Class 11 Accountancy (Financial Accounting) Chapter 7 Depreciation, Provisions and Reserves

Key Concept: Method Recognition

c) Undervaluation of inventories

[Solution Description] Undervaluation of inventories or stock is a common method used to create a secret reserve, as it reduces assets and thus shows reduced profits.

Key Concept: Basic Concept

b) Wear and tear

[Solution Description] The causes of depreciation include wear and tear, expiration of legal rights, obsolescence, and abnormal factors. Each of these leads to a decrease in the value of an asset over time.

Key Concept: Continuous Process

b) Continuous process

[Solution Description] Depreciation is not a one-time calculation; it continuously reduces the asset’s value over its useful life until it reaches its residual value or is fully depreciated.

Key Concept: Cost Components

d) Interest on loan

[Solution Description] The cost of an asset for depreciation calculation includes invoice price, freight, transportation, transit insurance, installation, registration, and initial repair costs. Interest on loan used to purchase the asset is not considered part of these costs.

Key Concept: Dividend Usage

b) General Reserve

[Solution Description] General reserves can be used for dividend distribution as they are part of retained earnings which can be distributed to shareholders.

Key Concept: Real-world Application

b) Written Down Value Method

[Solution Description]

For companies like a technology firm that face rapid obsolescence of their equipment, it is more beneficial to use the Written Down Value (WDV) method of depreciation. This method acknowledges the decreased utility and rapidly declining value of assets, as it charges higher depreciation initially and progressively less over the years.

The WDV method aligns well with high-tech industries where assets quickly lose value, ensuring expenses match the declining usefulness and efficiency of equipment.

Key Concept: Basic Concept

b) Simplicity

[Solution Description] The main advantage of the Straight Line Method is its simplicity and ease of understanding, which makes it easy to apply.

Key Concept: Depreciation and Tax

b) It reduces taxable income

[Solution Description]

Depreciation is considered in tax calculations as it reduces taxable income. By deducting depreciation from revenue, businesses lower their taxable profit, which in turn decreases the amount of income tax they need to pay.

Key Concept: Straight-Line Depreciation

b) \$5,000

[Solution Description] To calculate the annual depreciation expense using the straight-line method, we use the formula:

$$\text{Annual Depreciation Expense} = \frac{\text{Cost of Asset}}{\text{Useful Life}}$$

Substituting the given values:

$$\text{Annual Depreciation Expense} = \frac{50000}{10} = 5000$$

Hence, the annual depreciation expense is \$5,000.

Key Concept: Impact of Depreciation

b) Decreases book value

[Solution Description] When accumulated depreciation is transferred to the asset account, it decreases the asset’s book value. Book Value = Original Cost – Accumulated Depreciation. This means that after transfer, the net carrying amount or book value is reduced by the accumulated depreciation.

Key Concept: Abnormal Factors

d) Permanent and not continuing

[Solution Description]

Accidental losses from factors like floods are permanent but not continuing or gradual, as they occur suddenly without forewarning.

Key Concept: Purpose Identification

c) To allocate the cost of tangible assets over time

[Solution Description] Recording depreciation helps match the cost of an asset with the revenue it generates over its useful life, maintaining accurate financial records.

Key Concept: Basic Definition

d) Depletion

[Solution Description] The term used to describe the reduction in availability of material in mines and quarries is “depletion”. Depletion refers to the consumption or exhaustion of a resource over time as it is extracted.

Key Concept: Compliance Check

c) To comply with accounting standards

[Solution Description] Businesses must provide depreciation to ensure compliance with accounting standards, which require that asset values are represented accurately in financial statements over time.

Key Concept: Provision Examples

c) Provision for doubtful debts

[Solution Description] A provision is created for expenses that relate to the current accounting period but are not yet incurred or certain. Among the options provided, “Provision for doubtful debts” is explicitly mentioned in the syllabus as an example of provisions.

Key Concept: Depreciation Calculation

c) \$20,000

[Solution Description]

To calculate the annual depreciation using the Straight Line Method, we use the formula:

$$\text{Annual Depreciation} = \frac{\text{Original Cost} – \text{Residual Value}}{\text{Useful Life}}$$

Given that the original cost is \$100,000, residual value is \$0, and useful life is 5 years, we substitute these values into the formula:

$$\text{Annual Depreciation} = \frac{100,000 – 0}{5} = 20,000$$

Therefore, the annual depreciation charge would be \$20,000.

