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Thread: CPT Notes - Accounts - Fundamenal of Accounting.

  1. #1
    deepika
    Guest

    Thumbs up CPT Notes - Accounts - Fundamenal of Accounting.

    fundamenal of accounting

    contents

    1. Accounting concepts, principles and conventions
    2. Meaning and scope of accounting
    3. Journal & ledger
    4. Trial balance
    5. Subsidiary books
    6. Cash book
    7. Bank reconciliation statement
    8. Bills of exchange
    9. Depreciation
    10. Rectification of errors
    11. Capital and revenue expenditure
    12. Stock valuation
    13. Consignment
    14. Joint venture
    15. Profit and loss appropriation accounts
    16. Treatment for goodwill
    17. Joint life policy
    18. Introduction to company accounts
    19. Issue of shares
    20. Issue of debentures
    21. Redemption of preference shares.

  2. #2
    deepika
    Guest

    Thumbs up Fundamenal of Accounting . Accounting Concepts, Principles and Conventions.

    Accounting Concepts, Principles and Conventions

    Accounting Concepts- Accounting concepts define the assumptions on the basis of which financial statements of a business entity are prepared.

    Accounting Principles- Accounting principles are the body of doctrines commonly associated with the theory and procedures of accounting serving as an explanation of current practices and as a guide for selection of conventions or procedures where alternative exists.

    Accounting principles must satisfy the following conditions:

    1. They should be based on real assumptions.
    2. They must be sample, understandable and explanatory.
    3. They must be followed consistently.
    4. They should be able to reflect future predictions.
    5. They should be informational for the users.

    Accounting Principles- Accounting conventions emerge out of accounting practices, commonly known as accounting principles, adopted by various organizations over a period of time. These conventions are derived by usage and practices.

    1. Entity Concept- Entity concept states that the business enterprise is a separate identity apart from its owner. Entity concept means that the enterprise is liable to the owner for capital invested by him. Capital invested by the owner is treated by the liability of the business because of this concept and owner has the claim on the profit of the business

    2. Money Measurement Concept-As per this concept, only those transactions which can be measured in terms of money are recorded. Transactions, even if they affect the results of the business materially, are not recorded if they are not convertible in monetary terms. For the examples employees of the business are the assets of the organizations but their measurement in monetary term is not possible therefore not recorded in the books of account of the organizations. This concept ignores that money is an inelastic yardstick for measurement as it is based on the implicit assumptions that purchasing power of the money is not of sufficient important as to require adjustment. Many transactions and events are not recorded in the books of accounts just because they cannot be measured in monetary terms. Therefore it is recognized by all the accountants that this concept has its own limitations and inadequacies.

    3. Periodicity Concept- This is also called the period of definite accounting period. According to this concept accounts should be prepared at the end of every accounting period. This period makes the accounting system workable and term accrual meaningful. Accounting concepts is helpful in:

    1. Comparing of financial statements of different periods
    2. Uniform and consistent accounting treatment for ascertaining the profit and assets of the company
    3. Matching periodic revenue with expenses for getting correct results of the business operations.

    4. Accrual Concepts- under accrual concept, the effects of transactions and other events recognized on mercantile basis i.e. when they occur, they are recoded whether payment has been made or not made.

    Accrual means recognition of revenue and costs as they are earned or incurred not as money is received or paid. The accrual concept relates to measurement of income, identifying assets and liabilities.

    5. Matching Concept- In this concept all expenses matched withed the revenue of that period should only be taken into consideration. In the financial if any revenue is recognized, and then expenses related to that revenue should also be recognized. It is necessary that every expense identify every income. This concept is based on accrual concept as it considers the occurrence of the expenses and income and do not concentrate on actual inflow or outflow of cash.

    6. Going Concern Concept- The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operations for the foreseeable future. The valuation of assets of the business is dependent on this assumption. Traditionally histirical cost is followed.

