Railway Accounts Department Examinations

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

 

Fixed Cost and its importance in BEP

 

Fixed Cost & its importance in BEP

 

·         Meaning:  A cost does not change with an increase or decrease in the Goods produced.

 

·         In General, companies can have two types of costs, i.e., Fixed Costs and Variable Costs.

 

·         Also called as Indirect cost or Overhead costs.

 

·         Examples:  Lease Rentals, Salaries, Insurance, Taxes, Interest expense, Depreciation etc.

 

·         All Sunk costs are Fixed Costs.  But, all fixed costs are not sunk costs..

 

·         Sunk cost: Money that has already been spent and which cannot be recovered.  Examples are Machinery Cost, Lease expense, etc.

 

·         A fixed cost per unit is always variable; Whereas Variable cost per unit is always fixed.

 

·         Segregation of Total Costs into fixed Costs and Variable costs helps the Management to decide the scale of Production and Breakeven analysis. 

 

·         Example: A company Produces Pens.  Their fixed costs are Rs. 10000 and Variable costs are Rs. 10 per Pen.  Find the Total cost for 100 Pens and 200 Pens.

100 Units

Costs

No of Pens

Rate per Unit

Total

Fixed

100

100

10000

Variable Costs

100

10

1000

Total costs

100

110

11000

Selling Price

100

120

12000

Profit

100

10

1000

 

200 Units:

Costs

No of Pens

Rate per Unit

 

Fixed

200

50

10000

Variable Costs

200

10

2000

Total

200

60

12000

Selling price

200

120

24000

Profit

200

60

12000

 

·         From the above, the Fixed Cost per Unit is changed from Rs. 100 to Rs.50 when Production was increased from 100 units to 200 Units.  Whereas, Variable cost is remain fixed though production was increased from 100 units to 200 units.

 

So, when change in the Production:

 

·         Fixed cost per unit is variable  (though Total Fixed cost is fixed)

 

·         Variable cost per unit is fixed. (though Total Variable cost is variable)

 

·         The segregation of Total costs into Fixed Costs and Variable costs helps the firms to analyze the breakeven analysis. (Where there is no profit, no loss) and increase their profit capacity.

BEP –Break Even Point = Fixed Costs / Sales Price per Unit – Variable Cost per unit

·         In above example 100 units production level, BEP is 10000/120 – 10 = 91 Units.  

 

·         That means at the point of 91 units, there is no profit or no loss.

 

At 91 units

 

Costs

No of Pens

Rate per Unit

 

Fixed

91

109.90

10000

Variable Costs

91

10

910

Total

91

119.90

10911

Selling price

91

120

10920

Profit

91

0.10

9

 

Profit Rs.9 is almost negligible.  Hence at the production of 91 units, there is no profit, and there is no loss.   So Break Even Point (BEP) is 91 units

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