Key Concept: Depreciation Impact

b) Increases

[Solution Description] Under the written down value method, depreciation is calculated as a percentage of the asset’s book value at the beginning of each year. As years pass, the book value decreases due to accumulated depreciation, leading to lower annual depreciation charges. However, because the asset ages, it often requires more repairs, increasing repair expenses over time. Therefore, repair expenses generally increase.

Key Concept: Legal Compliance

d) To comply with legal requirements

[Solution Description] Businesses are required to provide depreciation on fixed assets to comply with legal requirements and tax regulations. Depreciation reflects the wear and tear of assets and helps ensure that financial statements present a realistic view of the business’s assets and liabilities.

Key Concept: Concept Identification

a) Technological changes

[Solution Description] Causes of obsolescence include factors like technological changes, improvements in production methods, change in market demand, and sometimes legal descriptions that make assets less relevant or useful.

Key Concept: Factors Identification

d) Employee turnover

[Solution Description] Estimation of useful life can be influenced by various factors such as technological changes, repair and maintenance policy, market conditions, etc. Employee turnover is not typically a factor affecting the useful life of an asset.

Key Concept: Asset Disposal

c) Depreciate over 5 years at \$10,000 per year

[Solution Description] Since the extension retains a separate identity, it should be depreciated independently based on its useful life. The annual depreciation can be calculated using straight-line depreciation:

$$\text{Annual Depreciation} = \frac{\$50,000}{5} = \$10,000$$

Therefore, the annual depreciation for the extension is \$10,000.

Key Concept: Balance Sheet Presentation

c) Shown on liabilities side after capital

[Solution Description] Reserves are shown on the liabilities side after capital as they represent appropriations of profit that belong to the owners/shareholders of the business. They do not get deducted from assets unlike provisions.

Key Concept: Compulsion Element

d) Provisions ensure true profit calculation as they account for known liabilities

[Solution Description] Provisions are a charge against profits and are mandatory for determining true profit. They represent known liabilities or expenses that must be accounted for even if they result in zero or negative profits.

Key Concept: Journal Entry Sequencing

c) 3, 2, 1

[Solution Description]

The correct sequence involves first removing the original cost from the Asset account, then recording the provision for depreciation, and finally recognizing the cash received.

Correct order:

1. Remove the asset at its original cost:

$$\text{Asset Disposal A/c Dr. To Asset A/c}$$

2. Record the accumulated depreciation:

$$\text{Provision for Depreciation A/c Dr. To Asset Disposal A/c}$$

3. Record the proceeds of sale:

$$\text{Bank A/c Dr. To Asset Disposal A/c}$$

Therefore, the correct sequence is 3, 2, 1.

Key Concept: Purpose of Depreciation

b) To match costs with revenue

[Solution Description] The purpose of charging depreciation against revenue is to match costs with revenues for a specific accounting period. This is based on the matching principle, which ensures that expenses are recorded in the same period as the related revenues.

Key Concept: Journal Entry Sequencing

a) 1, 2, 3

[Solution Description]

The correct sequence of journal entries for asset disposal involves transferring the original cost, then the accumulated depreciation, followed by the proceeds from the sale.

The steps are as follows:

1) Transfer the original cost of the asset to the Asset Disposal Account:

$$\text{Asset Disposal A/c Dr.} \to \text{Asset A/c}$$

2) Transfer the accumulated depreciation to the Asset Disposal Account:

$$\text{Provision for Depreciation A/c Dr.} \to \text{Asset Disposal A/c}$$

3) Record the cash received from the sale:

$$\text{Bank A/c Dr.} \to \text{Asset Disposal A/c}$$

Therefore, the correct order is: 1, 2, 3.

Key Concept: Depreciation Methods

c) It spreads the cost evenly over the useful life of the asset.

[Solution Description] The Straight Line Method allocates an equal amount of depreciation expense each year over the useful life of the asset.

Key Concept: Comprehensive Journal Entries

b) Bank A/c Dr. To Machine A/c To Profit and Loss A/c

[Solution Description]

To find the profit on sale, we calculate the difference between the sale price and the book value of the asset. Here, the sale price is \$15,000 and the book value is \$12,000. Therefore, the profit is:

$\text{Profit} = \$15,000 – \$12,000 = \$3,000$

The journal entry to record this profit on sale would involve crediting the Profit and Loss Account, as profits are credited to this account. Hence, the correct journal entry is: $\text{Bank A/c Dr.} \$15,000$,

$\text{To Machine A/c} \$12,000$,

$\text{To Profit and Loss A/c} \$3,000$

Thus, the appropriate option is: “b) Bank A/c Dr. To Machine A/c To Profit and Loss A/c”.