    7. Cost Concept- By this concept, the value of van asset is to be determined on the basis of historical cost, in other words acquisition cost. This concept is followed in the interest of objectivity.

    8. Realization Concept- It closely follows the cost concept. Any change in the value of assets is recorded only when it is realized. However under this concept all probable losses are considered any probable gain is not accounted for.

    9. Dual Aspect Concept- This concept is the core of double entry book-keeping. Every transaction or event has two aspects. It means if the enterprise acquires an asset it has to depart from another in form payment of cash or obligation to pay in future resulting increase in liability. Accounting equation is based on this concept based on which balance sheet is prepared. Accounting equation may be explained as follows:
    Assets= Capital + Liability or Assets-Capital= Liability or Assets- Liability=Capital Accounting equation suggests the fact that for every debit there is an equivalent credit.

    10. Conservatism- This concept suggests that all possible losses should be provided for but any anticipated loss should not be considered. When there are many alternative values of assets lesser value should be recorded in the books. ‘Cost price or market price whichever is lower’ is recorded in the books originated from this concept.

    For this concept there qualities are required:

    1. Prudence 2. Neutrality 3. Faithful presentation of alternative values.

    11. Consistency-In order to achieve comparability of financial statements of an enterprise through time, accounting policies are followed consistently from one period to another; a change in accounting policies are made only in exceptional cases.

    The concept of consistency is applied when accounting method of accounting is equally acceptable. For example a company can adopt straight line or diminishing balance method of depreciation. But following the principles of consistency it is advisable to follow the same method of depreciation over a period of time.

    Changes should be made only in the following cases:

    1. To bring books of accounts in accordance with the issued Accounting Standard.
    2. To compliance with the provision of law.
    3. When under changed circumstances it is felt that new method will reflect more true and fair picture it the financial statement.

    12. Materiality-This principle permits other concepts to be ignored, if the effect is considered material. This principle is an exception of full disclosure. According to this principle, all the items having significant effect on the business should be disclosed in the financial statement and any insignificant item which will only increase the work of the accountant, should not be disclosed. It is on the judgement, common sense and discretion of the accountant which item is material and which is not. For example depreciation on calculator purchased is shown 100% in the year it is purchased. This is because amount of calculator is very small to be shown in the balance sheet though it is an asset of the business.

    Fundamental Accounting Assumptions
    1. Going concern 2. Consistency 3. Accrual

    Four principal qualitative characteristics of financial statements are:

    Understandability - Relevance - Reliability - Comparability

    Other Characteristics:

    1. Materiality 2. Faithful Representation 3. Substance Over Form 4. Neutrality 5. Prudence
    6. Full, fair and adequate disclosure 7. Completeness

  3. #3
    deepika
    Guest

    Thumbs up Fundamenal of Accounting . Meaning and Scope of Accounting.

    Meaning and Scope of Accounting

    The American Institute of Public Accountants formulated definition in 1961

    Accounting is an art of recording classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the result thereof.

    Procedure of Accounting

    Recording Classifying Summarising Analysing Interpreting Communicating

    1. Recording- This is the basic function of accounting. This is the first stage of accounting. Recording is done in
    the book called ‘Journal’.

    2. Classifying

    Classification is concerned with the systematic analysis of the recorded data. The book containing classified information is called ‘ Ledger’. 3.

    Summarising- This process leads to the preparation of the following financial statements:
    i) Trial Balance ii) Balance Sheet iii) Profit & Loss A\C iv) Cash-Flow Statement

    4. Analysing- it means methodical classification of the data given in the financial statements. It is concerned with the establishment of relationship between the items of the Profit & Loss A\C and the Balance Sheet.

    5. Interpreting- This is the final function of the accounting. The recorded financial data is analysed and interpreted in a manner that will enable the end-users to make a meaningful judgment about the financial condition and profitability of the business.

