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Q1 What is ‘Depreciation’? Ans: Depreciation may be described as a permanent, continuing and gradual shrinkage in the book value of fixed assets. It is based on the cost of assets consumed in a business and not on its market value.
Q2 State briefly the need for providing depreciation. Ans: Depreciation needs to be provided because an asset is bound to undergo wear and tear over a period of time. This reduces the working capacity and effectiveness of the asset. Hence, this should reflect the value of the asset, at which it is carried in the books of accounts.
1) For ascertaining the true profit or loss
2) For showing the true and fair view of the financial position
3) To ascertain the accurate cost of production
4) To provide funds for replacement of assets
5) To prevent the distribution of profits out of capital
6) For avoiding over payment of Income tax.Q3 What are the causes of depreciation? Ans: Causes of Depreciation:
1) By Constant Use
2) By Expiry of Time
3) By Expiry of Legal Rights
4) By Obsolescence
5) By Accident
6) By Depletion
7) By Permanent fall in Market PriceQ4 Explain basic factors affecting the amount of depreciation. Ans: The factors affecting the amount of depreciation:
1) Total Cost of asset
2) Estimated useful life of asset
3) Estimated Scrap ValueQ5 Distinguish between straight line method and written down value method of calculating depreciation. Ans: Straight line method
1) Depreciation is calculated on the original cost of an asset.
2) Equal amount of depreciation is charged each year over the useful life of the asset.
3) Book value of the asset becomes zero at the end of its effective life.
4) It is suitable for assets such as patents, copyright, land and buildings which have lesser possibility of obsolescence and lesser repair charges.
5) As depreciation remains the same over the years but repair cost increases in the later years, there will be an unequal effect over the life of the asset.
6) It is not recognized under the income tax act.Value method
1) Depreciation is calculated on the reducing balance, i.e., the book value of an asset.
2) Diminishing amount of depreciation is charged each year over the useful life of the asset.
3) Book value of the asset can never be zero.
4) It is suitable for assets which needs more repair in the later years such as plant and machinery, car.
5) As depreciation cost is high and repairs are less in the initial years but in the later years the repair costs increase and depreciation cost decreases, there will be equal effect over the life of the asset.
6) It is recognized under the income tax act.Q6 “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. Ans: Written Down Value Method is suitable because under this method depreciation charge declines in later years. Hence, total of depreciation and repair charges remain similar or equal year after year.
Q7 What are the effects of depreciation on profit and loss account and balance sheet? Ans: Depreciation is charged as expenditure in Profit and Loss account and the depreciation figure is deducted from the value of concerned assets in the assets side of the balance sheet.
In that case, it reduces the profit of the concern;On the other hand, it reduces the assets side in the balance sheet.
Here, it is worth mentioning that Depreciation is a non - cash expenditure.Q8 Distinguish between ‘provision’ and ‘reserve’ . Ans: Provision Reserve - Provision refers to an amount that is kept aside from a company’s profit in order to cover probable expenses arising in future or a possible reduction in the value of an asset.
- Provisions are important for a business as they address certain expenses in business and payments made for them. Provisions should not be regarded as savings as these are created to meet expenses for an anticipated liability in future.
- It appears in the income statement in the form of expenses and is recorded as a current liability in the balance sheet.
- Reserve is the term which refers to a sum or percentage of profit that a company retains or keeps aside at the end of a financial year towards meeting future contingencies that may occur.
- It is also used to strengthen the business.
- Stabilises the financial position of a company by being used for expansion of assets, dividend payments and investments.
Q9 Give four examples each of ‘provision’ and ‘reserves’. Ans: Four examples of ‘Provision’ are as follows:-
1) Provision for Depreciation of Assets
2) Provision for Taxation
3) Provision for Bad and Doubtful Debts
4) Provision for Discount on DebtorsFour examples of ‘Reserves’ are as follows:-
1) General Reserve
2) Capital Reserve
3) Reserve for Redemption of Debentures
4) Workmen Compensation FundQ10 Distinguish between ‘revenue reserve’ and ‘capital reserve’. Ans: Revenue Reserve Capital Reserve - Revenue reserve is the type of reserve that is created from the net profit that a company makes during a financial year.
- This reserve is not distributed to shareholders in the form of dividends but is kept for meeting future requirements of the business.
- Revenue reserve is created from revenue profit which is earned from the daily operations of the business. Revenue reserve is added in a profit and loss appropriation account.
- A capital reserve is the type of reserve that is created from capital profits.
- The purpose for which a capital reserve is created is for preparing the company for sudden events like inflation, business expansion, funds for a new project.
- A capital reserve is created from capital profit earned through sales of capital assets such as the sale of fixed assets, profit on the sale of shares.
- The special property of capital reserve is that these are permanently invested and cannot be used for any other purpose apart from which it is created.
Q11 Give four examples each of ‘revenue reserve’ and ‘capital reserves’. Ans: Four examples of revenue reserve are given below:
1. General Reserve
2. Retained Earnings
3. Dividend Equalization Reserve
4. Debenture redemption ReserveFour 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.Q12 Distinguish between ‘general reserve’ and ‘specific reserve’. Ans: General Reserve Specific Reserve - A reserve created without any specific purpose.
- These Can be utilized on whichever purpose necessary for business.
- Some examples are Fund reserves, retained earnings.
- Reserve created with a specific purpose
- It needs to be used only for the purpose it is created
- Some examples are Dividend equalisation reserve, Debenture redemption reserve etc.
Q13 Explain the concept of ‘secret reserve’. Ans: Secret reserve is the amount by which the assets of an organization are understated or its liabilities are overstated. An entity might establish a secret reserve for competitive reasons, to hide from other businesses that it is in a better financial position than appears in its financial statements.