Key Concept: Basic Concept

c) Equal usage

[Solution Description] The straight line method assumes that the asset is used equally over its useful life, resulting in equal depreciation expense each year.

Key Concept: Basic Definition

c) Decrease in asset value

[Solution Description] Depreciation measures the decrease in asset value due to factors such as time, use, or obsolescence.

Key Concept: Basic Definition

c) To account for the reduction in natural resources quantity

[Solution Description] Depletion in accounting is primarily used to account for the reduction of natural resources, such as minerals or oil reserves, over time as they are extracted.

Key Concept: Method Recognition

b) Written Down Value Method

[Solution Description] The Written Down Value Method results in a decreasing depreciation charge because it calculates depreciation on the reduced book value of the asset each year.

Key Concept: Basic Nature

b) Appropriation of profit

[Solution Description] A general reserve is created when no specific purpose is mentioned and it serves the function of strengthening the financial position of an organization.

Key Concept: Basic Formula Application

c) 8.45%

[Solution Description]

To find the depreciation rate R, we use the formula:

$$R = \left(1 – \left(\frac{s}{c}\right)^{\frac{1}{n}}\right) \times 100$$

Substituting the given values: $R = \left(1 – \left(\frac{6000}{10000}\right)^{\frac{1}{5}}\right) \times 100$

$R = \left(1 – (0.6)^{0.2}\right) \times 100$

After calculating, we find: $R \approx 8.45%$

Key Concept: Basic Definition

a) Wear and tear

[Solution Description] Depreciation in fixed assets primarily occurs due to wear and tear from regular use, passage of time leading to obsolescence, or a reduction in asset utility.

Key Concept: Definition Recall

d) Writing-off the cost of intangible assets

[Solution Description] Amortization refers to the periodic write-off of the cost of intangible assets such as patents, copyrights, trademarks, franchises, and goodwill.

Key Concept: Types of Reserves

d) Debenture Redemption Reserve

[Solution Description] Specific reserves are allocated for specific purposes, unlike general reserves which can be used for any purpose.

Key Concept: Basic Definition

c) Patent

[Solution Description] Intangible assets are non-physical assets that have value. Examples include patents, copyrights, and goodwill. These do not have a physical presence but provide economic benefit.

Key Concept: Causes of Depreciation

b) Technological changes

[Solution Description] The syllabus mentions causes of depreciation as wear and tear, expiration of legal rights, obsolescence, and abnormal factors. Among these, “Technological changes” can be associated with obsolescence.

Key Concept: Source Identification

b) Revenue Reserve

[Solution Description] Revenue reserves are created from revenue profits arising from the normal operations of a business, and they are available for dividend distribution.

Key Concept: Basic Concepts

d) All of the above

[Solution Description] The total cost of an asset includes all expenditures necessary to acquire the asset and prepare it for use. This encompasses purchase price, freight and transportation costs, installation cost, registration costs, and any commission paid on purchase.

Key Concept: Asset Disposal

c) \$2,000

[Solution Description] To find the gain on sale of an asset, subtract the book value of the asset from the sale price. Here, the book value is \$8,000 and it is sold for \$10,000. Therefore, the gain on sale is:

$$\text{Gain on Sale} = \$10,000 – \$8,000 = \$2,000$$

Key Concept: Definition Check

b) The estimated economic or commercial life of the asset

[Solution Description] The useful life of an asset is the period over which it is expected to be used by the enterprise, taking into account factors like usage level and maintenance.

Key Concept: Depreciation Transfer

b) Debit Provision for Depreciation Account, Credit Asset Disposal Account

[Solution Description] When disposing of an asset, the accumulated depreciation is transferred by debiting the Provision for Depreciation Account and crediting the Asset Disposal Account.

Key Concept: Basic Concept

b) It assumes equal utility of an asset over its useful life.

[Solution Description] The Straight Line Method assumes that an asset provides equal utility over its useful life. This assumption doesn’t account for situations where efficiency declines or repair costs increase, which are typical limitations.

