NCERT Solutions for Class 11 Accountancy Chapter 7 Depreciation, Provisions & Reserves

Q.1 What is depreciation?

Ans.

Depreciation is decline in the value of a tangible fixed asset. In accounting, depreciation is the process of allocating depreciable cost over useful life of a fixed asset.

Q.2 State briefly the need for providing depreciation.

Ans.

Need for Depreciation:

• Matching of costs and revenue.
• Consideration of tax.
• True and fair financial position.
• Compliance with law.

Q.3 What are the causes of depreciation?

Ans.

The various causes of depreciation are:

• Wear and Tear due to use or passage of time.
• Expiration of legal rights.
• Obsolescence.
• Abnormal factors.

Q.4 Explain basic factors affecting the amount of depreciation.

Ans.

The basic factors affecting the amount of depreciation are:

• Cost of asset.
• Estimated net residual value.
• Depreciable cost.
• Estimated useful life.

Q.5 Distinguish between straight line method and written down value method of calculating depreciation.

Ans.

Q.6 “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 for charging depreciation if the management does not want to increase burden on profits and loss account of depreciation and repair, because this method results in almost equal burden of depreciation and repair expenses taken together every year on profit and loss account. While on straight line method, the total amount charged against profit on account of depreciation and repair taken together will not be uniform throughout the life of the asset, rather it will keep on increasing from year to year.

Q.7 What are the effects of depreciation on profit and loss account and balance sheet?

Ans.

Depreciation is charged on fixed assets and is an expense for the business. It is shown on the debit side of the profit and loss account as an expense.

In the Balance Sheet, it is shown by way of deduction from the concerned asset. Hence the book value of the asset is reduced.

Q.8 Distinguish between ‘provision’ and ‘reserve’.

Ans.

Q.9 Give four examples each of ‘provision’ and ‘reserves’.

Ans.

Examples of provision:

• Provision for depreciation.
• Provision for bad and doubtful debts.
• Provision for taxation.
• Provision for discount on debtors.
• Provision for repairs and renewals.

Examples of Reserve:

• General reserve.
• Workmen compensation fund.
• Investment fluctuation fund.
• Capital reserve.
• Dividend equalisation reserve.

Q.10 Distinguish between ‘revenue reserve’ and ‘capital reserve’.

Ans.

Q.11 Give four examples each of ‘revenue reserve’ and ‘capital reserve’.

Ans.

Examples of Revenue Reserve:

• General reserve.
• Workmen compensation fund.
• Investment fluctuation fund.
• Dividend equalisation reserve.
• Debenture redemption reserve.

Examples of Capital Reserve:

• Premium on issue of share or debenture.
• Profit on sale of fixed assets.
• Profit on redemption of debentures.
• Profit on revaluation of fixed asset and liabilities.
• Profits prior to incorporation.

Q.12 Distinguish between ‘general reserve’ and ‘specific reserve’.

Ans.

When the purpose for which reserve is created is not specified called general reserve or free reserve, while Specific reserve is the reserve which is created for some specific purpose and can be utilised only for that purpose.

Q.13 Explain the concept of ‘secret reserve’.

Ans.

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

It is a reserve which does not appear in the balance sheet. It may also help to reduce the disclosed profits and also the tax liability. The secret reserve can be merged with the profits during the lean periods to show improved profits.

Q.14 Explain the concept of depreciation, what is the need for charging depreciation and what are the causes of 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 it’s market value.

Causes of Depreciation:

• Wear and Tear due to use or passage of time: Wear and tear means deterioration and the consequent diminution in an assets value, arising from its use in business operations for earning revenue. An asset deteriorates simply with the passage of time, even though they are not being put to any use.
• Expiration of legal rights: Certain categories of assets loose their value after the agreement governing their use in business comes to an end after the expiry of pre-determined period. Examples of such assets are patents, copyrights, leases etc.
• Obsolescence: It is another factor leading to depreciation of fixed assets. Obsolescence means the fact of being ‘out-of-date. It implies to an existing asset becoming out-of-date on account of the availability of better type of asset. It arises from such factors as technological changes, improvement in production methods, change in market demand for the product or service output of the asset.
• Abnormal factors: Decline in the usefulness of the asset may be caused by abnormal factors such as accidents due to fire, earthquake, floods, etc.

