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(i) Normal and Natural wear of Tear

(ii) Loss

(iii) replacement

(iv) Tax

(v) Historical

Original cost on 01.01.2016 = ₹ 2,00,000

Less: Dep for 2015-16 for 3 months = ₹ 5,000

W.D.V. on 01.04.2016 = ₹ 1,95,000

Less: Dep for 2016-17 for 12 months = ₹ 19,500

W.D.V. on318t March, 2017 = ₹ 1,75,500

This statement is False. 

Underwritten down value method depreciation is calculated at a certain fixed rate of percentage every on the balance of the asset which is brought forward from the previous year.

Depreciation p.a. = Cost of computer (×) percentage

= 40,000 × \(\frac{8}{100}\)

= ₹ 3,200 p.a.

Depreciation p.a. = \(\frac{Costo\,of\,Asset(-)Scrapvalue}{Estimated\,life\,of\,asset}\)

= \(\frac{23,000-2,000}{7}\)

= \(\frac{21,000}{7}\)

= ₹ 3,000 p.a.

Under the Reducing Balance Method of depreciation amount of depreciation changes every year.

For depreciating a five years lease fixed installment Method of depreciation is suggested.

Four examples of revenue reserve are given below: 

1. Genera Reserve 

2. Retained Earnings 

3. Dividend Equalization Reserve 

4. Debenture redemption Reserve 

Four examples of capital reserve are given below: 

1. Issues of shares at premium 

2. Profit or issue of shares 

3. Sale of fixed assets 

4. Profit on redemption of debentures.

1. General reserves 

2. Specific reserves

1. Capital reserve and 

2. Revenue reserve. 

Reserve is an appropriation of profit retained to meet unknown liabilities or contingencies.

Reserves: Reserves are created for strengthening the financial positions and future growth. It’is created out of profit earned business. 

1. Revenue Reserve: It is created out of revenue profit, i.e., revenue earned from normal activities of the business. 

It can be used for either general purpose or specific purpose. It is of two types:

a. General Reserve: When the reserve is created without any specified purpose, then there serve is called general reserve. It is a free reserve and so can be used for any purpose. It can also be used for future growth and expansion. For example, reserve funds, retained earnings, contingencies reserves, etc.

b. Specific Reserve – When reserve is created for some specific purpose, then the reserve is called specific reserve. Example of specific reserve are given below. Debenture Redemption Reserve, Investment Fluctuation Reserve. Dividend Equalization Reserve, Workmen Compensation Fund.

c. Capital Reserve – It is created out of capital profit, i.e., gain from other than normal activities of business operations, such as sale of fixed asset, etc. it is created to meet the capital loss. It cannot be distributed as dividend.

The example of capital reserves are given below: Premium on issue of Shares and debentures, Premium on issue of debentures. Profit of redemption of debentures, Profit on sale of fixed assets. Profit on reissue of forfeited shares Profit prior to incorporation.

d. Secrete Reserves: Reserves that are created by overstating liabilities or understating assets are known as secrete reserves. They are not shown in the Balance sheet. These reduce tax liabilities, as the liabilities are overstated. It is created by management to avoid competition by reducing profit. 

Creation of secrete reserve is not allowed by Companies Act, 1956, which requires full disclosure of all materials facts and accounting policies, while preparing final statements.

Provision is a charge against profit to meet certain known liabilities or contingencies.

 Provisions are the amount that is created against profit to meet the known liability; however, the amount of liability is uncertain. It is created for specific liability. Creation of provision is compulsory even if, there is no profit. The underlying principle behind creation of provision is conservatism, viz., to prepare for future loss. The main rationale for making provisions is to provide cushion to the future business performance against the uncertain and unforeseen losses that may arise from the past transactions. A few examples of provisions are given below:

Provision for bad and doubtful debts 

Provisions for depreciation 

Provisions for taxation 

Provisions for discount on debtors

Provisions are made by debiting the Profit and Loss Account on estimate basis. The provision are created on the basis of past experiences. Every year, a business may experience common losses, such as depreciation of fixed assets, taxation, etc., which are although known; however, their exact amount of future period is unknown. Thus, business creates provision of certain percentage every year, which is truly based on the intuitions and past experiences. These unascertained liabilities in form of provisions are kept aside, which help future business activities, undisturbed from the future losses.

Accounting treatment for provision for doubtful debts is: Profit and Loss A/c Dr To Provision for Doubtful Debts (Provision for doubtful debt made)

This statement is False.

