## Saturday, April 24, 2021

### Depreciation Methods

Depreciation Methods

1996 Qn. Enumerate the methods of calculating Depreciation. Discuss the merits and limitations of these methods  - 20 marks

Ans:

1.       Straight Line Method / Fixed Installment Method

·         Fixed Percentage throughout the life of Asset

·         Fixed Amount throughout the Life of Asset

·         Easy to calculate

Calculation:

·          Depreciation  = Cost of Asset –Scrap value (estimated) / Estimated Life

·         Example:  Building cost – 10 lacs,  Life – 50 years , Scrap value at the end of life – 2 lacs

·         Depreciation per year = 10,00,000 – 2,00,000 / 50  = Rs. 16000

Merits:

·         Calculation of Depreciation is Simple and easy to understand

·         Depreciation burden on Profit and Loss Account equally throughout the life of the Asset

·         Asset can be completely written off.

·         Suitable for the Assets having fixed working life.

Limitations:

·         Actual use of the asset is not considered.

·         Ignores the Interest factor.  That means not take into the account, the loss of interest on the amount invested in the Asset.

·         With the passage of time, the cost of maintenance of an asset goes up.  So initially the maintenance and depreciation together is less and goes up year after year.  So, the burden on the Profit and Loss account is uneven.

·          Difficult to assess the life of the Asset and Scrap value at the end of the life.  So, only estimated life and estimated scrap may not correct.

2.       Written Down Value (WDV) Method / Diminishing Balances Method:

·         Rate of percentage is fixed.

·         But, the Asset value is decreased year by year due to charging the Depreciation (duly deducting from the Asset value)

·         Though the percentage is fixed, but the Depreciation is calculated on the written down value of the Asset.

·         Useful for Assets like Buildings & Machinery, where the Repairs are required more due to passage of the time.

Example:

Cost of the Building is Rs. 10 Lacs.  Estimated Life of Asset is 50 years.

Depreciation for the 1st year =  Rs. 10,00,000 / 50  = Rs. 20,000

Depreciation for the 2nd year = Rs. 9,80,000 / 50 = Rs. 19,600  ( Rs. 9,80,000 = Rs. 10,00,000 – Rs.20,000)

Depreciation for 3rd year = Rs. 9,60,400 /50 = 19,208 (Rs. 9,60,400 = Rs. 9,80,000 – Rs.19,600)

It is goes on till 50th year.

Merits:

·         Equally charged to Profit & Loss Account.  Because initially Depreciation is high and repairs are low. When Asset becomes older, Depreciation is low and the repairs are high.  So equally burdened throughout the life of the Asset.

·         Very logical because in the earlier years, the Asset is more productive and yields the better results compared to the later years.   So Depreciation too initially more and gradually reducing along with the passage of the time.

Limitations:

·         Assets cannot be completely written off.  But the balance lying at the end of life is negligible and can be charged to Profit and Loss Account of the last year.

·         Like Straight Line method, this method too ignores the Interest factor.

·         Actual usage of Asset is ignored.

3.       Annuity Method

·         Takes into the account the interest lost on the acquisition of the Asset (which is ignored in the previous two methods)

·         Interest is calculated on the book value of Asset and the same is debited to Asset Account and credited to Interest Account.

·         The Depreciation is based on the Interest rate and the life of the Asset and will be calculated with the help of Annuity Tables.

Example:  A lease is purchased on 1.1.2020 for 5 years at a cost of Rs. One Lac.  It is proposed to depreciate the Lease by Annuity method charging 12 %, one must write off a sum of Rs. 0.277410 for every Re One.

Calculation of Depreciation for 1st year =  Rs. 1,00,000 x 0.277410 = Rs. 27741

Calculation of Interest for 1st year = Rs. 1,00,000 x 12 % = Rs. 12000

At the end of First year, Rs. 1,00,000 – Rs. 27,741 + Rs.12,000 = Rs. 84259

Calculation of Depreciation for 2nd year = Rs. 27,741 (no change.  It is fixed throughout the life of the Asset)

Calculation of Interest for 2nd year = Rs. 84,259 x 12 % = 10,111

At the end of 2nd year = Rs.84,259 – Rs. 27,741 + 10,111 = 66,629

So, it is goes on till the completion of the Fifth year.

