This note is designed by the ‘Basics in Maths’ team. These notes to do help the TS intermediate second-year Accountancy students.
These notes cover all the topics covered in the TS I.P.E second year Accountancy syllabus and concept to help you solve all the types of Inter Accountancy problems asked in the I.P.E and entrance examinations.
DEPRECIATION: It is a permanent, continuous and gradual shrinking in the book value of a fixed asset.
DEPLETION: It refers to the physical deterioration by the exhaustion of natural resources. (e.g. ore deposits in mines, oil wells, quarries, etc.,)
FIXED INSTAL MENT METHOD: A method under which the depreciation provided annually on the fixed asset remains the same throughout the life span of the asset.
NONCASH EXPENSE: Expenses that may be operational in nature but that do not affect the payment of cash (e.g. depreciation).
OBSOLESCENCE: diminution in the value of fixed assets due to new inventions, new improvement, change in fashions, change in customer’s tastes and preferences.
RESIDUAL VALUE (scrap value): The realisable value of fixed assets after the expiry of its estimated economic life.
SINKING FUND: A fund created for the repayment of along-term liability or the replacement of an asset at a set date in the future.
DEPRECIATIONFUND: A fund created for the replacement of an asset at a set date in the future.
WRITTEN DOWN VALUE: The value of a fixed asset after depreciation.
WRITTEN DOWN VALUE METHOD: A method under which depreciation is calculated at a fixed percentage on the original cost of the asset in the first year and on written down value in the subsequent year.
DOUBLE ENTRY SYSTEM: The accounting system of recording both the receiving (debit) and giving (credit) aspects of a business transaction is called a double-entry system.
SINGLE ENTRY SYSTEM: It is a mixture of a double-entry, single entry and no entry. It is an incomplete double-entry system.
STATEMENT AFFAIRS: To find out capital, a statement showing various assets and liabilities of a business concern is prepared on a particular date, which is called a statement of affairs. It is similar to a balance sheet.
CAPITAL COMPARISON METHOD: Under this method, the profit/ loss for a particular period is ascertained by comparing the closing capital of the opening capital.
Meaning of depreciation
Depreciation means a fall in the value or quality of an asset. The word depreciation is derived from the Latin word “depretium”. ‘De’ means decline and ‘pretium’ means price. it is the decline in the price or value of the fixed assets. Depreciation is described as a permanent, continuing and gradual shrinkage in the value of fixed assets. It is based on the cost of the asset consumed in a business and not on its market value.
The depreciation is that part of the original cost of a fixed asset that is consumed during its period of use by the business. Thus, depreciation is the loss of value of a fixed asset arising from use, effluxion of time or obsolescence. Depreciation sometimes restricted to fixed tangible assets but in the UK, it also usually includes the amortization of intangible assets. However, the tangible fixed assets lose their value over a period of time as they are used in the business operation and they do not last forever. If any amount is received on the sale of the fixed asset is deducted from the cost of it. Then the remaining value of the fixed asset is said to have” depreciated value” by that amount over its period of usefulness to the business.
For example, if a motor vehicle was bought for Rs 100000 and it was sold 5 years later for Rs 10000. It means the motor van value has depreciated over the period of its use by Rs 90000. Therefore, the depreciation for each year will be estimated while the fixed asset continues to be useful and be charged(debited) to the profit and loss account. Since depreciation is treated as a business expense and charged to the profit and loss account, it reduces the net profit of the business and the value of the asset.
DEFINITIONS OF DEPRECIATION
According to the American institute of certified public accountants (AICPA-USA),” depreciation accounting is a system of accounting while aims to distribute the cost or other basic value of a tangible capital asset, less salvage value (if any) over the estimated useful life of the asset (which may be a group of assets) in a systematic and rational manner .it is a process of allocation, not of valuation.”
SIGNIFICATION OR NEED FOR PROVIDING DEPRECIATION
- To ascertain true results of business operations: – As depreciation is treated as expenditure, it must be charged to profit and loss account against income to assets the real profit /loss of the business.
- To show the fixed asset at their original worth in the balance sheet: -If depreciation is not provided, the value of the asset shown in the balance sheet is not correct. Hence, the real value of the asset must be shown in the balance sheet after deducting depreciation from its book value.
For example, machinery is purchased for ₹10,000, and its estimated working life is 10 years.
Then, the depreciation to be charged to the asset every year will be 10,000/10 years =1000. Though the value of the asset is depreciated by ₹1000 every year, if it is shown as ₹ 10,000 in the balance sheet, it will not reflect the real financial position of the business.
- To provide funds for the replacement of asset: – The amount charged as depreciation is nothing but setting aside a profit and this amount accumulates and will be available for replacement of the asset at the end of its useful life.
- To ascertain the true cost of production: -for calculating the cost of production, it is necessary to charge depreciation as an item of cost of production. Otherwise, it would not present true cost of production.
- To follow the legal provisions: – in the case of a joint-stock company, it is compulsory to provide depreciation on fixed assets and without providing for depreciation on fixed assets and without providing for depreciation, dividends cannot be declared to the shareholders.
CAUSES OF DEPRECIATION
1. Wear and tear: – The decrease in the value of the fixed asset due to the constant use is said to be wear and tear. It is a deterioration in an asset value, arising from its use in business operations for earnings income.
Example: Machinery, Furniture and fixtures are depreciated by wear and tear.
2 . Depletion: – It is the loss of natural resources mineral wealth due to the constant extraction of raw material from mines, quarries, oil wells etc.
3. Accidents: – The assets lose their value if it is met with an accident. An accident means the breakdown of an asset which decreases the value of assets. It is not a gradual decrease but causes a permanent loss in asset value.
4. Obsolescence: – it is the processing out of date. due to new inventions, technological improvement, availability of the better type of asset, or change in market demand the existing asset becomes obsolete or outmoded. This results in a decrease in the value of the asset.
5. Fluctuations: – the asset value may get decreased due to the fluctuations/charges in the market conditions.
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