Need for Depreciation:

• Matching of costs and revenue: The rationale of the acquisition of fixed assets in business operations is that these are used in the earning of revenue. Every asset is bound to undergo some wear and tear and hence lose value, once it is put to use in business.
• Consideration of Tax: Depreciation is a deductible cost for tax purposes. However tax rules for the calculation of depreciation amount need not necessary be similar to current business practices.
• True and fair financial position: If depreciation on assets is not provided for, then the assets will be overvalued and the balance sheet will not depict the correct financial position of the business.
• Compliance with Law: Apart from tax regulations, there are certain specific legislations that indirectly compel some business organisations like corporate enterprises to provide depreciation on fixed assets.

Q.15 Describe in detail two methods of recording, depreciation. Also give the necessary journal entries.

Ans.

In the books of account, there are two types of arrangements for recording depreciation on fixed assets:

• Charging depreciation to asset account or
• Creating provision for depreciation/ Accumulated depreciation account.

(1) Charging Depreciation to Asset Account:

According to this, depreciation is deducted from the depreciable cost of the asset (credited to the asset account) and charged (or debited) to profit and loss account.

Journal entries under this recording method are as follows:

(2) Creating Provision for Depreciation Account/ Accumulated Depreciation Account:

This method is designed to accumulate the depreciation provided on asset in a separate account generally called ‘Provision for Depreciation’ or ‘Accumulated Depreciation’ account.

Characteristics:

Asset account continues to appear at its original cost year after year over its entire life:

Depreciation is accumulated on a separate account instead of being adjusted in the asset account at the end of each accounting period.

Following journal entries are recorded under this method:

Q.16 Explain determinants of the amount of depreciation.

Ans.

The determination of depreciation depends on three parameters, viz. cost, estimated useful life and probable salvage value.

Cost of Asset:

Cost (original or historical asset) of an asset includes invoice price and other costs, which are necessary to put the asset in use or working condition. Besides the purchase price, it includes freight and transportation cost, transit insurance, installation cost, registration cost, commission paid on purchase of asset add items such as software, etc.

Estimated Net Residual Value:

Net Residual value (also known as scrap value or salvage value for accounting purpose) is the estimated net realizable value (sale value) of the asset at the end of its useful life. The net residual value is calculated after deducting the expenses necessary for the disposal of the asset.

Depreciable cost of an asset is equal to its cost less net residual value.

Estimated useful life of Asset: Useful life of an asset is estimated in terms of number of years, it can be effectively used for business operations. For example, if a machine can work for 25 years but is likely to become obsolete in 15 years on account of availability of a better type of machine due to improved technology, its useful life will be considered as only 15 years.

Useful life depends up on the following factors:

• Pre-determined by legal or contractual limits, e.g. in case of leasehold asset, the useful life is the period of lease.
• The number of shifts for which asset is to be used.
• Repair and maintenance policy of the business organisation.
• Technological obsolescence.
• Innovation/improvement in production method.
• Legal or other restrictions.

Q.17 Name and explain different types of reserves in details.

Ans.

A reserve is created by retention of profit of the business can be for either a general or a specific purpose.

General Reserve: When the purpose for which reserve is created is not specified, it is called General Reserve. It is also termed as free reserve because the management can freely utilize it for any purpose. General Reserve strengthens the financial position of the business.

Specific Reserve: Specific reserve is the reserve, which is created for some specific purpose and can be utiised only for that purpose. Examples of specific reserves are:

Dividend equalisation reserve: This reserve is created to stabilize or maintain dividend rate. In the year of high profit, amount is transferred to Dividend Equalisation reserve and in year of low profit, this amount is used to maintain the rate of dividend.

Workmen Compensation Fund: It is created to provide for claims of the workers due to accident, etc.

Investment fluctuation fund: It is created to make for decline in the value of investment due to market fluctuations.

