Depreciation: NBSE Class 10 Book Keeping

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Get summaries, questions, answers, solutions, notes, extras, theories, practicles, PDF, and guide of Chapter 6 Depreciation, NBSE Class 10 Book Keeping (BK) textbook, which is part of the syllabus of students studying under Nagaland Board. These solutions, however, should only be treated as references and can be modified/changed.

Summary

Depreciation is the loss in value of things used in business over time. Fixed assets like machines and furniture lose value due to constant use. This loss happens gradually and affects how much an asset is worth. For example, a chair bought years ago will not be as good or valuable today. Depreciation records this change in value.

There are several causes for depreciation. Assets lose value when used daily. Time also reduces their worth. Sometimes new inventions make old machines useless. Minerals get depleted when extracted from mines. The market value of investments can fall permanently. Accidents can damage assets too. All these factors cause depreciation.

Recording depreciation is important for many reasons. It helps calculate the real profit or loss of a business. It shows the true value of assets in accounts. It provides funds to replace old assets. It helps determine the correct cost of making goods. It ensures dividends come from profits only. It avoids paying extra income tax.

Several factors affect how much depreciation is charged. These include the total cost of the asset, its expected life, scrap value, chances of becoming outdated, additions to assets, and legal rules. Each factor is considered before deciding the amount of depreciation.

Two common methods exist for calculating depreciation. The first is the straight-line method. Here, equal amounts are deducted each year. This method is simple and easy to understand. It suits small firms and less valuable items like furniture. However, it has flaws. It does not reduce the burden on final years when repair costs rise.

The second method is the diminishing balance method. Here, depreciation decreases each year. It starts with a high amount and reduces yearly. This method suits long-life assets like buildings and machinery. It balances repair and depreciation costs. But it cannot reduce an asset’s value to zero.

Both methods have advantages and disadvantages. Straight-line method charges fixed depreciation. Diminishing balance method reduces it yearly. Straight-line suits small-value assets while diminishing balance suits big ones. Income tax laws prefer the diminishing balance method.

Examples explain how to prepare accounts using both methods. Practical questions help practice calculations. Theoretical questions test understanding of concepts. Assignments cover definitions, causes, and objectives of depreciation. They also discuss differences between methods and their uses.

Depreciation impacts business accounts significantly. It shows how assets lose value over time. Recording it properly keeps accounts accurate. This process ensures businesses run smoothly and plan for future needs.

Textbook solutions

Multiple Choice Questions (MCQs)

1. Depreciation is a/an

a. Loss
b. Asset
c. Income
d. Valuation

Answer : a. Loss

2. Depreciation is provided on:

a. Current assets
b. Fictitious assets
c. Fixed assets
d. Intangible assets

Answer : c. Fixed assets

3. Depreciation is caused by:

a. Obsolescence
b. Wear and tear
c. Passage of time
d. All of the above

Answer : d. All of the above

4. Depreciation under straight line method:

a. Remains constant each year
b. Increases each year
c. Decreases each year
d. None of the above

Answer : a. Remains constant each year

5. Depreciation is calculated on:

a. Wasting assets
b. Current assets
c. Fictitious assets
d. Fixed assets

Answer : d. Fixed assets

6. In diminishing balance method, depreciation is calculated on ______ of assets

a. Original cost
b. Average cost
c. Written down value
d. Market value

Answer : c. Written down value

Very Short Answer Type Questions

1. What is depreciation?

Answer: Loss in the value and utility of assets due to their constant use and expiry of time is termed as depreciation.

2. A mobile phone manufacturer has recently acquired a patent for new technology. What will have to be written in its ledger against the cost of patent written off?

Answer: In the patent account, Amortization Expenses will come in the credit side.

3. Is depreciation a cash expense?

Answer: No, depreciation is not a cash expense.

4. What are the factors affecting depreciation?

Answer: The factors affecting depreciation are: i. The estimated useful life of assets ii. Estimated scrap value iii. Chances to obsolescence iv. Addition to assets v. Legal provision

5. What formula will you use for calculating depreciation using the straight-line method?

Answer: Annual depreciation = Scrap value or residual value or break up or salvage value / Expected or estimated the life of the asset.