Merits:

·         This Method is scientific, because the depreciation is ascertained from the Annuity Tables duly taking the Interest foregone.

·         Provides recovery of invested Capital along with the Interest.   This is lack of the earlier two methods.

·         Suitable to such Assets which requires heavy investments initially.

Limitations:

·         Calculation of Depreciation becomes very difficult when additions are made to the Assets.

·         Calculation of Interest rate is arbitrary.

·         Not suitable for the Assets whose value is small.

·         Depreciation (which is fixed) and Interest (which is calculated on the diminishing value of Asset) are not uniform.

4.       Depreciation Fund Method:

·         This method is more realistic compared to previous methods. Because it provides the ready cash to the Company to replace the Asset at the end of life of Asset without any difficulty.

·         The amount written off as Depreciation should be kept aside and invested in readily saleable securities, preferably Govt Securities. With the accumulated securities, the company is able to replace the Asset at the end of life of the Asset.

·         Here, the Depreciation is not credited to the Asset Account.  Instead it is credited to Depreciation Fund Account

·         Journal entries are as follows

A.      Depreciation A/c  Dr    100

To Depreciation Fund A/c   100

B.      Depreciation Fund Investments A/c   Dr 100

To Bank A/c                                                                        100

C.      Interest on Depreciation Fund Investments A/c Dr   10

To Depreciation Fund Investments A/c          10

·         Depreciation Fund Investments A/c shown on Assets Side

·         Depreciation Fund A/c shown on Liabilities side

·         The Asset continues to be shown at its original cost in the Balance sheet during its life period.

5.       Insurance Policy Method:

·         Instead of amount invested in Securities under Depreciation Fund method, a Insurance premium paid to cover the value of the Asset.

·         The Asset continues to be shown at its original cost in the Balance Sheet during its life period

·         The journal entries are

A.      Depreciation Insurance policy A/c  Dr 100

To Bank A/c                                                        100

B.      Profit & Loss A/c Dr   100

To Depreciation Reserve A/c 100

6.        Sum of Digits Method

Example:  Machine purchased at a cost of Rs. 10000.  Life is 5 years.

Formulae of Depreciation = Remaining life of the Asset / Sum of the digits of the life in years x cost of Asset

= 5/(1+2+3+4+5) x 10000

= 5/15 x 10000

= 3333

Second Year Depreciation calculation

= 4/(1+2+3+4)  x (10000-3333)

= 4/10 x 6667

= 2667

7.       Revaluation Method:

·         Very easy method. No formulas, no calculation specially.

·         Useful for small items like cattle, loose tools.  It’s not useful to maintain an account for single item.

·         At the end of year, the asset value is revalued and the difference between Opening Value and Revalue is charged as Depreciation in the Profit and Loss account.

·         Example:  Loose tools opening balance on 1.4.2019 is Rs. 10000.  On 31.03.2020, the same asset is revalued at Rs. 7500.  The difference Rs. 2500 was charged as Depreciation to Profit and Loss Account for the year ending 31.3.2020.

·         Merits and Limitations are not much. Just this method is useful for small assets like cattle, loose tools etc.

8.       Depletion Method:

·         Used for Quarries, Mines etc

·         Depreciation is calculated as per actual tonne of output

·         Example:

A Mine is purchased for Rs. 1,00,000.  Estimated Total quantity is 100 Tonnes.

Estimated Depreciation per Tonne = 100000/100 = Rs.1000

In 2019-20, the output is 5 Tonnes, the Depreciation = 5 x 1000 = Rs. 5000.9

9.       Machine Hour Rate Method:  (2004 -5 marks)

·         It is similar to Depletion method.

·         Depreciation is calculated based on the Number of machine hours used in that particular year.

Example:

An Machine is purchased at the cost of Rs. 1,00,000 /-.  Estimated Machine hours during its life is 10000.

