FINAL ACCOUNTS IIIUSTRATIONS PART 2

Illustration 14 :

From the following transactions pass journal entries and show ledger accounts in the Books of S. Banerjee and prepare a Trial Balance.

Started business with cash Rs. 1,50,000, Goods worth Rs. 80,000, Office Equipment Rs. 70,000 and his private car worth Rs. 1,20,000 which will henceforth be used solely for business purpose.

Bought furniture worth Rs. 40,000 of which those worth Rs. 10,000 are for office use and the balance for stock. Purchased 3 motor cars worth Rs. 1,50,000 each from Ganguly & Co. for stock.

Purchased 2 motor cars worth Rs. 80,000 each from Ganguly & Co. for business use. Purchased for cash 1 motor car worth Rs. 70,000 for private use.

Returned motor cars worth Rs. 1,50,000 from stock and that worth Rs. 80,000 for business use to Ganguly & Co.

Sold office equipment for Rs. 40,000

Sold one of the motor cars for stock for Rs. 2,00,000; paid landlord Rs. 12,000 for rent. One-third of the premises is occupied by the proprietor for his own residence.

Sold the third car for Rs. 3,50,000.

  

Solution :

In the books of Mr. S. Banerjee

								Dr. (Rs.)		Cr. (Rs.)
	a)	Cash A/c					Dr.	150000
		Stock A/c					Dr.	80000
		Office Equipment A/c					Dr.	70000
		Motor car Q/c					Dr.	120000
		To capital A/c								420000
		(Sundry Assets introduced as Capital to start
		business)
	b)	Furniture A/c					Dr.	10000
		Purchase A/c					Dr.	30000
		To cash A/								40000
		(Purchase of furniture worth Rs. 40000 out of which
		Rs.10000 for office decoration and Rs. 30000 for stock)
	c)	Purchase A/c					Dr.	450000
		To Ganguli & Co.								450000
		(Purchased 3 motor cars for stock purpose)
	d)	Motor Car A/c					Dr	160000
		To Ganguli & Co.								160000
		(Purchased 2 motor cars for office use)
	e)	Drawings A/c					Dr.	70000
		To Cash A/c								70000
		(Bought 1 office car for private use)
	f)	Ganguli & Co.					Dr.	230000
		To Return outward A/c								150000
		To Motor car A/c								80000
		(Motor car worth Rs. 150000 from stock and Rs.80000
		from business use returned to Ganguli & Co.)
	g)	Cash A/c					Dr.	40000
		To Office Equipment A/c								40000
		(Office equipment worth Rs. 40000 sold)
	h)	Cash A/c					Dr.	200000
		To Sales A/c								200000
		(Being one motor car from stock sold)

	i)	Rent A/c						Dr.	8000
		Drawings A/c						Dr.	4000
		To Cash A/c							12000
		(Rent paid to landlord, 1/3 of the premises occupied
		by the proprietor for personal residence)
	j)	Cash A/c						Dr.	350000
		To Sales A/c							350000
		(Sold the third car for cash)
Dr.				Cash Account					Cr.
		Particulars		Rs.			Particulars		Rs.
To Capital				1,50,000		By Furniture			10,000
To Office Equipment				40,000		By	Purchase		30,000
To	Sales			2,00,000		By Drawing			70,000
To	Sales			3,50,000		By Rent			8,000
						By Drawings			4,000
						By Balance c/d			6,18,000
				7,40,000					7,40,000
Dr.				Stock Account					Cr.
		Particulars		Rs.			Particulars		Rs.
To Capital				80000		By Balance c/d			80000
Dr.				Office Equipment A/c					Cr.
		Particulars		Rs.			Particulars		Rs.
To Capital				70000		By Cash A/c			40000
						By	Balance c/d		30000
				70000					70000
Dr.					Motor Car A/c				Cr.
		Particulars		Rs.			Particulars		Rs.
To Capital				120000		By Ganguli & Co.			80000
“	Ganguli & Co.			160000		“	Balance c/d		200000
				280000					280000

