheet.

Exam Tip: Remember that depreciation is non-cash, meaning it reduces net profit on the P&L but does not reduce the cash balance on the asset side of the balance sheet.

 

Question 8. Distinguish between ‘provision’ and ‘reserve’.
Answer:

 

Question 9. Give four examples each of ‘provision’ and ‘reserves’.
Answer: Four common examples of provisions are:
1. Provision for bad and doubtful debts
2. Provision for tax liabilities
3. Provision for depreciation on assets
4. Provision for discount to debtors

Four common examples of reserves are:
1. General Reserve
2. Dividend Equalization Reserve
3. Capital Redemption Reserve
4. Debenture Redemption Reserve
In simple words: Provisions include savings for unpaid taxes or bad debts, while reserves include general savings or special funds to pay back debentures.

Exam Tip: Be clear that provisions are for specific, estimated liabilities, whereas general reserves are free and can be used for any business purpose.

 

Question 10. Distinguish between ‘revenue reserve’ and ‘capital reserve’.
Answer:

 

Question 11. Give four examples each of ‘revenue reserve’ and ‘capital reserve’.
Answer: Four examples of revenue reserves are:
1. General Reserve
2. Investment Fluctuation Fund
3. Dividend Equalization Reserve
4. Debenture Redemption Reserve

Four examples of capital reserves are:
1. Securities Premium Reserve (Premium on issue of shares)
2. Profit earned on the forfeiture of shares
3. Gain on the sale of non-current fixed assets
4. Profit realized on redemption of debentures
In simple words: Revenue reserves include general savings and dividend safety funds, while capital reserves include profits from selling machinery or issuing shares at a higher price.

Exam Tip: In exams, use modern terminology such as "Securities Premium Reserve" instead of "Issues of shares at premium" to secure full marks.

 

Question 12. Distinguish between ‘general reserve’ and ‘specific reserve’.
Answer:

 

Question 13. Explain the concept of ‘secret reserve’.
Answer: A secret reserve is an undisclosed reserve that is not visibly shown in the Balance Sheet. It is typically created by deliberately understating the value of assets or overstating the value of liabilities. This practice reduces the reported profits of the business, which in turn helps lower tax obligations and conceals high profitability from competitors. However, the creation of secret reserves is prohibited under corporate laws (such as the Companies Act) because it violates the principle of full disclosure and fails to present a true and fair view of the financial statements.
In simple words: A secret reserve is a hidden saving made by making the business look poorer than it actually is. It is illegal because companies must show their real financial health.

Exam Tip: Emphasize that secret reserves violate the "Full Disclosure Principle" of accounting, which makes them illegal under modern company law.

 

Long Answer Type Questions

 

Question 1. Explain the concept of depreciation. What is the need for charging depreciation and what are the causes of depreciation?
Answer:
Concept of Depreciation:
Depreciation refers to the systematic and gradual reduction in the recorded value of a tangible fixed asset over its estimated useful life. This decrease is not a sudden loss but a continuous process representing the wear, consumption, or obsolescence of the asset.

Need for Charging Depreciation:
1. **Ascertaining Correct Financial Performance:** Charging depreciation as an operating expense in the Profit and Loss Account ensures that the business calculates its true profits by matching asset costs with the revenues they generate.
2. **Presenting an Accurate Financial Position:** To present a true and fair view of the business, fixed assets must be shown in the Balance Sheet at their depreciated book value rather than their original cost.
3. **Determining Accurate Cost of Production:** Including depreciation in manufacturing expenses helps determine the real cost of goods produced, ensuring correct product pricing.
4. **Accumulating Funds for Asset Replacement:** As a non-cash expense, the depreciation charge retains cash within the business, which can be utilized to replace the asset when its useful life ends.
5. **Regulatory Compliance:** It is legally mandatory under the Companies Act and the Income Tax Act to charge depreciation on assets.

Causes of Depreciation:
1. **Physical Wear and Tear:** Regular and continuous use of assets in business operations leads to physical deterioration.
2. **Efflux of Time:** Some assets lose their utility and value merely with the passage of time, whether they are actively used or kept idle.
3. **Obsolescence:** Rapid changes in technology or market demand can render existing assets outdated.
4. **Accidents and Natural Calamities:** Unforeseen events like fire, accidental damage, or natural disasters can lead to a permanent loss in asset value.
In simple words: Depreciation is the loss in an asset's value over time. We record it to find true profits, keep our balance sheet accurate, and save up money for future replacements.

Exam Tip: When writing this as a long-form answer, use clear subheadings and point-by-point explanations to make the answer examiner-friendly and highly structured.

 

Question 2. 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: The two major methods of calculating depreciation are:

1. Straight Line Method (SLM)
This is also known as the Original Cost Method. Under this approach, a fixed and equal amount of depreciation is charged in each accounting period over the useful life of the asset.

Calculation Formula:
Annual Depreciation = \( \frac{\text{Historical Cost of Asset} - \text{Estimated Residual Value}}{\text{Estimated Useful Life in Years}} \)
If the annual depreciation amount is known, the rate can be determined as:
Rate of Depreciation = \( \frac{\text{Annual Depreciation Amount}}{\text{Original Cost of Asset}} \times 100 \)

Advantages:
* Highly simple to calculate and easy to understand.
* The asset's book value can be reduced completely to its scrap value or zero.
* It distributes an equal burden of depreciation on the Profit and Loss Account every year.