Debenture Redemption reserve: It is created to provide funds for redemption of debentures.

Reserves are also classified as revenue and capital reserves according to the nature of the profit out of which they are created.

Revenue Reserves: These are created from revenue profits which arise out of the normal operating activities of the business and are otherwise freely available for distribution as dividend. Examples of Revenue reserves are:

• General Reserve;
• Workman Compensation fund;
• Investment fluctuation fund;
• Dividend equalisation reserve.
• Debenture redemption reserve.

Capital Reserves: These are created out of capital profits which do not arise from the normal operating activities. These reserves can be used for writing off capital losses or issue of bonus shares in case of a company.

Examples are:

• Premium on issue of shares or debentures.
• Profit on sale of fixed assets.
• Profit on redemption of debentures.
• Profit on revaluation of fixed asset and liabilities.
• Profits prior to incorporation.
• Profits on reissue of forfeited shares.

Q.18 What are ‘provisions’? How are they created? Give accounting treatments in case of provision for doubtful debts.

Ans.

According to the Companies Act, Provision refers to the amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or the amount retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.

Examples of provisions:

• Provision for depreciation of assets.
• Provision for taxation.
• Provision for bad and doubtful debts.
• Provision for discount on debtors.
• Provision for repairs and renewals of assets.

Accounting treatment for provisions:

When business transaction takes place on credit basis, debtors account is created and its balance is shown on the asset-side of the balance sheet.

For creating a provision for doubtful debts the journal entry is:

Q.19 Ganga Ltd. purchased a machinery on January 01, 2014 for 5,50,000 and spent 50,000 on its installation. On September 01, 2014 it purchased another machine for 3,70,000. On May 01, 2015 it purchased another machine for 8,40,000 (including installation expenses).

Depreciation was provided on machinery @10% p.a. on original cost method annually on December 31. Prepare:

1. Machinery account and depreciation account for the years 2014, 2015, 2016 and 2017.
2. If depreciation is accumulated in provision for Depreciation account then prepare machine account and provision for depreciation account for the years 2014, 2015, 2016 and 2017.

Ans.

(a)

Note: As per the solution, the balance of machine account, as on 01/01/2015 is 12,22,667; whereas, as per the textbook, the balance is 12,22,666.

(b)

Note: As per the solution, the balance of provision for depreciation account, as on 01/01/2015 is 5,87,333; whereas, as per the textbook, the balance is 5,87,334.

Q.20 Azad Ltd. purchased furniture on October 01, 2014 for 4,50,000. On March 01, 2015 it purchased another furniture for 3,00,000. On July 01, 2016 it sold off the first furniture purchased in 2014 for 2,25,000. Depreciation is provided at 15% p.a. on written down value method each year. Accounts are closed each year on March 31.

Prepare furniture account, and accumulated depreciation account for the years ended on March 31, 2015, March 31, 2016 and March 31, 2017. Also give the above two accounts if furniture disposal account is opened.

Ans.

Working Note:

Note: As per the solution, the loss on sale of furniture is 1,15,544 whereas, as per the textbook, the balance is 1,15,546.

As per the solution, the balance of provision for depreciation accounts is 85,960 whereas, as per the textbook, the balance is 85,959.

Q.21 M/s Lokesh Fabrics purchased a Textile Machine on April 01, 2011 for 1,00,000. On July 01, 2012 another machine costing 2,50,000 was purchased. The machine purchased on April 01, 2011 was sold for 25,000 on October 01, 2015. The company charges depreciation @ 15% p.a. on straight line method.

Prepare machinery account and machinery disposal account for the year ended March 31, 2016.

Ans.

Q.22 The following balances appear in the books of Crystal Ltd. on Jan 01, 2015:
Machinery account on: 15,00,000;
Provision for depreciation account: 5,50,000

On April 01, 2015 a machinery which was purchased on January 01, 2012 for 2,00,000 was sold for 75,000. A new machine was purchased on July 01, 2015 for 6,00,000. Depreciation is provided on machinery at 20% p.a. on straight line method and books are closed on December 31 every year.