The working life of fixed assets decreases with passes of time. The value of these assets decreases every year as new technology introduced in the market old becomes outdated so it is necessary to depreciate an asset even it is not in use.

If the management does not want to expert undue burden on the profits due to high depreciation and repair costs in the latter years of the assets, then ‘written down method’ should be a preferred method to provide depreciation. This is because the cost of depreciation reduces; whereas, repair and maintenance expenses increase in the latter years. However, on ‘ the whole, it does not expert increasing burden on profits.

(i) Depreciation is a non-cash expense.

(ii) The depreciation account is a Nominal account.

(iii) Wages paid on the installation of Machinery is Debited to Machinery A/c.

(iv) Depreciation is charged whether a business is making a profit or loss.

(v) Depreciation reduces the value of the Asset.

Capital reserve is created out of Capital profits which is used for writing off capital losses or issue of bonus shares.

Under this method, the market value of the asset is ascertained at the end of each year. Any difference between the book value and market value is the depreciation.

When the purpose for which a reserve is created is not specified, it is called a General reserve. 

1. Profit on sale of fixed assets and 

2. Premium on issue of shares or debentures.

Revenue reserve is created out of the revenue profits which arise out of the normal operating activities of the business. 

1. General reserve and 

2. Investment fluctuation reserve.

Specific reserve is the reserve which is created for some specific purpose and can be utilised only for that purpose. 

Reserves that are created by overstating liabilities or understating assets are known as Reserves secrete reserves. They are not shown in the balance sheet. These reduce tax liabilities, as the liabilities are overstated. It is created by management to avoid competition by reducing profit. Creation of secrete reserve in not allowed by Companies Act, 1956 that requires full disclosure of all material facts and accounting policies while preparing final statements.

I. Advantages of Straight Line Method : 

a. It is simple to calculate. 

b. Asset can be completely written off, i.e., asset can be depreciated until the net scrap value is zero. 

c. Same amount of depreciation is charged every year. Therefore, it helps in easy comparison of Profit and Loss Account for different years. d. It is used for assets that have low repairs and maintenance expenses and are continuously used over a period of time

Limitations of Straight Line Method : 

a. Burden of depreciation is mere on profit and loss account in the later years, when repair and maintenance costs increase, as asset becomes older. b. Value of asset becomes zero in the books even if asset is still in usable condition in business. 

Uses of Straight Line Method : 

• This method is useful where repairs and maintenance expenses on asset are low. 

• It is also useful when an asset is continuously used from one year to another. 

• It is useful when the value of assets, such as patent, copyright, goodwill, etc., becomes zero

II. Written Down value Method :

This method is applicable where depreciation is charged on the diminishing balance, i.e., book value of the asset. In this method, asset’s value goes on diminishing year after year and the amount of depreciation declines. 

Advantages of Written Down value Method : 

a. It is based on the logical assumption that asset is used more in the earlier years, so more cost is charged in form of depreciation. 

b. It is suitable for the assets where repairs are more in the later years, as depreciation is lesser and on a whole the combined burden of depreciation and repairs experts equal pressure on the net profit over years. 

c. This method is accepted by the income tax authorities. 

d. As more depreciation is charged the earlier years, so the loss due to obsolescence of the asset is reduced.

Limitations of Written Down Value Method :

a. It is difficult to calculate and is a time consuming process. 

b. The value of an asset cannot be zero, thus the asset cannot be completely written off, 

c. There arises shortage of fuflds for replacement of new asset. This happens due to the fact that the amount of depreciation is retained and used in the business. Consequently, at the end of the useful life of an old asset, business finds it difficult to arrange funds for its replacement. Uses of Written Down Value Method :

a. It is useful when assets have long life. 

b. It is useful for those assets that require more repair and maintenance costs in the later years. 

c. It provides easy calculation to provide depreciation of additional asset purchased during a year.

1. To show correct profit/loss position. 

2. To show the asset at the correct market value. 

Under this method, not only the reduced cost of the asset is charged as depreciation, but also the interest it would have carried in case the cost of the asset is invested outside. The depreciation will be as per annuity table.

Under this method, an insurance policy is taken for the required sum for replacing the asset to be written off.

Under this method, depreciation at fixed percentage is calculated on the reduced balance of the asset brought forward from the previous year.

Under this system, the amount written off as depreciation should be kept aside and invested in readily saleable securities. When the life of the asset expires, the securities are sold and a new asset is purchased with the help of sale proceeds. 

Under this method, a fixed percentage of the original cost is written off every year, as annual depreciation.

1. Straight line method 

2. Diminishing value method

1. Cost of the asset and 

2. Scrap value