Disadvantages:
* It does not take into account the interest on capital invested in the asset.
* As the asset gets older, repair expenses rise, creating an unequal combined burden (depreciation + repairs) on the P&L account in later years.
* The book value may reach zero even while the asset is still physically operational.

Where Useful: Most suitable for assets that have low repair requirements and a low risk of rapid obsolescence, such as buildings, patents, leases, and furniture.

2. Written Down Value Method (WDV)
Also known as the Diminishing Balance Method. Under this method, a fixed rate of depreciation is applied every year to the reducing book value (written down value) of the asset rather than its original cost. Consequently, the annual depreciation amount decreases each year.

Calculation Formula for Depreciation Rate (R):
\[ R = \left[1 - \sqrt[n]{\frac{S}{C}}\right] \times 100 \]
Where:
* \( R \) = Rate of depreciation (in %)
* \( n \) = Useful life of the asset (in years)
* \( S \) = Scrap value / Residual value
* \( C \) = Original cost of the asset

Advantages:
* It balances out the total charge on the P&L account because high depreciation in early years matches low repairs, and low depreciation in later years matches high repairs.
* It is a highly realistic approach as the benefit derived from assets generally declines with age.
* Highly recognized and approved under the Income Tax Act.

Disadvantages:
* The asset's book value can never be mathematically reduced to absolute zero.
* The calculation of the depreciation rate is relatively complex.

Where Useful: Most suitable for assets that suffer from high obsolescence and require significant repairs as they get older, such as plant and machinery, motor vehicles, and computers.

Comparison Table:

In simple words: The straight line method charges the same amount of depreciation every year, while the written down value method charges a percentage on the remaining book value, so the depreciation amount decreases each year.
Exam Tip: Focus on the repair cost argument: SLM places an unequal burden on the P&L account over time, while WDV keeps the total burden of depreciation and repairs relatively constant.

 

Question 3. Describe in detail two methods of recording depreciation. Also give the necessary journal entries.
Answer: There are two primary approaches used to record depreciation in accounting books:

Method 1: Charging Depreciation directly to the Asset Account
In this method, the depreciation amount is directly credited to the respective asset account, thereby reducing its book value.

Accounting Treatment & Journal Entries:
1. Upon purchasing the asset:
Asset A/c ... Dr.
    To Cash / Bank / Vendor A/c
*(Being the asset purchased including installation and delivery charges)*

2. For charging annual depreciation:
Depreciation A/c ... Dr.
    To Asset A/c
*(Being depreciation charged on the asset)*

3. For transferring depreciation to the Profit and Loss Account:
Profit and Loss A/c ... Dr.
    To Depreciation A/c
*(Being the depreciation amount transferred to Profit and Loss Account)*

Presentation in Balance Sheet: The asset is shown on the assets side at its net written down value (Original Cost less accumulated depreciation). A drawback of this method is that the original cost of the asset cannot be easily seen on the face of the balance sheet.

Method 2: Crediting Depreciation to the Provision for Depreciation Account
Under this approach, depreciation is not deducted from the asset account. Instead, it is accumulated in a separate account called the 'Provision for Depreciation' or 'Accumulated Depreciation' Account.

Accounting Treatment & Journal Entries:
1. Upon purchasing the asset:
Asset A/c ... Dr.
    To Cash / Bank / Vendor A/c
*(Being the asset acquired)*

2. For recording annual depreciation:
Depreciation A/c ... Dr.
    To Provision for Depreciation A/c
*(Being depreciation credited to the provision account)*

3. For transferring depreciation to the Profit and Loss Account:
Profit and Loss A/c ... Dr.
    To Depreciation A/c
*(Being depreciation expense transferred to Profit and Loss Account)*

Presentation in Balance Sheet: The asset continues to be shown at its original historical cost on the assets side. The total accumulated depreciation is shown as a deduction from the asset cost or on the liabilities side. This provides a clear view of both the original cost and total depreciation charged till date.
In simple words: We can either reduce the asset's value directly every year, or we can keep the asset at its original price and save up the depreciation separately in a "Provision for Depreciation" account.

Exam Tip: In exams, clearly state that the second method is superior because it preserves the historical cost of the asset on the face of the balance sheet.

 

Question 4. Explain determinants of the amount of depreciation.
Answer: The core factors that determine the calculation of depreciation are:

1. Historical Cost of the Asset: This represents the total capital outlay required to acquire the asset and bring it to its working condition. It encompasses the net purchase price, import duties, freight, transit insurance, and any direct installation or setup expenses.
Total Cost = Purchase Price + Freight + Installation Charges

2. Estimated Net Residual Value: This is the expected cash scrap or salvage value that the business expects to recover when selling or disposing of the asset at the end of its useful life, net of any disposal costs.

3. Estimated Useful Life: This is the time period (or total units of output) during which the asset is expected to be useful to the business. It is based on economic utility and wear, which can be shorter than the actual physical lifespan of the asset.
In simple words: To find out how much value an asset loses, we need to know what it cost to get it ready to use, how long we can use it, and what it will be worth when we are done with it.

Exam Tip: Be careful in calculations: always deduct the estimated scrap value from the historical cost before dividing by the useful life under the straight-line method.