Dr.			Furniture A/c		Cr.
	Particulars	Rs.		Particulars	Rs.
To Cash		10000	By Balance c/d		10000
Dr.			Purchase A/c		Cr.
	Particulars	Rs.		Particulars	Rs.
To Cash		30000	By Balance c/d		480000
To Ganguli & Co.		450000
		480000			480000
Dr.		Return Outward A/c			Cr.
	Particulars	Rs.		Particulars	Rs.
To	Balance c/d	150000	By	Ganguli & Co.	150000
Dr.		Ganguli & Co. A/c			Cr.
	Particulars	Rs.		Particulars	Rs.
To	Return Outward	150000	By	Purchase	450000
To	Motor Car	80000	By	Motor Car	160000
To	Balance c/d	380000
		610000			610000
Dr.		Drawings A/c			Cr.
	Particulars	Rs.		Particulars	Rs.
To	Cash	70000	By Balance c/d		74000
To	Cash	4000			.
		74000			74000
Dr.			Sales A/c		Cr.
	Particulars	Rs.		Particulars	Rs.
			By Cash		200000
To	Balance c/d	550000	By Cash		350000
		550000			550000

Dr.			Rent A/c	Cr.
	Particulars	Rs.	Particulars	Rs.
To Cash		8000	By Balance c/d	8000
Dr.		Capital A/c		Cr.
	Particulars	Rs.	Particulars	Rs.
To	Balance c/d	420000	By Cash	150000
To	Stock	80000
To	Office Equipment	70000	By Motor Car	120000
		420000		420000
		Trial Balance
			Dr.	Cr.
			Rs.	Rs.
	Cash		618000
	Stock		80000
	Office Equipment		30000
	Motor Car		200000
	Furniture		10000
	Purchase		480000
	Ganguli & Co.			380000
	Drawings		74000
	Return outward			150000
	Sales			550000
	Rent		8000
	Capital			420000
			1500000	1500000

2.5           DEPRECIATION

Depreciation is the diminution in the value of assets due to use, wear and tear and efflux of time. It is an estimated charge against profit for use of fixed assets. The provision for depreciation is to create funds for replacement of assets. It may either be written off against asset accounts or it may be Depreciation Provision Account keeping Asset Account

at cost. There are various method of depreciation, such as,–

1)       Straight-line method or Fixed instalment method - This is simple and most widely used method. An equal portion of the cost of the asset is allocated to each period of use.

2)       Diminishing/reducing value method

  

3)        Annuity method

4)        Insurance Policy

5)        Revaluation

6)        Unit charging system.

i)       Production unit.

ii)       Time unit

7)        Machine Hour Rate.

8)       Sum of the digits method. The entry for depreciation will be :–

Depreciation A/c                                                        Dr.

To Respective Asset A/c

The most commonly methods of depreciation are –

1)        Straight line method and

2)        Reducing / Diminishing value method.

For depreciation, Students are advised to go thorough

i)       International Accounting Standard - 4, and

ii)       Indian Accounting Standard - 6 for a thorough knowledge on the subject.

Methods of Calculating Depreciation

There are a number of methods of calculating depreciation on the original cost or on the replacement cost of the assets. Each method adopts one or more of the following principles —

(a)        depreciation is a function of time;

(b)        depreciation is a function of use;

(c)        depreciation is a function of time and use;

(d)        depreciation is a function of time and maintenance; and

(e)        depreciation is a function of time and interest.

Whatever method is applied in the accounts, it must be suitable to the circumstances prevailing in the organisation. The different methods are discussed as follows :

(1)        Straight line method : This is the method of providing for depreciation by means of periodic charges over the assumed or anticipated life of the asset.

Example :

If, C = Cost of the asset depreciated = Rs. 10,000. R = Residual value of the asset = Rs. 500.

n = Life of the asset = 4 years.

  

Then,

D = Proportion of cost of asset depreciated under this method

=	C − R	=	10,000 − 500	= 0.2375 or 23.75%
	n × C		4 × 10,000

So, amount of depreciation is 23.75% of Rs. 10,000 = Rs. 2,375 each year.

Proof :

Year		Cost and balance b/d	Depreciation	Balance c/f
		Rs.	Rs.	Rs.
	1	10,000	2,375	7,625
2		7,625	2,375	5,250
3		5,250	2,375	2,875
4		2,875	2,375	500

(Depreciation has been calculated to the nearest Rupee.)

Thus, by using this method an equal amount of depreciation is charged during each period, irrespective of its use. This method is simple and is usefully applied to all types of fixed assets, particularly in connection with patents, leasehold and similar assets having definite life. Its use in cost accounts affords a better comparative costs for its uniform charge. However, the total cost of depreciation and repair and maintenance costs of assets increase progressively.