Short Answer Type Questions

1. What do you mean by “depreciation”? Jot down some of its features.

Answer: Loss in the value and utility of assets due to their constant use and expiry of time is termed as depreciation. i. Depreciation is loss in the value of assets ii. Loss should be gradual and constant iii. Depreciation is the exhaustion of the effective life of business iv. Depreciation is the normal feature v. Maintenance of assets is not depreciation vi. It is a continuing decrease in the value of assets

2. Enumerate the advantages of the Straight Line Method of calculating depreciation.

Answer: The advantages of the Straight Line Method of calculating depreciation are:

i. Simplicity. This is the simplest method of providing depreciation.
ii. Assets can be completely written off. According to this method, assets can be written off to zero.
iii. Knowledge of total depreciation charged. The amount of total depreciation charged can be easily known by multiplying the yearly amount of depreciation with the number of years, the asset has been used.
iv. Suitable for small firms. The straight-line method is the most suitable method for small firms.
v. Suitable for firms having a large number of old and new machines. The weaknesses of this method are removed if the firm has both old and new machines
vi. Useful for assets having less value. This method is the most suitable for charging depreciation on assets of less value such as furniture, fixture and patents etc.

3. Discuss the merits and demerits of calculating depreciation by Diminishing Balance Method.

Answer: The merits and demerits of calculating depreciation by Diminishing Balance Method are:

Merits: i. Calculation of depreciation is easier as compared to other methods of calculating depreciation except for straight-line method. ii. This method is approved by income tax authorities. iii. It seems logical even to a layman that the value of the asset goes on diminishing year after year, so the depreciation should also be charged on the reducing balances.

Demerits: i. It is very difficult to determine the rate by which the value of the asset could be written down to zero. ii. The amount charged as depreciation is not invested outside the business, so no interest is received. iii. The amount of depreciation goes on declining year after year, whereas the asset is used equally every year.

Long Answer Type Questions

1. Explain the term “depreciation”. Discuss the various methods of calculating depreciation.

Answer: Fixed assets are constantly used in the business. The assets lose their value gradually due to their constant use. Loss in the value and utility of assets due to their constant use and expiry of time is termed as depreciation.

The various methods of calculating depreciation are:

• Fixed instalment method: It is the simplest method of charging depreciation. The original cost of the asset is divided by the estimated life period of the asset.
• Diminishing balance method: Under the diminishing balance method, the value of an asset upon which depreciation is to be calculated goes on diminishing, so the amount of depreciation to be charged every year also goes on declining.

2. State the difference between the fixed instalment and diminishing balance method of calculating depreciation.

Answer: The difference between the fixed instalment and diminishing balance method of calculating depreciation are:

Bases of Difference	Straight Line Method	Diminishing Balance Method
Amount of Depreciation	An equal amount of depreciation is charged every year.	The amount of depreciation goes on reducing year after year.
Calculation of Depreciation	Depreciation is calculated on the original cost of the assets.	Depreciation is calculated on the reducing the balance of asset.
Zero Level	The value of assets can be written down to zero.	The value of assets cannot be written down to zero.
Effect on Profit and Loss Account	The initial years of the life of the asset bear less amount of depreciation and repairs but final years bear the same amount of depreciation but more repairs and maintenance charges.	Every year bears almost the same charges. Depreciation goes on declining, whereas repairs and maintenance charges go on increasing.
Suitability	This method is useful for assets of less value such as patents, furniture and fixtures etc.	The method is suitable for assets having a longer life and more value such as land and building, plant and machinery etc.
Recognition by Income Tax law	The straight-line method is not recognised by Income Tax law	Written down value method is recognised by Income Tax law.

3. State the four main causes of providing depreciation.

Answer: The four main causes of providing depreciation are: 

i. By constant use: The loss in the value, efficiency and utility of fixed assets due to its constant use is termed as depreciation.
ii. By the expiry of time: The effective life of assets goes on decreasing with the passage of time.
iii. By obsolescence: The old assets will become obsolete due to new inventions, improved techniques and technological advancements.
iv. By depletion: Loss of mineral wealth due to the constant working of mines is also depreciation, but specifically known as ‘depletion.’
v. Permanent fall in price: Though fluctuations in the market value of fixed assets is not recorded in the books, sometimes we have to account for this loss such as permanent fall in the value of investments.
vi. By abnormal factors: Depreciation may also be due to the loss in the value of assets by accidents and damage.