 

Question 5. Name and explain different types of reserves in details.
Answer: Reserves represent profits retained in the business rather than distributed as dividends. They are classified as follows:

1. Revenue Reserve
These are created out of normal operating profits earned from the core business activities. They are available for dividend distribution and help strengthen the general financial position.
Revenue reserves are sub-divided into:
* General Reserve: These are free reserves created without any specific purpose in mind. They enhance financial strength and can be used for any future contingency or expansion.
* Specific Reserve: These are created for a designated purpose and can only be utilized for that specific objective. Examples include:
  * Dividend Equalization Reserve: Created to maintain a stable dividend rate in years of low profits.
  * Workmen Compensation Fund: Kept aside to meet any compensation claims from workers.
  * Investment Fluctuation Fund: Used to cover declines in the market value of investments.
  * Debenture Redemption Reserve: Created to accumulate funds for paying back debentures.

2. Capital Reserve
These are created out of capital profits, which are gains from non-recurring, non-operating activities. Capital reserves are generally not available for distributing cash dividends.
Examples of capital profits that form capital reserves include:
* Profits earned prior to incorporation.
* Premium received on the issue of shares or debentures.
* Profits made from the forfeiture of shares.
* Profits realized from the sale of fixed assets.
* Capital Redemption Reserve.
* Profit on the revaluation of assets and liabilities.
In simple words: Revenue reserves are saved from regular daily profits and can be used for anything or given as dividends. Capital reserves are saved from special one-time gains and cannot be given out as cash dividends.

Exam Tip: Remember that Capital Reserve is used for writing off capital losses or issuing fully paid bonus shares, not for paying normal dividends.

 

Question 6. What are ‘provisions’? How are they created? Give accounting treatment in case of provision for doubtful Debts.
Answer:
A provision represents a sum of money kept aside by debiting the profit and loss account to cover a specific recognized liability, or an anticipated loss or expense whose precise value is yet to be determined. Some common examples of provisions include provision for depreciation on assets, provision for bad and doubtful debts, and provision for discount allowed to debtors.

The primary goal of creating a provision is to ensure all anticipated costs and losses are properly recorded. By establishing a provision account, the business estimates and records expected liabilities, losses, and expenses during the current financial year. This helps in calculating the accurate profit or loss and ensures that assets and liabilities are shown at their realistic values in the balance sheet.

Importance of Provision:
1. To meet anticipated losses and liabilities: Provisions are set up to handle expected future liabilities and losses, including provisions for taxation, doubtful debts, and discounts on debtors.
2. To meet known losses and liabilities: It is created to address recognized expenses and liabilities, such as provisions for repairs and renewals.
3. To present correct financial statements: For a business to showcase an accurate and fair picture of its profitability and financial position, keeping provisions for identified losses and obligations is essential.

Thus, establishing a provision is necessary to determine the actual profit or income of the current period. It is treated as a charge against revenue or profits.

Accounting Treatment
Since a provision is a charge against profit, it is debited to the profit and loss account. In the balance sheet, a provision can either be presented on the assets side as a subtraction from the related asset, or on the liabilities side alongside current liabilities.
1. Treatment on asset side - The provision for doubtful debts is subtracted from total sundry debtors, while the provision for depreciation is subtracted from the cost of the corresponding asset.
2. Treatment on liability side - Provisions for repairs and other charges are shown on the liabilities side under current liabilities.
In simple words: A provision is money set aside from profits to cover a known future expense or loss whose exact amount is not yet certain. It ensures the business does not overstate its profits and shows assets at their correct values.

Exam Tip: Remember that provisions are always a charge against profit (debited to Profit & Loss Account) and are not an appropriation of profit, unlike reserves.

 

Numerical Questions

 

Question 1. On April 01, 2010, Bajrang Marbles purchased a Machine for Rs. 2,80,000 and spent Rs. 10,000 on its carriage and Rs. 10,000 on its installation. It is estimated that its working life is 10 years and after 10 years its scrap value will be Rs. 20,000.
(a) Prepare Machine account and Depreciation account for the first four years by providing depreciation on straight line method. Accounts are closed on March 31st every year.
(b) Prepare Machine account, Depreciation account and Provision for depreciation account (or accumulated depreciation account) for the first four years by providing depreciation using straight line method accounts are closed on March 31 every year.
Answer:
(a) When Provision for Depreciation Account is not maintained:
 

 

 

Working Notes:
1. Calculation of annual depreciation \[ \text{Depreciation p.a.} = \frac{\text{Cost} - \text{Scrap Value}}{\text{Estimated Life of Assets (years)}} \] \[ = \frac{(2,80,000 + 10,000 + 10,000) - 20,000}{10} \] \[ = \text{Rs. } 28,000 \text{ per annum} \]
(b) When Provision for Depreciation Account is maintained:

 

 

 

 

 

Exam Tip: Be careful with carriage and installation costs - they must be added to the purchase price to calculate the total cost of the machine. Also, note that when a Provision for Depreciation account is prepared, the Machinery Account always shows the original cost at the end of each year.