(2)       Reducing balance method : This is the method of providing for depreciation by means of periodic charges calculated as a constant proportion of the balance of the asset after deducting the amounts previously provided. This is also called written down value method.

Example :

Assuming the same data as before,

D = Proportion of reducing balance of cost of asset depreciated in each period.

= 1 − ⁿ _C^R = 1 − 4 _10,000⁵⁰⁰

=   1– 0.4729

=    0.5271  or 52.71%

(if the residual value is nil, assume R =1)

  

Proof :

Year		Cost and balance b/d	Depreciation @ 52.71 %	Balance c/f
		Rs.	Rs.	Rs.
	1	10,000	5,271	4,729
2		4,729	2,493	2,236
3		2,236	1,179	1,057
4		1,057	557	500

Because of its simplicity, this method is popular and is extensively used for taxation purposes. It is observed that a heavier depreciation is borne in the earlier years when repairs are lighter, and that the increasing repair cost is counterbalanced, in later years, by the reduced annual charge for depreciation. The use of this method for costing purposes is justifiable only if its effect is to provide a uniform charge for the services of the asset throughout its life; otherwise, the cost of production in subsequent years appears to decrease, although they are produced under identical conditions.

(3)       Production unit method : This is the method of providing for depreciation by means of a fixed rate per unit of production calculated by dividing the value of the asset by the estimated number of units to be produced during its life.

Example :

Assuming C and R to have the same value as before

and	NU =  Estimated units to be produced during its life = 38,000 units.
Then,	D	=	Depreciation per unit
		C − R		10,000 − 500			9,500
	=	N U	=	= 38,000		=
							38,000

= Re. 0.25 per unit.

Thus, if 4,000 units are produced in a certain period, Rs. 1,000 will be charged as depreciation.

This method gives emphasis on usage and ignores time factor. The depreciation charge is high in periods of abnormal activity and low when machines are idle. This method is suitable for wasting assets such as mines and quarries. If estimated production during the life can be determined, this method satisfies the costing requirement that the cost of an asset should be evenly spread over the work done by it. However, the main disadvantage of this method is that a separate record of output of each of the assets has to be maintained and this method cannot be applied were output are of different types.

  

(4)        Production hour method : This is the method of providing for depreciation by means of a fixed rate per hour of production calculated by dividing the value of the asset by the estimated number of hours of its life.

Example :

Assuming C and R to have the same value, and

NH  =	Estimated number of working hours of its life = 19,000 hrs.
Then,	D =	Depreciation per hour
		C − R		10,000 − 500
	=	N H	=	= 19,000	= Re. 0.50 per hour

Thus, for a work of 1,000 hours in a certain period, depreciation charge will be :

Rs. 1,000 × Re. 0.50 = Rs. 500.

This method is usefully applied in cases of costly automatic machines having a limited but definite working life. This method is similar to production unit method. However, under this method, there is no need for all the units to be produced to be one type or even similar to one another as the charge is based upon the time involved in their production, and not on their number.

(5)        Annuity method : This is the method of providing for depreciation by means of periodic charges, each of which is a constant proportion of the aggregate of the cost of the asset depreciated and interest at a given rate per period on the written down value of the asset at the beginning of each period.

Example :

If C = Rs. 10,000; n = 4 years; r = rate of interest 4% per annum;

an

=

present value of an annuity certain of

1 per year.

1−

1

=

(1+ r ) n

r

Then,

D = amount of periodic depreciation charge under this method

C

=

C × r

=

10 000 × 0 04

=

400

a n

1−

1

,

.

1−

1

1

1.

1+ r

)

n

)

4

1.0 4

(

1− (

169859

=  Rs. 2,755

 Proof :

	Year		Cost and	Interest @ 4%	Total	Annual	Balance c/f
			balance b/f	(nearest rupee)		provision
			Rs.	Rs.	Rs.	Rs.	Rs.
		1	10,000	400	10,400	2,755	7,645
2			7,645	306	7.951	2,755	5,196
3			5,196	208	5,404	2,755	2,649
4			2,649	106	2,755	2,755	Nil

The amount of depreciation is heavy in this method and is intended to cover the cost of opportunity lost by not investing the capital elsewhere.

This method is based on the concept that money invested in an asset earns interest. This method is suitably used for the redemption of leases over a fairly long period. It is a scientific method where investment funds outside a business is not required.