4. Why is calculating depreciation important? What is its impact on Profit and Loss account and balance sheet?

Answer: Calculation of depreciation is important because of the following reasons.

 i. The ultimate objective of accounting is to determine the correct net income. This objective will not be achieved unless we account for depreciation in the books of accounts.
ii. Provision for depreciation reduces the value of assets with the amount of depreciation and assets are shown at their true and fair value.
iii. The proper method of depreciation will make the funds available for the purchase of fresh assets.
iv. In the absence of provision for depreciation, the sales price of the commodity will be fixed at lower rates, because the cost of production will also be lower due to the ignorance of depreciation. Profit will thus be reduced.
v. Depreciation is charged out of profit and loss account, so the profit after charging it will be less. Shareholders will get dividend out of this profit.
vi. Provision for depreciation avoids overpayment of income tax.

Practical Questions

Questions

Question 1

A trader purchased a machine for ₹ 80,000 on January 1, 2014. It was decided to charge depreciation at 20% per annum on the original cost of the asset. Calculate the machinery account and depreciation account for 3 years. The accounts were closed on December 31.

Question 2

Ikalo Sema purchased a machine for ₹ 25,000 on January 1, 2011. Its probable useful life was estimated at 10 years and its probable scrap value at the end of that period at ₹ 3,000. It was decided to write off the depreciation by equal annual instalments over the years. Show the machinery account for the first 3 years. (Ans: Depreciation per year: ₹ 2,200; balance of machinery account on 31.12.13: ₹ 18,400)

Question 3

Dimapur Paper Mill purchased a plant for ₹ 35,000 on January 1, 2015 and spent ₹ 2,000 on its installation. The estimated life of the plant is 8 years, after which its break-up value will be only ₹ 5,000. Using the straight line method to calculate the amount of annual depreciation, prepare the plant account for the first 3 years assuming that the accounts were close on December 31. (Ans: Depreciation per year: ₹ 7,000; balance of machinery account on 31.12.17: ₹ 41,000)

Question 4

The original cost of furniture amounted to ₹ 9,000 and was written off at 10% original cost as depreciation at the end of each year. Prepare the ledger account for the first 3 years. Also calculate how the account will appear if 10% was written off on the diminishing balance. (Ans: Closing balance: ₹ 6,300; Straight line method: ₹ 900 per year; Diminishing balance after 3 years: ₹ 6,561)

Question 5

Asenla purchased a plant on January 1, 2009 for ₹ 48,000. She depreciates it every year on December 31, using diminishing balance method at a rate of depreciation of 20%. Show the machinery account and depreciation account for the first 3 years. (Ans: Depreciation: ₹ 9,600 (2009); ₹ 7,680 (2010); ₹ 6,144 (2011); Diminishing balance on 1.1.12: ₹ 24,576)

Question 6

An asset was purchased for ₹ 48,000 on January 1, 2007. The life of the asset was estimated to be 5 years and it was estimated to depreciate at 95% of the cost by the fixed instalment method over that period. Calculate the depreciation and written down value. (Ans: Depreciation: ₹ 9,120; Written down value on 31.12.11: ₹ 2,400)

Question 7

On January 1, 2002, a company purchased a machine for ₹ 3,00,000. Depreciation is charged at 20% p.a. on original cost every year. The machine is sold for ₹ 1,00,000 on November 30. Prepare the machinery account based on the assumption that the books are closed on March 31 every year. (Hint: Depreciation charged during the four years will be ₹ 15,000, ₹ 60,000, ₹ 60,000, and ₹ 40,000, respectively. Loss on sale of machine: ₹ 25,000)

Question 8

Zhenito Zho buys a machine for ₹ 50,000 on July 1, 2009. He decides to depreciate the machine at 10% on December 31, each year. This is based on the cost price for 2009 and the value at the start of the year for the subsequent years. Calculate the machine account for the first 3 years. (Ans: Depreciation for 6 months: ₹ 2,500 (2009); ₹ 4,750 (2010) and ₹ 4,275 (2011); balance of machinery account on 31.12.11: ₹ 38,475)