 

Question 2. On July 01, 2010, Ashok Ltd. Purchased a Machine for Rs. 1,08,000 and spent Rs. 12,000 on its installation. At the time of purchase it was estimated that the effective commercial life of the machine will be 12 years and after 12 years its salvage value will be Rs. 12,000. Prepare machine account and depreciation Account in the books of Ashok Ltd. For first three years, if depreciation is written off according to straight line method. The accounts are closed on December 31st, every year.
Answer:

 

Working Notes:
1. Calculation of annual depreciation \[ \text{Depreciation p.a.} = \frac{\text{Cost} - \text{Scrap Value}}{\text{Estimated Life of Asset (Years)}} \] \[ = \frac{(1,08,000 + 12,000) - 12,000}{12} \] \[ = \text{Rs. } 9,000 \text{ per annum} \] For the year 2010, the machine was used for 6 months (July 01, 2010 to December 31, 2010): \[ \text{Depreciation for 2010} = \text{Rs. } 9,000 \times \frac{6}{12} = \text{Rs. } 4,500 \]
In simple words: Since the machine was bought on July 1st and accounts are closed on December 31st, we charge depreciation only for 6 months in the first year. For the next two years, full-year depreciation of Rs. 9,000 is charged.

Exam Tip: Always pay attention to the purchase date and the closing date of the accounting year. When an asset is purchased during the year, calculate depreciation on a pro-rata basis for the number of months it was actually used.

 

Question 3. Reliance Ltd. Purchased a second hand machine for Rs. 56,000 on October 01, 2011 and spent Rs. 28,000 on its overhaul and installation before putting it to operation. It is expected that the machine can be sold for Rs. 6,000 at the end of its useful life of 15 years. Moreover an estimated cost of Rs. 1,000 is expected to be incurred to recover the salvage value of Rs. 6,000. Prepare machine account and Provision for depreciation account for the first three years charging depreciation by fixed installment Method. Accounts are closed on December 31, every year.
Answer:

 

Working Notes:
1. Calculation of Net Scrap Value \[ \text{Scrap Value} = \text{Salvage Value} - \text{Estimated cost to recover the salvage value} \] \[ = \text{Rs. } 6,000 - \text{Rs. } 1,000 = \text{Rs. } 5,000 \]
2. Calculation of annual depreciation \[ \text{Depreciation p.a.} = \frac{\text{Cost} - \text{Net Scrap Value}}{\text{Estimated Life of Asset (years)}} \] \[ = \frac{(56,000 + 28,000) - 5,000}{15} \] \[ = \text{Rs. } 5,267 \text{ per annum} \]
3. Depreciation for 2011 (for 3 months, October 01 to December 31): \[ \text{Depreciation for 2011} = \text{Rs. } 5,267 \times \frac{3}{12} \approx \text{Rs. } 1,316.75 \text{ (taken as Rs. 1,316)} \]
In simple words: The scrap value is reduced by Rs. 1,000 because that represents the cost to recover the salvage value. Since the machine was bought on October 1st, we only record 3 months of depreciation for 2011, and full-year depreciation of Rs. 5,267 for subsequent years.

Exam Tip: Remember to deduct any estimated cost to recover the scrap value from the salvage value before calculating annual depreciation. Also, round off the figures carefully to the nearest rupee.

 

Question 4. Berlia Ltd. Purchased a second hand machine for Rs. 56,000 on July 01, 2011 and spent Rs. 24,000 on its repair and installation and Rs. 5,000 for its carriage. On September 01, 2012, it purchased another machine for Rs. 2,50,000 and spent Rs. 10,000 on its installation. Depreciation is provided on machinery @10% p.a. on original cost method annually on December 31. Prepare machinery account and depreciation account from the year 2011 to 2014. Also prepare machinery account and depreciation account from the year 2011 to 2014, if depreciation is provided on machinery @10% p.a. on written down value method annually on December 31.
Answer:
(i) Under Original Cost Method:
 

 

Working Notes (Original Cost Method):
1. Annual Depreciation on Machinery purchased on July 01, 2011: \[ \text{Total Cost} = \text{Rs. } 56,000 + \text{Rs. } 24,000 + \text{Rs. } 5,000 = \text{Rs. } 85,000 \] \[ \text{Annual Depreciation @ 10\%} = \text{Rs. } 85,000 \times 10\% = \text{Rs. } 8,500 \text{ per annum} \] For 2011 (6 months): \[ \text{Depreciation} = \text{Rs. } 8,500 \times \frac{6}{12} = \text{Rs. } 4,250 \]
2. Annual Depreciation on Machinery purchased on September 01, 2012: \[ \text{Total Cost} = \text{Rs. } 2,50,000 + \text{Rs. } 10,000 = \text{Rs. } 2,60,000 \] \[ \text{Annual Depreciation @ 10\%} = \text{Rs. } 2,60,000 \times 10\% = \text{Rs. } 26,000 \text{ per annum} \] For 2012 (4 months): \[ \text{Depreciation} = \text{Rs. } 26,000 \times \frac{4}{12} \approx \text{Rs. } 8,667 \]

(ii) Under Written Down Value Method:

 

 

 

Exam Tip: Be careful with the written down value calculations when multiple machines are involved. Always track each machine's written down value separately to apply the 10% rate on the correct reducing balance every year.