    6. Communicating- It is concerned with the transmission of summarized, analysed and interpreted information to the end-users.to make them enable them to take rational decision

    Users of Accounting Information:


    Internal Users
    External Users
    Board of Directors Investors
    Partners Lenders
    Managers Suppliers
    Officers Government Agencies e.g. Income Tax
    Department
    Employees
    Customers

    Objectives of Accounting

    1. Systematic recording of transactions Journal, Ledger
    2. Ascertainment of transactions Manufacturing A\C, Trading
    A\C, Profit & Loss A\C
    3. Ascertainment of financial position of the business Balance Sheet
    4. Providing information to the users for rational decisionmaking Financial Reports
    5. To know the solvency position **************

    Functions of Accounting:

    Measurement Forecasting Decision
    Making
    Comparison
    & Evaluation
    Control Government
    Regulation &
    Control

    Book-Keeping- Book-keeping is an activity concerned with the recording of financial data relating to business
    operation in a significant and orderly manner.

    Objectives-

    Complete recording of transactions Ascertainment of financial effect on the
    transactions


    DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING


    S.no.
    Book-keeping
    Accounting
    1 It is a process concerned with recording of transaction. It is a process concerned with summarizing of the recorded transaction
    2 It is constitutes as a basic of accounting It is considered as a language of the business
    3 Financial statements do not from part of the process. Financial statements are prepared in this
    process on the basic of book-keeping records.
    4 Managerial decisions cannot be taken with the help of this record. Management takes decision on the basic of
    this record.
    5 There is no sub-field of book-keeping. It has sub-fields likes financial accounting,
    management accounting etc.
    6 Financial position of the business cannot
    be ascertained though book-keeping
    records.
    Financial position of the business is
    ascertained on the basic of the accounting
    reports.

    Sub-fields of Accounting


    1. Financial Accounting
    2. Management Accounting
    3. Cost Accounting
    4. Social Responsibility Accounting
    5. Human Resource

    Basis of selection of accounting policies:

    Prudence Substance over Form Materiality

  4. #4
    deepika
    Guest

    Thumbs up Fundamenal of Accounting - Journal & Ledger.

    JOURNAL & LEDGER

    Types of Accounts

    1. Personal Account- The accounts which are related with the persons and companies are called personal accounts. Ex. Ram A\C, Renu Pvt. Ltd. Co. etc.

    2. Real Account- Real Accounts which are related with assets (excluding debt) are called real accounts.
    Ex. Building A\C , Cash A\C , Goodwill A\C

    3. Nominal Account- The accounts which are related with expenses & losses and incomes & gains are called nominal accounts. Ex. Salary A\C, Rent A\C etc.

    Golden Rules \ Rules for Debiting and Crediting

    A. Personal Account-
    i. Debit the receiver.
    ii. Credit the giver.

    B. Real Account-
    i. Debit what comes in.
    ii. Credit what goes out.

    C. Nominal Account-
    i. Debit all expenses and losses.
    ii. Credit all incomes and gains.

    Journal-It is the book of original entry in which primary record of both aspects of a business transaction is recorded in order in which they arise i.e. in chronological order. A journal is called as books of original records or books of primary entries.

    Ledger- For each and every item or group of items of similar nature, an account is opened in a separate Book called ledger. A ledger is a set of accounts.

  5. #5
    deepika
    Guest

    Thumbs up Fundamenal of Accounting - Trial Balance.

    Trial Balance

    Trial Balance- It is a statement in which debit and credit balances of all the accounts of the ledger including cash and bank balances (taken from cash book) are shown to test arithmetical accuracy of the books of the accounts.

    Objectives-

    1. It ensures the arithmetical accuracy of the books.
    2. It helps to prepare final accounts.
    3. Some mistakes are detected by trial balance.
    4. It is just summary of the contents of the ledger.

    Errors disclosed by the Trial Balance


    1. Partial omission of posting an amount in ledger.
    2. Wrong totaling of subsidiary books.
    3. Errors in extraction of Trial Balance.
    4. Debit or credit entries are not entered at all.
    5. Same entry enters twice.
    6. Debits are entered as credits and vice-versa.
    7. Errors in calculating the balance of an account.
    8. Balance of an account entered wrongly in Trial Balance.
    9. Difference in amount between the entries.