Question 9

Tizit Textiles purchased a machine for ₹ 90,000 on April 1, 2009. Thereafter, it spent ₹ 6,000 on its carriage and ₹ 4,000 on its erection. The useful life of the machine was estimated to be ₹ 10,000 from the date of purchase and its scrap value after that period was calculated to be ₹ 20,000. Prepare the machine account and depreciation account for the first four years using the fixed instalment method. The accounts are closed on March 31 each year. (Ans: Depreciation ₹ 92,000 (2009); ₹ 84,000 (2010), ₹ 76,000 (2011) and ₹ 68,000 (2012); balance of machinery account on 1.1.13: ₹ 68,000)

Question 10

A purchased a machine for ₹ 2,40,000 on January 1, 2006 and spent ₹ 10,000 on its erection. He bought an additional machinery worth ₹ 1,00,000 on July 1, 2006. A sold the machine purchased on January 1, 2006 at ₹ 1,43,000 on July 1, 2008 and on the same date purchased a new machine for ₹ 2,00,000. Calculate the machinery account for the first 3 calendar years using the straight line method. The depreciation is charged at 5%. [Hint: calendar year indicates that the accounts are closed on December 31, each year.] (Ans: loss on sale of machinery: ₹ 75,750; balance of machinery account: ₹ 2,82,500)

Question 11

A plant purchased for ₹ 60,000 on April 1, 2009 is estimated to have a working life of 10 years. At the end of this period the plant is estimated to be valued at ₹ 20,920. The depreciation is provided at 10% in the diminishing balance method. Calculate the plant account for 4 years. The books are closed on March 31, every year. [Hint: residual balance is ignored when depreciation is calculated under diminishing balance method.] (Ans: balance of plant account on March 31: ₹ 39,366)

Question 12

Angelina Meruno purchased a second-hand machine on April 1, 2013 for ₹ 30,000 and also spent ₹ 4,000 on its repair and ₹ 1,000 on its installation cost. She sold the machine for ₹ 25,000 on October 1, 2015. Prepare the machine account after charging depreciation at 10% p.a., using diminishing balance method. The books are closed on March 31 every year. (Ans: loss on sale of machine: ₹ 1,932)

Question 13

On January 1, 2009, a firm purchased a machine for ₹ 32,000. The plant has an estimated useful life of 5 years, after which the scrap value will be only ₹ 2,000. Using the straight line method calculate the annual depreciation and prepare the plant account for the first 3 years. The accounts are closed on December 31. (Ans: balance of plant account on 31.12.11: ₹ 14,000)

Solutions

Extras

Additional questions and answers

1. Define obsolescence.

Answer : Obsolescence refers to the situation where new inventions or technological advancements render existing machines and equipment obsolete, even though they may not be completely useless. The firm will have to replace the old machine and equipment with the latest, up-to-date, and newly invented ones.

Q. What do you mean by depletion?

Answer : Depletion refers to the loss of mineral wealth due to the constant working of mines. As more mineral wealth is extracted from the mines, their value decreases over time.

Q. Define amortisation.

Answer : Amortisation is the term used to show the loss in the value of intangible assets such as goodwill, patents, and preliminary expenses. These assets are written off over a certain period.

Q. What is fluctuation?

Answer : Fluctuation refers to the increase and decrease in the market value of assets. While fluctuations in the market value of fixed assets are generally not recorded in the books, in the case of a permanent fall in the value of investments, fluctuations may be recorded.

Q. Is maintenance considered depreciation?

Answer : No, maintenance of assets is not considered depreciation.

Q. What is meant by “wear and tear” in depreciation?

Answer : “Wear and tear” in depreciation refers to the gradual loss in the value and utility of assets due to their constant use and the passage of time.

Q. What does scrap value mean?

Answer : Scrap value refers to the amount realized from the sale of an obsolete asset after it has become useless.