 

Question 5. Ganga Ltd. purchased a machinery on January 01, 2011 for Rs. 5,50,000 and spent Rs. 50,000 on its installation. On September 01, 2011 it purchased another machine for Rs. 3,70,000. On May 01, 2012 it purchased another machine for Rs. 8,40,000 (including installation expenses). Depreciation was provided on machinery @10% p.a. on original cost method annually on December 31. Prepare:
a. Machinery account and depreciation account for the years 2011, 2012, 2013 and 2014.
b. If depreciation is accumulated in provision for Depreciation account then prepare machine account and provision for depreciation account for the years 2011, 2012, 2013 and 2014.
Answer:
a. When Provision for Depreciation Account is not maintained:
 

 

Working Notes: Calculation of Annual Depreciation
Machinery I:
Original cost on 1Jan, 2011 = (5,50,000 + 50,000) = Rs. 6,00,000
10% Depreciation for 2011 = Rs. 60,000
10% Depreciation for 2012 = Rs. 60,000
10% Depreciation for 2013 = Rs. 60,000
10% Depreciation for 2014 = Rs. 60,000
Total accumulated = Rs. 2,40,000

Machinery II:
Original cost on 1Sep, 2011 = Rs. 3,70,000
10% Depreciation for 2011 (4 months) = Rs. 12,330 (approx. Rs. 12,333)
10% Depreciation for 2012 = Rs. 37,000
10% Depreciation for 2013 = Rs. 37,000
10% Depreciation for 2014 = Rs. 37,000
Total accumulated = Rs. 1,23,330 (approx. Rs. 1,23,333)

Machinery III:
Original cost on 1May, 2012 = Rs. 8,40,000
10% Depreciation for 2012 (8 months) = Rs. 56,000
10% Depreciation for 2013 = Rs. 84,000
10% Depreciation for 2014 = Rs. 84,000
Total accumulated = Rs. 2,24,000

Total accumulated depreciation of all machines = Rs. 5,87,330

b. If depreciation is accumulated in Provision for Depreciation Account:

 

 

 

 

Exam Tip: Show the calculations for each machine separately in your working notes. For example, in 2011, Machine 1 gets a full year of depreciation, but Machine 2 gets depreciation only for 4 months (September to December).

 

Question 6. Azad Ltd. purchased furniture on October 01, 2012 for Rs. 4,50,000. On March 01, 2013 it purchased another furniture for Rs. 3,00,000. On July 01, 2014 it sold off the first furniture purchased in 2012 for Rs. 2,25,000. Depreciation is provided at 15% p.a. on written down value method each year. Accounts are closed each year on March 31. Prepare furniture account, and accumulated depreciation account for the years ended on March 31, 2013, March 31, 2014 and March 31, 2015. Also give the above two accounts if furniture disposal account is opened.
Answer:
(i) If Furniture Disposal Account is not opened:
 

(ii) If Furniture Disposal Account is opened:

 

 

 

 

 

Working Notes:
1. Calculation of Profit or Loss on sale of furniture

Exam Tip: A Furniture Disposal Account is very useful for showing all transaction details of a sold asset in one place. Make sure to transfer the original cost of the asset from the Asset Account and the total accumulated depreciation up to the date of sale from the Provision for Depreciation Account.

 

Question 7. M/s Lokesh Fabrics purchased a Textile Machine on April 01, 2011 for Rs.1,00,000. On July 01, 2012 another machine costing Rs.2,50,000 was purchased . The machine purchased on Rs.01, 2011 was sold for Rs.25,000 on October 01, 2015. The company charges depreciation @15% p.a. on straight line method. Prepare machinery account and machinery disposal account for the year ended March 31, 2016.
Answer:

Computing the Gain or Loss on the Disposal of the Machine on October 1, 2015:

In simple words: We record the purchase of machinery and subtract a fixed depreciation of 15% each year using the straight-line method. When we sell the first machine, we find its value on that day, compare it with the selling price, and transfer the remaining loss to a separate disposal account.

Exam Tip: In straight-line depreciation, always calculate the rate on the original cost. When a machine is sold mid-year, compute the depreciation strictly for the months it was used during that year before transferring its book value to the disposal account.

 

Question 8. The following balances appear in the books of Crystal Ltd, on Jan 01, 2015
Machinery account on Rs. 15,00,000
Provision for depreciation account Rs. 5,50,000
On April 01, 2015 a machinery which was purchased on January 01, 2012 for Rs. 2, 00,000 was sold for Rs. 75,000. A new machine was purchased on July 01, 2015 for Rs. 6, 00,000. Depreciation is provided on machinery at 20% p.a. on Straight line method and books are closed on December 31 every year. Prepare the machinery account and provision for depreciation account for the year ending December 31, 2015.
Answer:

Determining the Profit or Loss on the Sale of the Machine on April 1, 2015:

In simple words: Under the provision for depreciation method, the machinery account remains at its original cost. All depreciation is gathered in a separate account, and when an asset is sold, we shift both its cost and total depreciation to a disposal account to calculate the profit or loss.

Exam Tip: Remember that when a provision for depreciation account is maintained, the asset account always displays the historical cost of the asset. Only transfer the total accumulated depreciation of the sold asset to the disposal account at the time of sale.