    Errors not disclosed by the Trial Balance

    1. Errors of omission
    2. Compensating Error
    3. Errors of principles entering both aspects of transaction twice in the books of accounts.
    4. Errors in entering a transaction on the correct side of a wrong account (errors of misposting)
    5. Entering wrong account bin the books of original entry (errors of commission).

    Suspense Account- If two sides of Trial Balance do not agree, it implies that there are certain one-sided errors
    in the books of account. If it is not possible to locate the errors, the amount of difference in Trial Balance is put
    in the account known as Suspense Account. If debit side of Trial Balance exceeds the credit side the difference
    in the Trial Balance is transferred to the credit side of the Trial Balance.

  6. #6
    deepika
    Guest

    Thumbs up Fundamenal of Accounting - Subsidiary books.

    SUBSIDIARY BOOKS
    Sub-division of journal:

    1. Cash Book-All cash transactions are recorded in the cash book.
    2. Purchase Day Book-All credit purchases of goods not assets are recorded in it.
    3. Sales Day Book- All credit sales of goods not assets are recorded in it.
    4. Purchases Returns Book-Returns out of credit purchases are recorded in it.
    5. Sales Returns Book- Returns out of credit sales are recorded in it.
    6. Bills Receivable Book-Receipt of bills from debtors is recorded in it.
    7. Bills Payable Book- Issue of bill to creditor is recorded in it.

    8. Journal Proper-
    Transactions not recorded in the above books are recorded in this book. It is divided in four parts which are as follows

    i)Opening Entries ii) Closing Entries iii) Adjustment Entries iv) Rectification Entries

    Important Points:


    i) Sales tax is calculated on net price i.e. price after deduction of trade discount.
    ii) Excise duty and other local taxes are calculated on gross price i.e. the price before deduction of trade discount.

    QUESTIONS:

    1. Credit purchases of goods are recorded in the a) Cash Book b) Purchase Book c) Journal Proper Book d) Journal Book

    2. Credit sale of assets is recorded in the a) Cash Book b) Sales Book c) Journal Proper Book d) Sales Return Book

    3. Recovery of money earlier written off as bad debt is recorded in the a) Cash Book b) Journal Proper Book c) Sales Book d) Purchases Book

    4. Cash paid for return of goods is recorded in the a) Cash Book b) Return Inward Book c) Return Outward Book d) Either a or b

    5. A separate column for cash discount is prepared in the a) Purchases Book b) Sales Book c) Cash Book d) Journal Proper Book

    6. Sales tax is calculated on a) Gross Price b) Net Price c) Either a or b d) Neither a or b

    7. Excise duty is calculated on a) Gross Price b) Net Price c) Either a or b d) Neither a or b

    8. A debit note issued by us for goods return is accounted for a) Purchase Return Book b) Sales Return Book c) Journal Proper Book d) Cash Book

    9. Salary outstanding is recorded in the a) Purchase Return Book b) Sales Return Book c) Journal Proper Book d) Cash Book

    10. Cash received Rs. 1000 in full settlement of a debt of R. 1010. Discount allowed in this case recorded in the a) Purchases Book b) Sales Book c) Cash Book d) Journal Proper Book

    11. The purchase day book is a part of a) journal b) Ledger c) Trial Balance d) Balance Sheet

  7. #7
    deepika
    Guest

    Thumbs up Fundamenal of Accounting - Cash Book.

    Cash Book

    Cash Book- Cash Book is a Subsidiary Book. It is also called Primary Book. It is also called journalized ledger as it serves the purpose of the Journal and Ledger. It is a Real A\C. Inflow of cash is recorded on the debit side and outflow of cash is recorded on the credit side.