Prepare the machinery account and provision for depreciation account for the year ending December 31, 2015.

Ans.

Working Note:

Depreciation charged on 2,00,000 of machinery in past three years:

2012 @ 20% = 40,000

2013 @ 20% = 40,000

2014 @ 20% = 40,000

2015 @ 20% = 10,000 (for three months)

Total Depreciation Charged = 1,30,000

Cost of machine on April 1, 2015 = (2,00,000 – 1,30,000) = 70,000

Profit on sale of machine = 75,000 – 70,000 = 5,000

Q.23 M/s Excel Computers has a debit balance of 50,000 (original cost 1,20,000) in computers account on April 01, 2010. On July 01, 2010 it purchased another computer costing 2,50,000. One more computer was purchased on January 01, 2011 for 30,000. On April 01, 2014 the computer which was purchased on July 01, 2010 became obsolete and was sold for 20,000. A new version of the IBM computer was purchased on August 01, 2014 for 80,000. Show computers account in the books of Excel Computers for the years ended on March 31, 2011, 2012, 2013, 2014 and 2015. The computer is depreciated @10% p.a. on straight line method basis.

Ans.

Note:

The answer given in the textbook, the closing balance as on 31^st March, 2015 is 83,917 but as per the solution the correct closing balance as on 31^st March, 2015 is 91,917.

Q.24 Carriage Transport Company purchased 5 trucks at the cost of 2,00,000 each on April 01, 2011. The company writes off depreciation @20% p.a. on original cost and closes its books on December 31, every year. On October 01, 2013 one of the trucks is involved in an accident and is completely destroyed.

Insurance company has agreed to pay 70,000 in full settlement of the claim.

On the same date the company purchased a second hand truck for 1,00,000 and spent 20,000 on its overhauling.

Prepare truck account and provision for depreciation account for the three years ended on December 31, 2013. Also give truck account if truck disposal account is prepared.

Ans.

Working Note:

Cost of truck at disposal:

= 2,00,000 – 1,00,000 = 1,00,000

Profit or Loss on sales of truck:

= 1,00,000 – 70,000 = 30,000 (Loss)

Q.25 Saraswati Ltd. purchased machinery costing 10,00,000 on January 01, 2011. A new machinery was purchased on 01 May, 2012 for 15,000 and another on July 01, 2014 for 12,00,000. A part of the machinery which originally cost 2,00,000 in 2011 was sold for 75,000 on October 31, 2014.

Show the machinery account, provision for depreciation account and machinery disposal account from 2011 to 2015 if depreciation is proved at 10% p.a. on original cost and account are closed on December 31, every year.

Ans.

Working Note:

Computation of Profit or Loss on Disposal:

Total Depreciation charged on Machine till Oct 1, 2014:

20,000 + 20,000 + 20,000 + 16,667 = 76,667

(2011) (2012) (2013) (2004 Oct)

Value of Machine ob Oct 1, 2014:

= 2,00,000 – 76,667 = 1,23,333

Loss on Sale of Machine:

= 1,23,333 – 75,000 = 48,333 (Loss)

Note: As per the solution, the balance of Machinery Disposal Account transferred to Profit and Loss Account is 48,333; however, as per the textbook the answer is 58,333.

Q.26 On October 01, 2010, a truck was purchased for 8,00,000 by Laxmi Transport Ltd. Depreciation was provided at 15% p.a. on the diminishing balance basis on this truck. On December 31, 2013 this truck was sold for 5,00,000. Accounts are closed on 31^st March every year.

Prepare a Truck Account for four years.

Ans.

Q.27 Kapil Ltd. purchased a machinery on July 01, 2011 for 3,50,000. It purchased two additional machines on April 01, 2012 costing 1,50,000 and on October 01, 2012 costing 1,00,000. Depreciation is provided @10% p.a. on straight line basis. On January 01, 2013 first machinery become useless due to technical changes. This machinery was sold for 1,00,000.

Prepare machinery account for 4 years on the basis of calendar year.