 

Question 9. M/s. Excel Computers has a debit balance of Rs. 50,000 (original cost Rs. 1, 20,000) in computers account on April 01, 2010. On July 01, 2010 it purchased another computer costing Rs. 2, 50,000. One more computer was purchased on January 01, 2011 for Rs. 30,000. On April 01, 2014 the computer which has purchased on July 01, 2010 became obsolete and was sold for Rs. 20,000. A new version of the IBM computer was purchased on August 01, 2014 for Rs. 80,000. Show Computers account in the books of Excel Computers for the years ended on March 31, 2011, 2012, 2013, 2014 and 2015. The computer is depreciated @10% p.a. on straight line method basis.
Answer:

Computing Profit or Loss on the Sale of the Computer Acquired on July 1, 2010:

In simple words: We keep track of multiple computers bought at different times. Each computer is depreciated by 10% of its original cost every year. When one of the computers is sold because it is outdated, we calculate its remaining value up to the date of sale and write off the loss.

Exam Tip: Watch out for the dates of purchase and sale to calculate depreciation for the exact number of months. In the final year, the oldest computer is already written down to its scrap value, so only apply the remaining depreciation of Rs. 2,000 instead of the full annual rate.

 

Question 10. Carriage Transport Company purchased 5 trucks at the cost of Rs. 2,00,000 each on April 01, 2011. The company writes off depreciation @ 20% p.a. on original cost and closes its books on December 31, every year. On October 01, 2013, one of the trucks is involved in an accident and is completely destroyed. Insurance company has agreed to pay Rs. 70,000 in full settlement of the claim. On the same date the company purchased a second hand truck for Rs. 1,00,000 and spent Rs. 20,000 on its overhauling. Prepare truck account and provision for depreciation account for the three years ended on December 31, 2013. Also give truck account if truck disposal account is prepared.
Answer:

Calculation of Loss Sustained from the Accident:

In simple words: We bought 5 identical trucks and calculated a 20% annual depreciation on each. When one truck met with an accident, we gathered all the depreciation we had charged on it so far, subtracted it from the truck's original cost, and compared this book value with the insurance money received to find the actual loss.

Exam Tip: Overhauling expenses of Rs. 20,000 spent on a second-hand truck are capital expenditure, so they must be added to the cost of the truck (Rs. 1,00,000) to make the total cost Rs. 1,20,000. Depreciation for this new truck is calculated on Rs. 1,20,000 for 3 months (October to December).

 

Question 11. Saraswati Ltd. purchased a machinery costing Rs. 10,00,000 on January 01, 2011. A new machinery was purchased on 01 May, 2012 for Rs. 15,00,000 and another on July 01, 2014 for Rs. 12,00,000. A part of the machinery which originally cost Rs. 2,00,000 in 2011 was sold for Rs. 75,000 on October 31, 2014. Show the machinery account, provision for depreciation account and machinery disposal account from 2011 to 2015 if depreciation is provided at 10% p.a. on original cost and account are closed on December 31, every year.
Answer:

Calculation of Gain or Loss on the Sale of a Portion of Machinery 1:

In simple words: We keep track of multiple machines over five years. When a part of the first machine (worth Rs. 2,00,000 originally) is sold, we calculate its depreciation up to the exact date of sale, deduct that total from its original price, and compare it with the sale amount to find the net loss.

Exam Tip: In questions where only a part of an asset is sold, make sure to separate that part from the remaining asset. Compute depreciation for the sold part only for the months used in that year (10 months from January to October in 2014, which gives Rs. 16,667).

 

Question 12. On July 01, 2011 Ashwani purchased a machine for Rs. 2,00,000 on credit. Installation expenses Rs. 25,000 are paid by cheque. The estimated life is 5 years and its scrap value after 5 years will be Rs. 20,000. Depreciation is to be charged on straight line basis. Show the journal entry for the year 2011 and prepare necessary ledger accounts for first three years.
Answer:

Computing Annual Depreciation:
Annual Depreciation = (Total Asset Cost - Estimated Residual Value) / Useful Life (in Years)
= (2,00,000 + 25,000) - 20,000 / 5
= Rs. 41,000 per annum

In simple words: We purchase machinery on credit and pay installation costs by cheque, adding both to find the total machinery cost. We then use the straight-line method to write off depreciation of Rs. 41,000 every full year, or Rs. 20,500 for the first six months.

Exam Tip: Capitalize installation costs by adding them directly to the asset's purchase price. Also, remember to charge depreciation on a pro-rata basis for the first year because the machine was bought on July 1 (exactly half a year).

 

Question 13. On October 01, 2010, a Truck was purchased for Rs. 8,00,000 by Laxmi Transport Ltd. Depreciation was provided at 15% p.a. on the diminishing balance basis on this truck. On December 31, 2013 this Truck was sold for Rs. 5, 00,000. Accounts are closed on 31st March every year. Prepare a Truck Account for the four years.
Answer:

Determining Profit or Loss on the Disposal of the Truck:

In simple words: We record the truck's decreasing value by charging 15% depreciation on the balance that remains at the start of each year (reducing balance method). When we sell the truck, we find its value on that day, and since we sold it for more than its book value, we make a profit of Rs. 25,498.

Exam Tip: In the written down value method, depreciation is computed on the reducing balance (the opening balance of that year), not on the original cost. Ensure you calculate the depreciation for exactly 9 months in the final year before determining the gain or loss.