    Kinds of Cash Book
    1. Single Column Cash Book
    2. Double Column Cash Book
    3. Triple Column Cash Book

    Petty Cash Book- In big business houses under main cashier a petty cashier is appointed. He is entrusted the task of making small payments.

    Imprest Petty Cash-Under this system petty cashier is given a fixed amount to make the small payments and at the end of each month he is reimbursed the amount he has paid during the amount so that the minimum amount (called imprest amount) can be maintained.

    Contra Entries- When entries for the same transactions are recorded on the both side of the cash book, those entries are called contra entries.

  8. #8
    deepika
    Guest

    Thumbs up Fundamenal of Accounting - Bank Reconciliation Statement.

    Bank Reconciliation Statement


    Bank Reconciliation Statement-

    Important Points-

    A. Cash Book is maintained by ‘The Business’.
    Pass Book is maintained by ‘The Bank’.

    B. Cash Book debit balance means ‘Favorable Balance’.
    Cash Book credit balance means ‘Unfavorable or Overdraft Balance’.
    Pass Book debit balance means ‘Unfavorable or Overdraft Balance’.
    Pass Book credit balance means ‘Favorable Balance’.

    C. Cash Book-Debited indicates ‘Increase in Bank Bal’.
    Cash Book-Credited indicates ‘Decrease in Bank Bal’.
    Pass Book-Debited indicates ‘Decrease in Bank Bal’.
    Pass Book-Credited indicates ‘Increase’ in Bank Bal.

    There are four reasons why balance of Cash Book does not agree with the balance of Pass Book:
    1. Entries recorded in the Cash Book but not recorded in the Pass Book.
    2. Entries recorded in the Pass Book but not recorded in the Cash Book.
    3. Some wrong treatment in Cash Book.
    4. Some wrong treatment in Cash Book.

    Amended Cash Book- Sometimes before preparing B.R.S. an Amended Cash Book is prepared which gives revised bank balance as per Cash Book and with the revised bank balance B.R.S. is prepared.

    Entries to be recorded in the Amended Cash Book-

    1. Wrong entries passed in the Cash Book.
    2. Entries not recorded in the Cash Book.

  9. #9
    deepika
    Guest

    Thumbs up Fundamenal of Accounting - Bills of Exchange.

    BILLS OF EXCHANGE

    Bills of exchange- A bill of exchange is an instrument in writing containing an unconditional order signed by the maker directing a certain person to pay a certain sum of money only to or to the order of a certain person or to the bearer of the instrument.

    Features of bill of exchange

    1. It must be in writing.
    2. It must contain an order to pay which is express or unconditional.
    3. It must be signed by the drawer.
    4. The drawer, drawee and payee must be certain, definite and individual.
    5. The amount of the bill must be certain
    6. The amount must be payable to a definite person or according to his order to the bearer of the bill.
    7. The bill must be accepted by the party (drawee) on whom bill is drawn.
    8. There must be definite date of payment.
    9. It must be properly stamped and dated.
    10. It is made by the drawer.
    11. Basically there are three parties- drawer, drawee and payee.

    Promissory Notes- A promissory note is an instrument in writing, not being a bank note or a currency note containing an unconditional undertaking signed by the banker to pay a certain sum of money only to the bearer of certain person.

    Features of the promissory notes

    1. It must be in writing.
    2. It must contain clear promise to pay.
    3. The promisor, the maker must sign the promissory note.
    4. Maker must be a certain person.
    5. The payee (one who is to receive money) must also be certain person.
    6. The sum payable must be certain.
    7. Promissory note must not be payable to bearer.
    8. It must be properly stamped.
    9. There are two parties of the promissory note – maker and payee.
    10. It is made by the promisor.

    Parties of a bill of exchange
    1. Drawer- Drawer is the creditor who draws the bill. For him bill is the Bill Receivable.
    2. Drawee- Drawee is the debtor who accepts to pay the bill. For him bill is the bill payable.
    3. Endorser- Endorser is one who endorses the bill to settle his account with his creditor.
    4. Endorsee- Endorsee is one who receives the bill from the endorser.
    5. Payor- Payor is the drawee who pays the bill.
    6. Payee- Payee is one who receives the payment from the drawee. One who holds the bill at the time of maturity, receives the payment.