Q. What is residual value?

Answer : Residual value is the expected amount to be realized even if the asset becomes obsolete, which is also known as scrap value, break-up value, or salvage value.

Q. Give any one cause of depreciation due to abnormal factors.

Answer : Depreciation may also occur due to the loss in the value of assets caused by accidents and damage.

Q. Mention any one objective of charging depreciation.

Answer : One objective of charging depreciation is for the determination of net profit or net loss, as loss in the value of assets is undoubtedly a business expense that must be recorded.

Q. Mention the special features of depreciation.

Answer : The special features of depreciation are:

• Depreciation represents a loss in the value of assets.
• The loss should be gradual and constant.
• Depreciation reflects the exhaustion of the effective life of business assets.
• Depreciation is a normal feature of asset usage.
• Maintenance of assets does not constitute depreciation.
• It signifies a continuing decrease in the value of assets.
• It involves the allocation of the cost of assets over the period of its life.

Q. Briefly explain depletion with an example.

Answer : Depletion refers to the loss of mineral wealth due to the constant working of mines. For example, if a mine initially contains 1,00,000 tons of coal and during the first year, coal worth 5,000 tons is extracted, the loss of 5,000 tons from the mine is considered a loss due to depletion. Depreciation on such mineral wealth is charged according to the depletion method.

Q. State any two objectives of charging depreciation.

Answer : Two objectives of charging depreciation are:

• For the determination of net profit or net loss by recording depreciation as a business expense in the profit and loss account.
• For showing assets at their fair and true value in the Balance Sheet by reducing their value through the provision for depreciation.

Q. Mention the legal provision regarding depreciation.

Answer : According to Accounting Standard-6 issued by the Institute of Chartered Accountants of India in November 1987, every company is required to make a provision for depreciation on its fixed assets

Q. Describe the calculation of depreciation under the straight line method?

Answer : Under the straight line method, the original cost of the asset is divided by the estimated life period of the asset. For example, if the value of the asset is ₹ 20,000 and its useful life is estimated to be 10 years, the amount of depreciation to be charged every year will be ₹ 2,000, i.e., ₹ 20,000/10. Depreciation to be charged every year will be fixed at ₹ 2,000 for every year. In certain cases where the scrap or residual value of the assets is given, the following formula is used: Annual Depreciation = (Cost of the asset – Scrap value) / Estimated life of the asset.

Q. What are the limitations of the straight line method?

Answer : The limitations of the straight line method are:

• Undue pressure on final years as the final years of the life of the asset have to bear more repairs and maintenance charges and also the same amount of depreciation, whereas initial years have to suffer less repair charges.
• No provision for replacement as the amount charged as depreciation is retained in the business and used in routine affairs, leaving the firm to arrange funds for the replacement of assets.
• Loss of interest since the amount of depreciation charged every year is not invested outside the firm, so no interest is received.
• Illogical method as it seems illogical to charge depreciation on the original cost of the asset every year when the balance of the asset is declining year after year.
• Unsuitable for assets having long life and more value as this method is not suitable for assets subject to additions and extensions from time to time, such as land, building, plant, and machinery.

Q. What are the advantages of the diminishing balance method?

Answer : The advantages of the diminishing balance method are:

• Easy calculation as depreciation is calculated every year on the opening balance of the asset, and depreciation on additions is separately calculated.
• Balanced effect on the profit and loss account of different years since in the initial years depreciation is more and maintenance charges are less, while in the final years depreciation is less but repairs and maintenance charges are more, ensuring every year bears almost the same charges.
• Approved method by income tax authorities.
• Logical method as it seems logical even to a layman that the value of the asset goes on diminishing year after year, so depreciation should also be charged on the reducing balances.
• Suitable for assets having long life as this method is suitable for assets which have long life and are subject to additions and extensions from time to time, such as land, building, plant, and machinery.

Q. Why is depreciation important for determining accurate net profit?

Answer : Depreciation is important for determining accurate net profit because loss in the value of assets is undoubtedly a business expense. It must be recorded and shown on the debit side of the profit and loss account for the correct calculation of net profit or net loss. Unless depreciation is accounted for in the books of accounts, the ultimate objective of accounting, which is to determine the correct net income, will not be achieved.