 

Question 14. Kapil Ltd. purchased a machinery on July 01, 2011 for Rs. 3,50,000. It purchased two additional machines, on April 01, 2012 costing Rs. 1,50,000 and on October 01, 2012 costing Rs. 1,00,000. Depreciation is provided @10% p.a. on straight line basis. On January 01, 2013, first machinery become useless due to technical changes. This machinery was sold for Rs. 1,00,000. Prepare machinery account for 4 years on the basis of calendar year.
Answer: The Machinery Account of Kapil Ltd. for four years under the straight line depreciation method is presented below:

Working Note:
Profit or Loss on sale of part of Machinery 1:

 

In simple words: The machinery was depreciated using the straight-line method, which means a fixed percentage is calculated on the original cost. When the first machine was sold on the very first day of 2013, we compared its written-down value of Rs. 2,97,500 with its selling price of Rs. 1,00,000 to find the loss of Rs. 1,97,500.

Exam Tip: Be careful with the calculation of depreciation for partial years. For example, in 2011, the first machine was only used for 6 months (July to December), so we only charge half of the annual depreciation.

 

Question 15. On January 01, 2011, Satkar Transport Ltd, purchased 3 buses for Rs. 10,00,000 each. On July 01, 2013, one bus was involved in an accident and was completely destroyed and Rs. 7,00,000 were received from the Insurance Company in full settlement. Depreciation is written off @15% p.a. on diminishing balance method. Prepare bus account from 2011 to 2014. Books are closed on December 31 every year.
Answer: Here is the Bus Account for Satkar Transport Ltd. prepared using the written down value method:

Working Note:
Profit or Loss Due to Accident:

 

In simple words: The written-down value method was used, so depreciation for each year was calculated on the book value at the start of that year. When one bus met with an accident in July 2013, we first charged depreciation for the 6 months it was used, leaving its value at Rs. 6,68,312. Since the insurance company paid Rs. 7,00,000, we actually made a profit of Rs. 31,688 on this settlement.

Exam Tip: When preparing accounts under the diminishing balance method, make sure you compute depreciation on the opening balance of each year, not the original cost. Also, if there is a profit on disposal (or insurance settlement), it must be debited to the asset account.

 

Question 16. On October 01, 2011 Juneja Transport Company purchased 2 Trucks for Rs. 10,00,000 each. On July 01, 2013, One Truck was involved in an accident and was completely destroyed and Rs. 6,00,000 were received from the insurance company in full settlement. On December 31, 2013 another truck was involved in an accident and destroyed partially, which was not insured. It was sold off for Rs. 1,50,000. On January 31, 2014 company purchased a fresh truck for Rs. 12,00,000. Depreciation is to be provided at 10% p.a. on the written down value every year. The books are closed every year on March 31. Give the truck account from 2011 to 2014.
Answer: Here is the Truck Account for Juneja Transport Company for the requested period:

Working Note:
Truck - 1 Profit or Loss due to Accident:

 

Truck - 2 Profit or Sale on sale:

 

In simple words: The transport company used the written-down value method. Since the financial year ends on March 31, we calculate depreciation for partial years based on how many months each truck was used before an accident or purchase occurred. Both truck 1 and truck 2 were sold or destroyed at a loss, which we calculated by subtracting the recovery amount from their written-down values on the date of disposal.

Exam Tip: Pay extreme attention to the financial year (closing on March 31) versus the calendar dates of events. For instance, Truck 3 was bought on January 31, 2014, meaning it was used for only 2 months (February and March) in the financial year ending March 31, 2014.

 

Question 17. A Noida based Construction Company owns 5 cranes and the value of this asset in its books on April 01, 2011 is Rs. 40,00,000. On October 01, 2011 it sold one of its cranes whose value was Rs. 5,00,000 on April 01, 2011 at a 10% profit. On the same day it purchased 2 cranes for Rs. 4,50,000 each. Prepare cranes account. It closes the books on December 31, 2012 and provides for depreciation on 10% written down value.
Answer: Here is the Cranes Account prepared on a written-down value basis. Note that because the books close on December 31 every year, the first financial year ending December 31, 2011 consists of only 9 months (from April 01 to December 31):

Working Notes:
1. Calculation of Crane Valued at Rs. 5,00,000:

 

 

2. Calculation of depreciation for remaining 4 cranes:

3. Calculation of depreciation for 2 new cranes:

In simple words: The cranes are depreciated using the written-down value method. Since the financial period ends on December 31, we calculate depreciation based on the number of months the cranes were used in 2011. The sold crane was used for 6 months, the existing 4 cranes for 9 months, and the newly purchased ones for 3 months. The profit from selling the crane is recorded on the debit side of the account.

Exam Tip: When books are closed on December 31 and the opening balance is given as of April 01, the first financial year contains only 9 months. Ensure you compute depreciation for all assets based on this 9-month period instead of a full 12-month year.

 

Question 18. Shri Krishan Manufacturing Company purchased 10 machines for Rs. 75,000 each on July 01, 2010. On October 01, 2012, one of the machines got destroyed by fire and an insurance claim of Rs. 45,000 was admitted by the company. On the same date another machine is purchased by the company for Rs. 1,25,000. The company writes off 15% p.a. depreciation on written down value basis. The company maintains the calendar year as its financial year. Prepare the machinery account from 2010 to 2013.
Answer: The Machinery Account for Shri Krishan Manufacturing Company from 2010 to 2013 is as follows:

Working Note:
Machine Costing 75,000 sold on Oct.01,2012:

 

In simple words: The written-down value of the destroyed machine on the date of the fire was Rs. 52,335. Since the insurance company agreed to pay only Rs. 45,000, we suffered a loss of Rs. 7,335 on this machine. For the remaining machines, we continued to charge the annual 15% depreciation on their opening values.