Hence Depreciation per hour = 100000/10000 = Rs. 10

In 2019-20, the Total machine hours used are 400, the Depreciation charged to the Profit & Loss Account in that year = 400 x Rs.10 = Rs.4000

10.   Repair Provision Method:

·         The theme of this method is, the estimated repairs during the life of the Asset also considers at the time of calculation of the Depreciation and charged Actual Repairs to the Repairs provision instead of Profit & Loss Account.

·         Example:

A Machine purchased at the cost of Rs. 1,00,000 /-.  Estimated life is 10 years. Estimated Scrap value is Rs. 10,000/-.  Estimated Repairs 5000

Depreciation& Repairs provision per year = Asset Value –Scrap Value + Estimated Repairs /No of years (life)

Depreciation& Repairs provision = 100000 – 10000 + 5000 / 10

Depreciation& Repairs Provision = 95000/10 = 9500  (Depreciation = 9000 & Repairs =500)

The Journal entry should be

Depreciation A/c Dr 9500

To Machinery A/c  9000

To Repairs Provision A/c  500

When Actual Repairs incurred

Repairs Provision A/c   Dr 300

To Bank A/c                     300

·         The Actual Repairs, if any, not charged to Profit & Loss Account, but to Repairs Provison A/c

*****

## Tuesday, April 20, 2021

### Differences between Receipts & Payments Account and Income & Expenditure Account

Differences between Receipts & Payments Account and Income & Expenditure Account

(1996 – 10 Marks)

 SN Basis Receipts & Payments A/c Income & Expenditure A/c 1 Nature It is a Statement (emerged from Cash Book summary), not an account emerged out of Double Entry system. It is an Account emerged out of Double Entry system 2 Similar to Cash Book / Cash Account Profit & Loss Account 3 Basis Cash Basis Mercantile / Accrual 4 Period Previous years, Current year & Next year Current year only 5 Outstanding / Prepaid  Expenses & Incomes Not considered Considered 6 Accounts All Three accounts such as, Personal Account, Real Account & Nominal Account Nominal Account only 7 Revenue & Capital Revenue and Capital transactions Revenue transactions nly 8 Transactions Cash transactions only Cash & Non Cash transactions 9 Starts with & Ends with Opening balance and Closing Balance of Cash on Hand & Cash at Bank There is no Opening balance and Closing Balance 10 Debit side Receipts Expenditure 11 Credit side Payments Income 12 Difference between two sides represents Closing balance of Cash at Hand and Cash in Bank ( Debit balance or Overdraft balance) Surplus or Deficit 13 Accompanied  by Nothing Balance Sheet

## Monday, April 19, 2021

First, let us discuss, the differences between Govt Accounts & Commercial Accounts

 GOVERNMENT ACCOUNTS COMMERCIAL ACCOUNTS 1.    Maintained on CASH basis.  It accounts Actual cash receipts and actual cash payments during the financial year. 1.    Maintained on ACCRUAL basis.   That means Accrued earnings, whether realised or not, and the liabilities incurred, whether actually disbursed or not. 2. Technically known as "FINANCIAL ACCOUNTS"    Maintained in accordance with the requirements of Government Accounts.  These accounts compiled annually for the purpose of representing a Consolidated Fund duly classified under the heads of accounts prescribed for Government accounting system. 2.  Technically knows as "CAPITAL AND REVENUE ACCOUNTS".      Facilitate a review of finances of the Railway as Commercial undertaking.  These are compiled every and included in the Annual Report of the Railway. 3. Mostly Government Accounts are maintained on Single entry system.   Note: At present, it is not in operation. All Govt organisations are maintained their accounts under Double Entry System only 3. Commercial Accounts are maintained on Double entry system. (For every Debit, there is equivalent Credit existed) 4. Government prepares Accounts of its incomings and outgoings only. (Not Profit & Loss A/c and Balance Sheet, since it is not commercial oriented) 4. Commercial firms prepares Profit & Loss A/c and Balance Sheet to know how much profit they earned during the year and what is their position (Assets and Liabilities) at the end of the year. 5. Government Accounts are designed "How little money it (Govt) need to take out of the pocket of the tax payer (citizen) in order to maintain its necessary activities i.e., welfare of the people, defence of the country etc". 5. Commercial Accounts are designed to show how much money the firm can put into the pockets of the owner/business in the form of Profit.