Key Concept: Method Recognition

c) Written Down Value Method

[Solution Description] The Written Down Value Method involves charging depreciation at a fixed percentage on the book value of the asset, resulting in a decreasing amount of depreciation each year. It is also known as the declining balance method.

Key Concept: Basic Definition

b) Cost of asset minus net residual value

[Solution Description] The depreciable cost is calculated by subtracting the net residual value from the cost of the asset. The formula for depreciable cost is:

$$\text{Depreciable Cost} = \text{Cost of Asset} – \text{Net Residual Value}$$

Key Concept: Depreciation Calculation

b) \$2,000

[Solution Description] The straight-line depreciation method calculates annual depreciation by dividing the depreciable cost of the asset by its useful life. Here, the formula is given as:

$$\text{Annual Depreciation} = \frac{\$20,000 – \$0}{10} = \$2,000$$

Therefore, the annual depreciation charge is \$2,000.

Key Concept: Related Terms

c) Writing off intangible assets

[Solution Description]

Amortisation refers to the process of gradually writing off the initial cost of an intangible asset over a period of time. It is similar to depreciation but applies to non-physical assets.

Key Concept: Basic Formula

b) Cost of Asset – Residual Value

[Solution Description] The depreciable cost of an asset is calculated using the formula: Depreciable Cost = Cost of Asset – Residual Value. This formula allows us to find out how much value of an asset will be allocated over its useful life as depreciation.

Key Concept: Formula Identification

c) $$\frac{\text{Cost of Asset} – \text{Estimated Residual Value}}{\text{Estimated Useful Life of the Asset}}$$

[Solution Description] In the Straight Line Method, the formula for calculating the annual depreciation amount is

$$\text{Depreciation} = \frac{\text{Cost of Asset} – \text{Estimated Residual Value}}{\text{Estimated Useful Life of the Asset}}$$

Key Concept: Basic Calculation

b) \$9,000

[Solution Description]

– The straight-line method formula is:

$ \text{Depreciation} = \frac{\text{Cost of Asset} – \text{Salvage Value}}{\text{Useful Life}} $

– Substitute the given values: $\text{Depreciation} = \frac{50000 – 5000}{5} = \frac{45000}{5} = 9000$

– Hence, the annual depreciation is \$9,000.

Key Concept: Depreciation Calculation

b) \$10,000

[Solution Description]

To calculate the depreciation expense using the written down value method, use the formula:

$$\text{Depreciation} = \text{Cost} \times \frac{\text{Rate}}{100}$$

For the first year, it becomes:

$$\text{Depreciation} = 50000 \times \frac{20}{100} = 10000$$

Thus, the depreciation expense in the first year is \$10,000.

Key Concept: Provision Impact

b) Decreases profit

[Solution Description] Creating a provision for bad debts involves recognizing an expense in the Profit and Loss account, which decreases net profit. The corresponding credit to the Provision for Doubtful Debts reduces the carrying amount of the debtors on the Balance Sheet.

Key Concept: Basic Concept

d) Straight Line Method

[Solution Description] The method where depreciation is distributed equally over the asset’s useful life is known as the Straight Line Method. It ensures that depreciation expense remains consistent annually.

Key Concept: Balance Sheet Treatment

d) Both B and C

[Solution Description] In the balance sheet, the Provision for Depreciation is shown as a deduction from the cost of the fixed asset on the assets side or it may also be shown on the liabilities side as a separate line item. This reflects the reduced value of the asset due to depreciation.

Key Concept: Basic Concept

b) To comply with tax regulations

[Solution Description] Businesses comply with legal requirements for depreciation primarily to adhere to tax regulations set by authorities. This ensures accurate financial reporting and helps in determining taxable income correctly.

Key Concept: Non-Cash Expense

b) Non-cash expense

[Solution Description]

Depreciation is considered a non-cash expense because it does not involve actual cash flow. Instead, it reflects the allocation of the cost of tangible assets over their useful lives as an expense on financial statements.

Key Concept: Causes of Depreciation

d) Increase in market demand

[Solution Description] The main causes of depreciation include wear and tear, obsolescence, expiration of legal rights, and abnormal factors like accidents. Increased market demand does not cause depreciation.