Exam Tip: When multiple identical assets are bought together and one is later destroyed or sold, divide the total book value by the number of assets to easily trace the individual book value of the affected asset.

 

Question 19. On January 01, 2010, a Limited Company purchased machinery for Rs. 20,00,000. Depreciation is provided @15% p.a. on diminishing balance method. On March 01, 2012, one fourth of machinery was damaged by fire and Rs. 40,000 were received from the insurance company in full settlement. On September 01, 2012 another machinery was purchased by the company for Rs. 15,00,000. Write up the machinery account from 2012 to 2013. Books are closed on December 31, every year.
Answer: The Machinery Account from 2012 to 2013 is as follows:

Working Note:
1. Machine (i)

2. 1/4th of machine (i)

 

3. 3/4th of Machine

4. New Machine
Depreciation on new machine for 2012: Rs. 15,00,000 * 15% * 4/12 = Rs. 75,000
Depreciation on new machine for 2013: Rs. 14,25,000 * 15% = Rs. 2,13,750

In simple words: When part of a larger machinery setup is sold or destroyed, it is best to divide the initial cost into separate components from the very beginning. Here, the machine was split into a 1/4th part and a 3/4th part. This helps in tracing the exact written-down value of the destroyed 1/4th part on March 01, 2012, which was Rs. 3,52,219, resulting in a loss of Rs. 3,12,219 after subtracting the insurance payout.

Exam Tip: Split the asset value into columns or separate working tables right from day one (2010 in this case) to make the calculations for the destroyed 1/4th portion straightforward and error-free when the event occurs in 2012.

 

Question 20. A Plant was purchased on 1st July, 2010 at a cost of Rs. 3,00,000 and Rs. 50,000 were spent on its installation. The depreciation is written off at 15% p.a. on the straight line method. The plant was sold for Rs. 1,50,000 on October 01, 2012 and on the same date a new Plant was installed at the cost of Rs. 4,00,000 including purchasing value. The accounts are closed on December 31 every year. Show the machinery account and provision for depreciation account for 3 years.
Answer: The Plant Account and the Provision for Depreciation Account are compiled below:

Plant Account

Provision for Depreciation Account

Working Note:
Profit or Loss on Sale of Plant:

 

In simple words: Under this system, the asset account is always kept at its original cost, and all annual depreciation is accumulated separately in the Provision for Depreciation Account. When the asset is sold, we transfer its total accumulated depreciation of Rs. 1,18,125 from the Provision account to the Asset account, allowing us to find the final book value and loss on disposal.

Exam Tip: Remember that when a Provision for Depreciation Account is maintained, no depreciation entry is recorded directly in the Asset Account at the end of normal years. This entry only appears in the Asset Account upon the sale of the asset to clear out the accumulated depreciation of the sold asset.

 

Question 21. An extract of Trial balance from the books of Tahiliani and Sons Enterprises on Mar 31 2015 is given below:

Additional Information:
- Bad Debts proved bad but not recorded amounted to Rs. 2,000.
- Provision is to be maintained at 8% of Debtors.
Give necessary accounting entries for writing off the bad debts and creating the provision for doubtful debts account. Also show the necessary accounts.
Answer: The required journal entries and ledger accounts are structured as follows:

 

Journal of Tahiliani and Sons Enterprises

 

Bad debts Account

Debtors Account

Provision for Doubtful Debt Account

Profit and Loss Account (Extract)

In simple words: When further bad debts of Rs. 2,000 are found, we reduce our debtors from Rs. 50,000 to Rs. 48,000. The new provision for doubtful debts is calculated at 8% of this new figure, which is Rs. 3,840. The total amount charged to the Profit and Loss Account is the sum of all bad debts plus the new provision, minus the old provision that was already in our books.

Exam Tip: Always deduct the new unrecorded bad debts from the trial balance debtors before calculating the new percentage for the provision of doubtful debts.

 

Question 22. The following information are extract from the Trial Balance of M/s Nisha traders on 31 March 2015.
Sundry Debtors Rs. 80,500
Bad debts Rs. 1,000
Provision for bad debts Rs. 5,000
Additional Information
Bad Debts Rs. 500
Provision is to be maintained at 2% of Debtors.
Prepare bad debts account, Provision for bad debts account and profit and loss account.
Answer: The required ledger accounts for bad debts, provision, and the profit & loss extract are as follows:

Bad debts Account

Provision for Bad debts Account

Profit and Loss Account (Extract)

In simple words: Since our old provision of Rs. 5,000 was quite large, it was more than enough to cover both the old bad debts of Rs. 1,000, the new bad debts of Rs. 500, and still leave the required Rs. 1,600 for the new provision. The leftover balance of Rs. 1,900 is an excess that is credited back to our Profit and Loss Account as income.

Exam Tip: When the old provision is larger than the total of the new provision plus the total bad debts, the difference is written back. This means it appears on the credit side of the Profit and Loss Account rather than being debited as an expense.