The Link Heads are Four.  They are 1. Demands Payable 2. Demands Recoverable 3. Traffic & 4 . Labour

 Demands Payable Demands Recoverable Traffic Labour Revenue Revenue Revenue Capital

 Demands Payable Labour Traffic Demands Recoverable Operated on Expenditure side Expenditure side Earnings side Earnings side Always having Credit balance Credit balance Debit balance Debit balance

How link is established between Govt & Commercial Accounts

 SN Receipts Amount (Rs. ) SN Expenditure Amount (Rs. ) 1 Commercial A/cs Coaching Earnings 30 1 Ordinary Working Expenses 70 Commercial A/cs 2 Goods Earnings 60 2 Appropriation to DRF 15 3 Sundry Earnings 10 3 Appropriation to Pension Fund 10 4 Gross Earnings (1+2+3) 100 4 Gross Working Expenses (1+2+3) 95 5 Suspense (Traffic & DR) - 10 5 Suspense (DP) + 5 6 Govt  A/cs Gross Receipts (4+5) 90 6 Gross Expenditure (4+5) 100 Govt.  A/cs 7 Misc Receipts 25 7 Misc. Expenditure 5 8 Total Revenue Receipts (6+7) 115 8 Total Revenue Expenditure 105

Net Receipts/Net Revenue/Surplus  = 115 -105 = 10.

The above surplus will be distributed/appropriated among various funds such as Development Fund, RRSK, Capital Fund, Debt Service Fund etc.

DEMANDS PAYABLE

·         One of the Link Heads connecting Government Accounts with Commercial Accounts

·         This is a suspense head operated under Demand No.12 N (Working expenses side)

·          It is in nature of "Sundry Creditors A/c" in commercial accounts

·         First, It records all the revenue liabilities of the month without taking into whether these are liquidated(settled) or not. Hence this Head is credited at this stage.

·         The payments towards the liquidation of above liabilities are debited to the Head "Demands Payable" and the balance represents the outstanding liabilities.

·         It is always having a Credit balance.

·         A separate account is kept for each month.  However on the recommendations of "Simplification committee on procedures in Railways Accounts", the Demands Payable Head should only be operated once towards the close of the year i.e., March to bring all unliquidated liabilities of that year into accounts of the year.

·         The object behind this practical method is "the fiscal year for the preparation of accounts is a financial year (not on monthly basis), the non - operation of the Head DP would not materially affect the Railway Accounts for first eleven months.  Hence A separate account of DP for 11 months dispensed and operated in March only in financial year.  However DP for April in subsequent year should operate only to clear the balance of previous year.

·         Journal Entries are

IN THE MONTH OF MARCH ACCOUNTS

 Date Transaction Debit Credit 31.03.2020 Revenue Demands A/c  (Say Demand No.3) Dr Rs.100 To Demands Payable A/c      Cr Rs. 100 (To bring into the account of revenue liabilities (not discharged) of last month in March A/cs)

IN THE MONTH OF APRIL ACCOUNTS

 Date Transaction Debit Credit 01.04.2020 Demands Payable A/c Rs.100 To Cheques& Bills            Cr. Rs. 100 (To account the discharging of last year (March) liabilities in April A/cs)

Ledger Account of Demands Payable A/c for the month of March, 2020

 Date Debit Amount Date Credit Amount 31.03.2020 To Balance C/d Rs. 100 31.03.2020 By Demand No. 03 Rs.100 Total Rs.100 Total Rs. 100 01.04.2020 By Balance C/d Rs. 100

*****

Demands Recoverable

Introduced from 01.04.1988.

