UNIT 3

Specialized Accounting

Q1) What is Depreciation? What are the purposes of providing the depreciation?

A1)

Depreciation means the reduction in the value of an asset due to its use, leading its wear and tear, or due to obsolescence or due to general market trend. The prescribed rules state that the amount of depreciation of a depreciable asset must be allocated in every accounting period throughout the life of the asset.

Depreciable assets are those assets that are used for the purpose of business which can be depreciated. That is, the value of the asset is considered as a business expense over the useful life of the asset. A company can depreciate most of the tangible assets like Building, Machinery, Vehicles, Furniture and Fixtures, Computers and Equipment and intangible assets like Patents, Copyrights and Computer Software.

Purposes of Providing Depreciation:

1. To keep capital untouched
2. To ascertain cost
3. To prepare true and fair statements

Q2) What are the different types of Reserves?

A2)

There are broadly three types of Reserves – Capital Reserves, Revenue Reserves ad Statutory Reserves.

Capital Reserve:

A capital reserve is taken out of the capital profit and is not shared as a dividend to the shareholder. This reserve cannot be created out of the profit earned from the core operation.

Few examples of capital reserves are:

1)     Cash received by selling current assets

2)     Premium earned on the issue of share and debentures

3)     Excess on revaluation of assets and liabilities

Revenue Reserve:

Revenue reserve is a portion of profit owned by the company and is kept aside for the use of other multiple purposes. This reserve is recorded in the profit and loss account and can be used the following way:

1)     Dividend to shareholder

2)     Expand the business

3)     Stabilise the dividend rate

In other words, Revenue reserves are portions of profits earned by a company’s normal operations which are then set aside.

Revenue reserves are divided into two types:

1)     General Reserve and

2)     Specific Reserve

Q3) What is provision? What are its types?

A3)

A provision is an amount that is set aside from a company’s profits, usually to cover an expected liability; the specific amount of the same might be unknown at present times.

In other words, a provision should not be understood as a form of savings, instead, it is recognition of an upcoming liability, in advance.

Types of Provisions in Accounting:

The most common type of provision is a provision for bad debt. A provision for bad debt is one that has been calculated to cover the debts during an accounting period that is not ‘expected’ to be paid.

The Other common kinds of provisions in accounting include:

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

Q4) What is the accounting treatment to create Reserves and Provisions?

A4)

Accounting Treatment for Reserves:

The accounting treatment of all types of reserves is similar. For creating a reserve, the following journal entry is passed:

Capital A/c    Dr.

To ___________ Reserve A/c

Accounting Treatment for Provisions:

The accounting treatment of all types of provisions is similar. For creating a provision for doubtful debts, the following journal entry is passed:

Profit and Loss A/c    Dr.

To Provision for _________ A/c

Q5) Explain in detail the methods of Depreciation.

A5)

Companies Act prescribes two methods for calculating depreciation:

-          Straight Line Method (SLM) and

-          Written Down Value Method (WDV)

Straight Line Method (SLM):

Straight line basis is calculated by dividing the difference between an asset's cost and its expected salvage value by the number of years it is expected to be used.

In other words, to calculate depreciation on straight line basis, company take the purchase price of an asset and then subtract the salvage value, its estimated sell on value when it is no longer expected to be needed. The resulting figure is then divided by the total number of years the asset is expected to be useful, referred to as the useful life.

Symbolically, the formula is –

Depreciation on Straight Line Basis = Purchase Price of Asset - Salvage Value

Estimated Useful Life of Asset

Written Down Value Method (WDV):

Under this method, the depreciation is calculated at a certain fixed percentage each year on the decreasing book value commonly known as WDV of the asset

WDV is calculated as Book value less Depreciation.

It is also known as Reducing Balance or Reducing Instalment Method or Diminishing Balance Method.