Key Concept: Basic Formula

c) $$\text{Depreciation} = \frac{\text{Cost of asset} – \text{Estimated net residual value}}{\text{Estimated useful life of the asset}}$$

[Solution Description] The formula for calculating annual depreciation using the straight line method is given by the difference between the cost of the asset and the estimated net residential value divided by the estimated useful life of the asset.

Key Concept: Written Down Value Method

c) It charges depreciation on the book value, decreasing annually.

[Solution Description] The written down value method charges depreciation on the book value of the asset, also known as the reducing balance method.

Key Concept: Method Comparison

b) Written Down Value Method

[Solution Description]

The written down value method calculates depreciation based on the current book value, leading to higher depreciation expenses in the initial years when the asset’s book value is higher. This method is better suited for assets subject to rapid obsolescence due to technological advancements, as it matches higher early depreciation with the decreasing utility of such assets. Therefore, the written down value method is more appropriate for these types of assets.

Key Concept: Impact Analysis

c) Assets are overstated

[Solution Description] If depreciation is not accounted for, it results in an overstatement of asset values on the balance sheet because the assets are still listed at their original purchase costs rather than reflecting any reduction in value over time due to usage or obsolescence.

Key Concept: Basic Definition

d) Purchase price, transportation, and installation cost

[Solution Description] According to Accounting Standard-6 of ICAI, the cost of a fixed asset includes its purchase price along with any additional expenses necessary to bring the asset to its working condition for its intended use. These may include costs like transportation and installation.

Key Concept: Depreciation and Amortization, Depreciation Impact

c) Decreases asset book value and net income uniformly.

[Solution Description]

Tangible assets like buildings and machinery are subject to depreciation, whereas intangible assets like patents are generally amortized using similar methods. When applying the straight-line method:

– Depreciation charges reduce the carrying value of tangible assets every year by a uniform amount, impacting net income negatively.

– Similarly, amortization reduces the value of intangible assets annually by a set amount.

– Both processes do not affect cash flow directly as they are non-cash expenses but reduce taxable income, thus affecting tax liabilities and reported profits.

– Financial statements reflect reduced total asset values and decreased net income.

Key Concept: Basic Advantage

c) It balances depreciation and repair expenses annually.

[Solution Description] The Written Down Value Method offers an equal burden of depreciation and repair expenses annually. This means that as the depreciation expense decreases over time, repair costs typically increase, balancing the overall cost burden each year.

Key Concept: Basic Definition

b) The estimated sale value at the end of its useful life minus disposal expenses

[Solution Description]

The net residual value of an asset is defined as the estimated net realisable value of the asset at the end of its useful life after deducting disposal expenses.

Key Concept: Depreciation Impact

d) It decreases the annual depreciation charge over time

[Solution Description] The Written Down Value Method results in a decreasing burden of depreciation expenses over time. This happens because the depreciation amount reduces each year as it is calculated on the reduced balance of the asset’s value, leading to lower depreciation charges in later years.

Key Concept: Tax Implications

b) Written down value method

[Solution Description] According to the syllabus, the Income Tax Law recognizes the written down value method of depreciation, while the straight line method is not recognized. This affects how companies may choose to report their financials for tax purposes.

Key Concept: Time Period

c) It provides a timeline for legal protection

[Solution Description] The pre-determined period defines the duration for which the legal rights are valid. After this time expires, the associated legal protections cease, affecting the value and utility of the asset.

Key Concept: Formula Application

b) 18%

[Solution Description] Using the formula for the rate of depreciation: $R = \left(1 – \frac{s}{c}\right) \times \frac{100}{n}$

Substitute the values: $s = 1000$,

$c = 10000$,

$n = 5$.

Calculate: $R = \left(1 – \frac{1000}{10000}\right) \times \frac{100}{5}$

$= \left(1 – 0.1\right) \times 20$

$= 0.9 \times 20$

$= 18%$.

Therefore, the rate of depreciation is 18%.

Key Concept: Passage of Time

c) Causes wear and tear

[Solution Description] Over time, even without active use, assets naturally deteriorate which results in a loss of value.

Key Concept: Basic Definition

c) Salvage value

[Solution Description] The value of an asset at the end of its useful life is commonly known as salvage value or scrap value.

Key Concept: Depreciation Calculation

d) Written down value method

[Solution Description] The written down value method, also known as the declining balance method or reducing balance method, calculates depreciation by applying a fixed percentage to the asset’s current book value. This results in decreasing depreciation charges over the asset’s useful life.