Purpose: to bring to account all dues pertaining to Rent/lease of Railway Land and Buildings and Interest and Maintenance Charges of Sidings.

When the amounts due for Railway has been raised in the form of Bills – Debited to Demands Recoverable and Credited to Abstract Z earnings.

On the receipt of remittance from the parties – Debited Cash A/c (RIB) and Credited to Demands Recoverable.

Journal Entries:

 Date Transaction Debit Credit 01.04.2010 Demands Recoverable A/c   Dr Rs.100 To Abstract Z (Sundry Earnings)        Cr. Rs. 100 (Raising bills for amounts due to Railways)

 Date Transaction Debit Credit 20.04.2010 RIB - Remittance Into Bank  A/c  Dr Rs.50 To Demands Recoverable            Cr. Rs. 50 (Receipt of Cash from the parties)

Ledger Account of Demands Recoverable A/c for the month of April, 2010

 Date Debit Amount Date Credit Amount 01.04.2010 To Abstract Z (Sundry Earnings) A/c Rs. 100 20.04.2010 By RIB  A/c Rs.50 30.04.2010 By Balance C/d Rs.50 Total Rs. 100 Total Rs. 100 01.05.2010 To Balance B/d Rs. 50

Closing Balance of D.R.: Represents unrealized amount in the form of outstanding “Demands Recoverable”

Examples: A. Land rent charges for engineering and commercial plots. B. Interest, maintenance charges & Inspection charges for sidings. C. Rent of Buildings & D. Maintenance charges for ROBs, FOBs and level crossings.

These are form a part of Sundry earnings (Abstract Z)

Clearance under the “Demands Recoverable” leads to reduction in Traffic Suspense.  Thus resulting in Better operating Efficiency.

It is always having Debit Balance.

Traffic A/c

Link Head connecting Govt Accounts and Commercial Accounts.  It is in nature of "Sundry Debtors A/c" in commercial accounts

      Debtor - All earnings (Local & Through)

      Creditor - All Recoveries for such earnings

      Balance: Unrealized earnings  - Always Debit balance

      OB - Previous Month's CB

Specimen Journal entries

 Date Transaction Debit Credit 01.01.2020 Traffic A/c Dr Rs.200 To Coaching Earnings A/c      Cr Rs. 200 (Being accounted the earnings for which realisation is due)

 Date Transaction Debit Credit 25.01.2020 Remittance Into Bank (RIB) A/c Dr Rs.150 To Traffic A/c                                 Cr Rs. 150 (Realisation of earnings due)

Ledger Account of Traffic A/c for the month of January, 2020

 Date Debit Amount Date Credit Amount 01.01.2020 To Coaching Earnings A/c Rs. 200 25.01.2020 By RIB A/c Rs. 150 31.01.2020 By Balance b/d Rs.50 Total Rs. 200 Total Rs. 200 01.02.2020 To Opening Balance Rs. 50

·         So, Traffic Account, being a Suspense account operated on Earnings side is always shows a Debit Balance.

####

Labour Account

First stage:

The amount on account of Labour should be debited to "WMS Account" by credit to 'Labour Suspense'   - in Capital JV

 Date Transaction Debit Credit 28.01.2020 WMS A/c                          Dr Rs.200 To Labour Suspense            Cr Rs. 200 (Being the details posted from Labour schedule)

Second stage:

The Muster Rolls/ Labour Pay sheets having been passed for payment and debited to 'Labour Suspense'  -   in CO7s

 Date Transaction Debit Credit 29.01.2020 Labour Suspense A/c       Dr Rs.200 To Cheques & Bills                                 Cr Rs. 200 (Being posted from the various Abstract of Bills {CO 7s) passed  For the month)

Ledger Account of Labour Suspense A/c for the month of January, 2020

 Date Debit Amount Date Credit Amount 29.01.2020 To Cheques & Bills A/c Rs. 190 28.01.2020 By WMS A/c Rs.200 31.01.2020 To Balance c/d Rs. 10 Total Rs. 200 Total Rs. 200 01.02.2020 By Opening Balance Rs. 10

**