    Different treatment of the bill

    1.Honour of the bill- When bill is paid at the maturity, it is called honour of the bill.

    2.Dishonour of the bill
    - When bill is not paid at the maturity, it is called dishonor of the bill.

    3.Discounting of the bill
    - Sometimes holder of the bill being in need of money before the due approaches his banker to pay against the bill. Bank pays the amount of bill after deducting the interest for that period. This process of raising fund from the bank called discounting of bill.

    4.Endorsement of bill- Sometimes holder of the bill sends the bill to his creditor to pay his dues. It is called endorsement of bill.

    5.Bill sent for collection- Sometimes holder of the bill sends the bill to his banker for collection. This is called bill sent for collection. On due date bill collects the amount on behalf of the party and credits his account with the amount.

    6.Renewal of the bill- In case drawee is not able to pay the bill on the due date sometimes he requests the holder of the bill to give him further time. At his request holder of the bill sometimes cancelles the old bill and draws a new bill. It is called renewal of the bill. New bill may include interest for the further period and noting charges, if any.

    7.Retiring of the bill- Sometimes drawee having sufficient fund pays the bill before the due date. For making early payment he gets some rebate on the bill. So payment of the bill before the due date is called retiring of the bill.

    Distinguish between Bill of Exchange and Promissory Note.

    Bills of Exchange
    Promissory Note
    1.In a bill there are three parties In a promissory note there are two parties
    2. In a bill there is an unconditional order to
    pay.
    In a promissory note there an unconditional
    promise to pay.
    3. The liability of the drawer of a bill is
    secondary and conditional.
    The liability of the maker of a promissory note
    is primary and absolute.
    4. The drawer of an accepted bill stands in immediate relation with the acceptor not the payee The maker of a promissory note stands in immediate relation with the payee.
    5. A bill must be accepted by the drawee or
    someone else on behalf of the drawee.
    A promissory note does not require any
    acceptance.
    6. In a bill of exchange drawer (maker) and the
    payee may be the same person.
    In a promissory note maker and the payee will never be the same person.

    JOURNAL ENTERIES

    TRANSACTIONS
    BOOKS OF DRAWER
    BOOKS OF DRAWEE
    A. When bill is retained by
    the drawer
    1.For bill drawn
    Bills Receivable A\C Dr.
    To Drawee A\C
    Drawer A\C Dr.
    To Bills Payable A\C
    2. For interest* Drawee A\C Dr.
    To Interest A\C
    Interest A\C Dr.
    To Drawer A\C
    3. For maturity of bill Cash A|C Dr.
    Rebate on bill A\C ** Dr.
    To B\R A|C
    B\P A\C Dr.
    To Cash A\C
    To Rebate on bill A\C
    4.For dishonor of the bill Drawee A\C Dr.
    To B\R A\C
    B\P A\C Dr.
    To Drawer

    BOOKS OF BANK
    B. When bill is discounted
    5. For discounting of the bill
    Bank A\C Dr.
    Discount bon bill A\C Dr.
    To B\R A\C
    Discounting of bill A\C Dr.
    To Drawer A\C
    To Discounting Charge A\C
    6. For maturity of bill NO ENTRY Cash A\C Dr.
    To Discounting of bill
    7. For dishonor of bill Drawee A\C Dr.
    To Bank A\C
    ( including noting charge, if
    any)
    Drawer A\C Dr.
    To Discounting of bill A\C
    To Noting Charges A\C
    C. When bill is sent for
    collection
    8. For bill sent for collection
    Bill sent for collection A\C Dr.
    To B\R A\C
    NO ENTRY
    9. For maturity of bill Bank A\C Dr.
    Collection Charges A\C Dr.
    To Bill sent for collection A\C
    Cash A\C Dr.
    To Drawer A\C
    To Collection Charges A\C
    10. For dishonor of bill Drawee A\C
    To Bill sent for collection A\C
    NO ENTRY
    Books of Endorser or Drawer
    Books of Endorsee
    D. When bill is endorsed
    11. For endorsement of bill
    Endorsee A\C Dr.
    To B\R A\C
    B\R A\C Dr.
    To Endorser A\C
    12. For maturity of bill NO ENTRY Cash A\C Dr.
    To B\R A\C
    13. For dishonor of bill Drawee A\C Dr.
    To Endorsee A\C
    Endorser A\C Dr.
    To B\R A\C