(6)       Revaluation method : This is the method of providing for depreciation by means of periodic charges each of which is equivalent to the difference between the values assigned to the asset at the beginning and the end of the period.

Example :

If, C = Cost of the asset = Rs. 10,000 ;

V = Value of asset at the end of one year = Rs. 7,000

Then, D = Amount of depreciation under this method = C – V = 10,000

– 7,000 =  Rs. 3,000.

This method is commonly used for depreciation of loose tools, livestock, patents, patterns, etc., which depreciate rapidly. This method is also used for use of assets in contracts.

(7)       Sum of the digits method : This is the method of providing for depreciation by means of differing periodic rates which is computed by taking a reduced proportion of the sum of an arithmetical progression in respect of the years of life of the asset, multiplied by the cost, less residual value, of the asset.

Example :

If, C = cost of asset = Rs.10,000; R = residual value = Rs. 400 ; n = 4yrs. Then, S = sum of years = 1 + 2 + 3 + 4 = 10

  

Then, depreciation charge :		Rs.
In  year l	4/10 of Rs. 9,600	3,840
year 2	3/10 of Rs. 9,600	2,880
year 3	2/10 of Rs. 9,600	1,920
year 4	1/10 of Rs. 9,600	960

This method is suitable for depreciation of motor vehicle and other assets which drop in value immediately after purchase. Thus the advantage of this method is that it takes into account of such drop in value of new asset and makes the decision to sell and repurchase before the estimated time an easier one.

The following should be noted for depreciation of the following types of fixed assets :–

(a)       Goodwill :No depreciation arises unless the firm’s profits are decreasing. Prudent firms try to write off goodwill over a number of years.

(b)       Freehold Land : In this case also no depreciation arises. Amounts written off should be shown separately.

(c)       Loose tools, Jigs and Patterns : Depreciation should be calculated on revaluation method.

(d)       Patents, Trade Marks, etc :There is a maximum legal life of such assets but the commercial life may be shorter. The asset should be depreciated by straight line method so that it is written off within the legal or commercial life whichever is shorter.

(e)        Mines, Oil wells, Quarries, etc. : Depreciation should be charged on depletion method.

Illustration 15 :

A company purchased a machine for Rs. 20,000 and paid cost of installation Rs. 1,000. At the date of purchase, the life of the machine was estimated at 15 years and hence it was decided to create a depreciation fund to be invested in Government Securities to provide for replacement of the machine.

Before expiration of the estimated life it was decided to dismantle the machine and replace it with a modern one. The cost of dismantling was Rs. 200 and the cost of purchase and installation of new machine was Rs. 23,000. Parts of the old machine estimated to be worth Rs. 500, were retained and the remainder sold as scrap for Rs. 750.

At the date of dismantling the old machine, the depreciation fund stood in the books at Rs. 16,500 and was represented by Government Securities costing the same amount. These securities were sold for Rs. 15,600.

You are required to write up the ledger accounts concerned.

Solution :
Dr.			Machinery A/c				Cr.
		Particulars	Rs.		Particulars		Rs.
To	Cash A/c			By	Cash A/c Scrap Sale		750
	Cost of Machine		20,000		Depreciation fund A/c – tfd..		15,400
	Installation		1,000		Profit & Loss A/c – Loss		4,350
To	Cash A/c				Balance c/d		23,500
	Cost of new Machine		23,000		— for old machine Part – 500
					— for new machine 23,000
			44,000				44,000
Dr.			Depreciation Fund A/c				Cr.
		Particulars	Rs.		Particulars		Rs.
To	Cash A/c – Cost of dismantling		200	By	Balance b/d		16,500
	Depreciation Fund
		Investment A/c – transferred	900
	Machinery A/c (Balancing figure)		15,400
			16,500				16,500
Dr.			Depreciation Fund A/c				Cr.
		Particulars	Rs.		Particulars		Rs.
To	Balance b/d		16,500	By	Cash A/c
					— Sale of securities		15,600
					— Depreciation Fund A/c
					– Loss tfd..		900
			16,500				16,500
		Working to find out loss on dismantling the old machine.
		Cost of old machine					Rs. 21,000
		Less :   Parts retained from Old machine				500
		Sale of Scrap				750	1,250
		Less :   Amount available from the balance of					19,750
		Depreciation Fund A/c					15,400
		Loss					4,350