Q. Explain how depreciation affects the true value of assets in the Balance Sheet.

Answer : Depreciation reduces the value of assets to reflect their true and fair value in the Balance Sheet. If depreciation is not charged, the assets will be shown at a value more than their actual worth. Provision for depreciation decreases the value of assets by the amount of depreciation, ensuring that assets are presented at their accurate and fair value in the Balance Sheet.

Q. State any two factors affecting the amount of depreciation.

Answer : Two factors affecting the amount of depreciation are: (i) Total cost of the assets (ii) Estimated useful life of the assets

Q. Explain any three causes of depreciation.

Answer : Three causes of depreciation are:

• By constant use: The loss in the value, efficiency, and utility of fixed assets due to their constant use is termed as depreciation.
• By expiry of time: The effective life of assets decreases with the passage of time. For example, if a lease has been obtained for 20 years, it will lose value annually and become valueless at the end of the term.
• By obsolescence: Old assets may become obsolete due to new inventions, improved techniques, and technological advancements.

Q. Enumerate the advantages and disadvantages of the straight line method.

Answer : The advantages of the straight line method are:

• Simplicity: This is the simplest method of providing depreciation and can be easily understood even by ordinary persons. Calculating depreciation using this method is also straightforward.
• Assets can be completely written off: According to this method, assets can be written off to zero since depreciation is calculated on the original cost of the asset at a specified rate, ensuring the value of the asset is fully allocated over its useful life.
• Knowledge of total depreciation charged: The total amount of depreciation charged can be easily determined by multiplying the yearly depreciation amount by the number of years the asset has been used.
• Suitable for small firms: This method is most suitable for small firms because it is easy, simple, and matches the size of such businesses.
• Balanced application: The weaknesses of this method are mitigated if the firm has both old and new machines, as higher maintenance costs on older machines and lower costs on newer ones balance each other.
• Useful for assets having less value: This method is ideal for charging depreciation on assets of lesser value, such as furniture, fixtures, and patents.

The disadvantages of the straight line method are:

• Undue pressure on final years: In the final years of the asset’s life, there are more repairs and maintenance charges along with the same amount of depreciation, whereas initial years incur fewer repair charges.
• No provision for replacement: The amount charged as depreciation is retained in the business and utilized in routine operations. Firms must arrange separate funds for the replacement of assets, despite charging depreciation annually.
• Loss of interest: The amount of depreciation charged every year is not invested outside the firm, resulting in no interest being earned. Other methods allow for investment of depreciation funds in securities to earn interest.
• Illogical method: Charging depreciation on the original cost of the asset every year seems illogical when the balance of the asset declines annually.
• Unsuitable for assets with long life and high value: This method is unsuitable for assets subject to frequent additions or extensions, such as land, buildings, plants, and machinery, as well as for assets with significant value.

Q. What are the disadvantages of the diminishing balance method?

Answer : The disadvantages or limitations of the diminishing balance method of providing depreciation are:

• The value of the asset cannot be reduced to zero. It is very difficult to determine the rate by which the value of the asset could be written down to zero.
• No funds for replacement. Though depreciation is charged every year, the amount charged is retained in the business and used in routine business operations. At the time of replacing assets, the firm has to bother about making arrangements for funds, although it has charged depreciation every year.
• Loss of interest. The amount charged as depreciation is not invested outside the business, so no interest is received. In certain methods, the amount is invested outside the business in securities, and interest is received.
• Higher rate of depreciation. The rate of depreciation in this method is higher because it will require a longer period to write off the asset if the rate is lower; the assets may become useless earlier.
• Unequal burden on profit and loss account. The amount of depreciation goes on declining year after year, whereas the asset is used equally every year.

Q. Explain how depreciation provides funds for the replacement of assets.

Answer : Depreciation provides funds for the replacement of assets through the provision of funds created by charging depreciation. The assets acquired and used in the business will become useless after the expiry of their estimated life or even before that, necessitating replacement with fresh assets. Proper methods of depreciation ensure that the funds required for purchasing new assets are made available over time.