    NOTES- * Interest on bill is generally added in the case of renewal of the bill.
    ** Rebate on bill is generally allowed in the case of retiring of bill.

    Some More Important Terms

    Grace Period- Additional period of three days given to the drawee to pay the bill, is called grace period.
    Noting Charges- whenever a bill is dishonored, it is the customary for the holder of such bill to have the fact of dishonor noted and certified by an officer called Notary. The charges payable to the Notary for this services is called noting or protesting charges.

    Rebate on bill- It is given to the drawee when bill is paid before the due date.

    Accomodation of bill- Generally a bill is drawn when sum is due. But sometimes a bill is drawn not to settle amount due but for the financial accommodation of the drawer as well as drawee. Then the bill is discounted, and the proceeds are utilized. Then on due date the drawer remits the fund to the drawee to honour of bill.

    Examples of Foreign Bill
    1. A bill drawn in India on a person resident outside India made payable outside India.
    2. A bill drawn outside India on a person resident outside India.
    3. A bill drawn outside India made payable in India.
    4. A bill drawn outside India and made payable outside India.

  10. #10
    deepika
    Guest

    Thumbs up Fundamenal of Accounting - Depreciation.

    DEPRECIATION

    Depreciation-Depreciation is a permanent, continuing and gradual shrinkage in the book value of a fixed asset.

    Objectives of providing depreciation
    1. Correct income measurement
    2. True financial position of business
    3. Funds for replacement of new assets
    4. Ascertainment of true cost of production

    Methods of charging depreciation

    1. Straight Line Method- Under this method depreciation is charged on original cost of the assets every year.
    Original cost includes purchase price, carriage on asset, installation cost and all other expenses regarding asset till it is installed. If the rate of depreciation is not given, depreciation is calculated as follows-

    Depreciation= Purchase Price + carriage + Installation Cost- Scrap Value (Residual Value)\ Life Of assets (No. of years)

    Features-

    1. Depreciation is charged on the original cost of the asset.
    2. Amount of depreciation remains same every same every year.
    3. Value of assets may become nil at the end of the life of the assets.
    4. Calculation of depreciation is easy.

    2. Diminishing Balance Method-Under this method depreciation is charged on the book value or written down value of assets i.e. the value cost less depreciation till last year.

    Features-1. Depreciation is charged on book value of assets.
    2. Amount of depreciation reduces every year.
    3. Value of assets never becomes nil.
    4. Calculation of depreciation is complex.

    Journal Entries


    1. For Purchase of assets
    Assets A\C - Dr.
    To Cash\ Bank\ Creditors
    2. For charging depreciation
    Depreciation A\C - Dr.
    Assets A|C
    3. For transfer of depreciation
    Profit &Loss A\C - Dr.
    To Depreciation
    4. For sale of assets
    Cash\ Bank\ Debtors A\C - Dr.
    To Assets A\C
    5. For loss on sale of assets
    Profit &Loss A\C - Dr.
    To Assets A\C
    6. For Profit on sale of assets
    Assets A\C - Dr.
    To Profit & Loss A\C

    Other Methods

    3. Sum of year’s digits method- in this method charge for depreciation for an accounting period is calculated in proportion of the remaining life of the asset at the beginning of every accounting period. Depreciation goes on decreasing every year.Formula-

    Remaining life of the asset\ sum of the digits of the life of an asset X cost of asset-scrap value

    4. Sinking Fund Method-
    Under this method annual depreciation is not deducted from asset but sinking fund is created with the annual depreciation. Apart from it amount of annual depreciation is invested every year outside the business. At the end investment is sold and the proceed is utilized to purchase a new asset to replace the old one.