Ans.

Q.28 A Noida based Construction Company owns 5 cranes and the value of this asset in its books on April 01, 2017 is 40,00,000. On October 01, 2017 it sold one of its cranes whose value was 5,00,000 on April 01, 2017 at a 10% profit. On the same day it purchased 2 cranes for 4,50,000 each.

Prepare cranes account. It closes the books on December 31 and provides for depreciation on 10% written down value.

Ans.

Q.29 Shri Krishan Manufacturing Company purchased 10 machines for 75,000 each on July 01, 2014. On October 01, 2016 one of the machines got destroyed by fire and an insurance claim of 45,000 was admitted by the company. On the same date another machine is purchased by the company for 1,25,000.

The company writes off 15% p.a. depreciation on written down value basis. The company maintains the calendar year as its financial year. Prepare the machinery account from 2014 to 2017.

Ans.

Working Note:

Cost of Machine as on 1 Jan, 2016 is (5,89,687 /10) = 58,968.8 i.e. 58,969

Loss on Sale of Machine = 58,969 – (Depreciation = 6,634 – Claim = 45,000) = 7,335

Note: As per the solution, the loss on settle of insurance claim is 7,335; however, the answer given in the textbook is 7,735.

As per the solution, the balance on machine account is 4,85,708; however, the answer given in the textbook is 4,85,709.

Q.30 On January 01, 2014 a Limited Company purchased machinery for 20,00,000. Depreciation is provided @15% p.a. on diminishing balance method. On March 01, 2016 one fourth of machinery was damaged by fire and 40,000 wer received from the insurance company in full settlement.
On September 01, 2016 machinery was purchased by the company for 15,00,000.
Write up the machinery account from 2016 to 2017. Books are closed on December 31, every year.

Ans.

Working Note:

Q.31 A Plant was purchased on 1^st July, 2015 at a cost of 3,00,000 and 50,000 were spent on its installation. The depreciation is written off at 15% p.a. on the straight line method. The plant was sold for 1,50,000 on October 01, 2017 and on the same date a new Plant was installed at the cost of 4,00,000 including purchasing value. The accounts are closed on December 31 every year.
Show the machinery account and provision for depreciation account for 3 years.

Ans.

Q.32 An extract of Trial balance from the books of Tahiliani and Sons Enterprises on March 31, 2017 is given below:

Additional Information:
Bad debts proved bad but not recorded amounted to 2,000.
Provision is to be maintained at 8% of Debtors.
Give necessary accounting entries for writing off the bad debts and creating the provision for doubtful debts account. Also show the necessary accounts.

Ans.

Q.33 The following information are extract from the Trial Balance of M/s Nisha Traders on 31^st March 2017.

Provision is to be maintained at 2% of Debtors.

Prepare bad debts account, Provision for bad debts account and profit and loss account.

Ans.

Q.34 Discuss in detail the straight line method and written down value method of depreciation. Distinguish between the two and also give situations where they are useful.

Ans.

Straight Line method:

This method is based on the assumption of equal usage of the asset over its entire useful life. It is also called fixed installment method because the amount of depreciation remains constant from year to year over the useful life of the asset. According to this method, a fixed and an equal amount is charged as depreciation in every accounting period during the life time of an asset. The amount annually charged as depreciation is such that it reduces the original cost of the asset to its scarp value at the end of its useful life.

\begin{array}{l}\text{Depreciation:}\\ \text{=}\frac{\text{Cost of asset – Estimated net residual value}}{\text{Estimated useful life of the asset}}\end{array} \begin{array}{l}\text{Rate of Depreciation:}\\ \text{=}\frac{\text{Annual depreciation amount}}{\text{Acquisition cost}}\text{x 100}\end{array}

Written Down Value Method:

Under this method, depreciation is charged on the book value of the asset. Since book value keeps on reducing by the annual charge of depreciation. It is also known as reducing balance method.