Q. Describe how depreciation avoids overpayment of income tax.

Answer : Depreciation avoids overpayment of income tax because, if depreciation is not charged, the profit and loss account will show more profit, leading to a higher income tax payment on that profit. By charging depreciation, the profit reduces, ensuring that less or the actual income tax due is paid, thereby avoiding overpayment of income tax.

Q. Explain the concept of amortisation with examples.

Answer : The word ‘amortisation’ is used to show the loss in the value of intangible assets. These assets include goodwill, patents, and preliminary expenses, among others. Such assets are written off over a certain period. For example, if a company acquires a patent, its cost may be spread out and written off over the years during which it is expected to provide benefits.

Q. Explain the concept of obsolescence and how it differs from depreciation.

Answer : Obsolescence refers to the situation where new inventions or technological advancements render existing machines and equipment outdated or obsolete, even though they may not be completely useless. For instance, a firm may need to replace old machinery with newer, more advanced equipment due to technological improvements. Obsolescence differs from depreciation because while depreciation is the gradual and continuing diminution in the value of an asset due to use, effluxion of time, or wear and tear, obsolescence specifically arises from external factors like new inventions or changes in market demands, making the asset less valuable or redundant.

Q. Describe the calculation process for depreciation using the diminishing balance method.

Answer : Under the diminishing balance method, the value of the asset on which depreciation is calculated goes on diminishing, so the amount of depreciation charged every year also declines. Depreciation is calculated on the opening balance of the asset each year at a fixed percentage. For example, if a machine is acquired for ₹1,00,000 and depreciation is charged at 10% annually under this method:

• In the first year, depreciation is calculated on ₹1,00,000: ₹10,000.
• In the second year, depreciation is calculated on ₹90,000 (₹1,00,000 – ₹10,000): ₹9,000.
• In the third year, depreciation is calculated on ₹81,000 (₹90,000 – ₹9,000): ₹8,100. This process continues, and the balance of the machine keeps reducing year after year, leading to declining amounts of depreciation.

Q. Compare the straight line method and diminishing balance method regarding suitability.

Answer : The differences between the straight line method and diminishing balance method regarding suitability are as follows:

• Suitability Based on Asset Value : The straight line method is suitable for assets of lesser value, such as furniture, fixtures, and patents, whereas the diminishing balance method is suitable for assets having longer life and higher value, such as land, buildings, plant, and machinery.
• Effect on Profit and Loss Account : Under the straight line method, initial years bear less depreciation but final years bear more repairs and maintenance charges, creating an unequal burden. However, under the diminishing balance method, every year bears almost the same charges since depreciation declines while repairs and maintenance increase, creating a balanced effect.
• Recognition by Income Tax Law : The straight line method is not recognized by income tax law, whereas the diminishing balance method is recognized by income tax authorities.

Q. What are the factors affecting the calculation of depreciation? Explain in detail.

Answer : The factors affecting the calculation of depreciation are as follows:

• Total cost of assets : The total cost of the asset includes the purchase price and all expenses incurred for acquiring, installing, and constructing the asset. This total cost is considered while determining the rate and amount of depreciation.
• Estimated useful life of assets : The estimated working life of the asset may be measured in terms of years, months, hours, output (units), or kilometers (for trucks). The value of the asset is allocated over its estimated useful life, and if the expected life is longer, the rate of depreciation will be lower, and vice versa.
• Estimated scrap value : Scrap value refers to the residual value expected to be realized even after the asset becomes obsolete. Depreciation is calculated by deducting the scrap value from the total cost of the asset. For example, if a machine costing ₹10,000 has a scrap value of ₹1,000 and an estimated life of 10 years, annual depreciation would be ₹900.
• Chances to obsolescence : If the asset is likely to become obsolete within a specific period, such as five years, its value is split over that duration. The chances of obsolescence affect the rate at which depreciation is charged annually.
• Addition to assets : Depreciation should also be charged on additions to assets. For instance, if furniture worth ₹10,000 exists on January 1, 2006, and additions worth ₹5,000 are made on July 1, 2006, depreciation is calculated separately for the original amount and the addition based on the time elapsed.
• Legal provisions : The method and rate of depreciation must comply with legal provisions. Companies must adhere to any legal requirements regarding the calculation and charging of depreciation.