    Journal Entries

    First Year-

    For annual contribution
    Depreciation A\C - Dr.
    To Sinking Fund A\C

    2. For transfer of depreciation
    Profit & loss A\C - Dr.
    To Depreciation A\C

    3. For investing amount of depreciation
    Sinking Fund Investment A\C - Dr.
    To Bank A\C

    Second Year

    For interest received
    Bank A\C - Dr.
    To Interest on SFI A\C

    For transfer of interest
    Interest on SFI A\C - Dr.
    To Sinking Fund A\C

    Note- All three entries as in case of the first year will also be passed.

    Last Year


    For sale of investment
    Bank A\C - Dr.
    To SFI A\C

    For profit
    SFI A\C - Dr.
    To Sinking Fund A\C

    For loss
    Sinking Fund A\C - Dr.
    To SFI A\C

    For sale of asset
    Bank A\C - Dr.
    To Asset A\C

    For transfer of sinking fund to asset account
    Sinking Fund A\C - Dr.
    To Asset (old) A\C
    Balance of Old Asset A\C represents profit ( credit side being higher) or loss (
    debit side being higher) which is transferred to P\L A\C.

    For purchase of new asset
    Asset (new) A\C - Dr.
    To Bank A\C

    5. Provision for Depreciation Method- Under this method depreciation is not deducted from asset a\c but it is credited to provision for depreciation a\c. Under this method asset is maintained at cost price. At the time of sale asset a\c is credited with the cost of asset sold

    Journal Entries

    For providing depreciation

    1. Depreciation A\C - Dr.
    To Provision for Depreciation A\C

    2. For transfer of depreciation
    Profit & Loss A\C - Dr.
    To Depreciation A\C

    3. For transfer of asset to asset disposal a\c
    Asset Disposal A\C - Dr.
    To Asset A\C

    4. For transfer of accumulated depreciation on asset sold to asset disposal a\c
    Provision for Depreciation A\C - Dr.
    To Asset Disposal A\C

    5. For sale of asset
    Bank A\C - Dr.

    Profit & Loss A\C (if sold at loss)Dr.
    To Asset Disposal A\C
    To Profit & Loss A\C (if sold at profit)

    Note- Asset Disposal A\C may alternatively not be opened; in that case, sale of asset will be credited to Asset A\C which will finally disclose the profit or loss.

    6. Machine Hour Method- Depreciation is calculated after estimating the total number of hours that a machine would work during the year.

    Depreciation= Cost X Total Machine Hours In a Year\Total Machine Hours in Life Time of the Machine

    7. Depletion Method-This method is used in case of mines, quarries etc. containing only a certain quantity of product.

    Depreciation= Cost X Total Quantity Extracted \ Total Quantity Stored

    8. Production Units Method-Under this method depreciation is determined based on the total production during the year.

    Depreciation= Total Cost- Scrap Value= Total Production during the year\ Total estimated production

    9. Provision for Repairs and Renewals- Under this method estimated amount pof depreciation of entire life of the asset is added to the cost of asset and then based on this figure depreciation is calculated.

    Change in the methods of depreciation

    1. Prospective Method- Under this method change is effective when and from decision of change is decided.
    2. Retrospective Method- Under this method change takes place from the very first year.

    Steps-1. First compute depreciation under new method.
    2. Then compute depreciation under old method.
    3. Deduct depreciation calculated in step 2 from the depreciation calculated in step 2; if there is any surplus that should be debited to P\L A\C and if there is any deficit that should be credited to P\L A\C.

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