This method involves the application of a pre-determined proportion/percentage of the book value of the asset at the beginning of every accounting period. The amount of depreciation reduces year after year.

\begin{array}{l}\text{Depreciation:}\\ \text{R =}\left[1-n\sqrt{\frac{s}{c}}\right]\text{x 100}\\ \text{Where,}\\ \text{R = Rate of depreciation}\\ \text{n = Expected useful life}\\ \text{s = Scrap value}\\ \text{c = Cost of an asset}\end{array}

Q.35 On April 01, 2010, Bajrang Marbles purchased a Machine for 1,80,000 and spent 10,000 on its carriage and 10,000 on its installation. It is estimated that its working life is 10 years and after 10 years its scrap value will be 20,000.
Prepare machine account and Depreciation account for the first four years by providing depreciation on straight line method. Accounts are closed on March 31^st every year.
Prepare Machine account. Depreciation account and Provision for depreciation account (or accumulated depreciation account) for the first four years by providing depreciation using straight line method accounts are closed on March 31 every year.

Ans.

Working notes:
Annual depreciation = 2,00,000/10 = Rs. 20,000.
Cost = 1,80,000 + 10,000 + 10,000 = Rs. 2,00,000

Q.36 On July 01, 2010, Ashok Ltd. purchased a machine for 1,08,000 and spent 12,000 on its installation. At the time of purchase it was estimated that the effective commercial life of the machine will be 12 years and after 12 years its salvage value will be 12,000.

Prepare machine account and depreciation account in the books of Ashok Ltd. for first three years, if depreciation is written off according to straight line method. The accounts are closed on December 31 every year.

Ans.

Amount to be written off = 1,08,000 + 12,000 – 12,000 = 1,08,000.

Annual amount of depreciation is equal to 1,08,000 divided by 12 which amounts to 9,000

For the first year, machine has been used for half year that’s why depreciation has been charged only 4,500

Q.37 Reliance Ltd. purchased a second hand machine for 56,000 on October 01, 2011 and spent 28,000 on its overhaul and installation before putting it to operation. It is expected that the machine can be sold for 6,000 at the end of its useful life of 15 years. More over an estimated cost of 1,000 is expected to be incurred to recover the salvage value of 6,000.
Prepare machine account and Provision for depreciation account for the first three years charging depreciation by fixed installment method. Accounts are closed on March 31, every year.

Ans.

\begin{array}{l}\text{Working Note:}\\ \text{Computation of Depreciation:}\\ \text{Cost of Machine 56,000}\\ \text{+}\text{28,000}\\ -\text{6,000 (scrap)}\\ \text{=}\text{78,000}\\ \text{+}\text{1,000 (Recover expenses)}\\ \text{=}\text{79,000}\\ \text{Depreciation =}\frac{79,000}{15}\text{=}\text{5,267}\end{array}

Q.38 Berlia Ltd. purchased a second hand machine for 56,000 on July 01, 2015 and spent 24,000 on its repair and installation and 5,000 for its cartage. On September 01, 2016, it purchased another machine for 2,50,000 and spent 10,000 on its installation.

(a) Depreciation is provided on machinery @10% p.a. on original cost method annually on December 31. Prepare machinery account and depreciation account from the year 2015 to 2018.
(b) Prepare machinery account and depreciation account from the year 2015 to 2018. If depreciation is provided on machinery @10% p.a. on written down value method annually on December 31.

Ans.

(a)

\begin{array}{l}\text{Working Note:}\\ \text{Computation on Depreciation:}\\ \text{M 1 = (56,000+24,000+5,000) @ 10\% = 8,500}\\ \text{M 2 = (2,50,000+10,000) @ 10\% = 26,000}\\ \text{Depreciation for 2015 on M 1 will be charged for half}\\ \text{year as it was purchased on 1st July,}\\ \text{i}\text{.e}\text{.,}\frac{\text{8,500}}{\text{2}}\text{= 4,250}\text{.}\\ \text{Depreciation on M 2 will be charged in 2016 for 4 months}\\ \text{only as it was purchased on 1st September:}\\ \text{=}\left[\text{26,000 x}\frac{\text{4}}{\text{12}}\right]\text{= 8,667}\end{array}

(b)