Q. State the objectives of charging depreciation and explain each briefly.

Answer : The objectives of charging depreciation are as follows:

• For determination of net profit or net loss : Depreciation is a business expense and must be recorded on the debit side of the profit and loss account to accurately calculate net profit or net loss. Charging depreciation ensures the correct determination of net income.
• For showing assets at fair and true value in the Balance Sheet : If depreciation is not charged, assets will appear at a value higher than their actual worth. Provision for depreciation reduces the value of assets to reflect their true and fair value in the Balance Sheet.
• Provision of funds for replacement of assets : Assets used in the business will eventually become obsolete and need replacement. Proper depreciation methods ensure that funds are available for purchasing new assets when required.
• Ascertaining accurate cost of production : Depreciation on factory plant and machinery forms part of factory overheads, which increases the cost of production. Ignoring depreciation leads to underestimating costs, resulting in reduced profits.
• Distribution of dividend out of profit only : Depreciation is charged against the profit and loss account, reducing the profit available for distribution as dividends. This ensures that dividends are paid out of profits and not capital.
• Avoiding over payment of income tax : If depreciation is not charged, the profit and loss account will show higher profits, leading to increased income tax payments. Charging depreciation reduces taxable income, ensuring the actual or lesser income tax is paid.

Q. Describe the differences between the straight line method and diminishing balance method?

Answer : The differences between the Straight Line Method and the Diminishing Balance Method are as follows:

• Amount of Depreciation :
  • In the Straight Line Method, an equal amount of depreciation is charged every year.
  • In the Diminishing Balance Method, the amount of depreciation goes on reducing year after year.
• Calculation of Depreciation :
  • Under the Straight Line Method, depreciation is calculated on the original cost of the asset.
  • Under the Diminishing Balance Method, depreciation is calculated on the reducing balance of the asset.
• Zero Level :
  • In the Straight Line Method, the value of the asset can be written down to zero.
  • In the Diminishing Balance Method, the value of the asset cannot be written down to zero.
• Effect on Profit and Loss Account :
  • In the Straight Line Method, the initial years of the life of the asset bear less amount of depreciation and repairs but the final years bear the same amount of depreciation with more repairs and maintenance charges.
  • In the Diminishing Balance Method, every year bears almost the same charges as depreciation goes on declining while repairs and maintenance charges go on increasing.
• Suitability :
  • The Straight Line Method is useful for assets of less value such as patents, furniture, and fixtures.
  • The Diminishing Balance Method is suitable for assets having longer life and more value, such as land, building, plant, and machinery.
• Recognition by Income Tax Law :
  • The Straight Line Method is not recognized by Income Tax law.
  • The Diminishing Balance Method is recognized by Income Tax law.

Q. Why is depreciation charged? What is its impact on the cost of production?

Answer : Depreciation is charged for several reasons, including the determination of net profit or net loss, showing assets at fair and true value in the Balance Sheet, providing funds for the replacement of assets, ascertaining accurate cost of production, distributing dividends out of profit only, and avoiding overpayment of income tax. Regarding its impact on the cost of production, depreciation on factory plant and machinery is considered a factory overhead. This increases the cost of production, leading to the price of the commodity being fixed at higher rates. If depreciation is not accounted for, the sales price of the commodity will be fixed at lower rates because the cost of production will also be lower due to ignoring depreciation, which ultimately reduces profit.

Q. How does depreciation affect dividend distribution and income tax?

Answer : Depreciation affects dividend distribution as it is charged out of the profit and loss account, so the profit after charging depreciation will be less. Shareholders receive dividends out of this reduced profit. If depreciation is not charged, the profit will be higher, resulting in excess dividend payments that should have been paid out of capital instead of profit. Concerning income tax, if depreciation is not charged, the profit and loss account will show more profit, leading to higher income tax payments. By charging depreciation, the profit reduces, ensuring that only the actual income tax due is paid, thus avoiding overpayment of income tax.

Q. Discuss the uses and suitability of the diminishing balance method.

Answer : The diminishing balance method is suitable for assets having long life. It is also appropriate for those assets which are subject to additions and extensions from time to time, such as land, building, plant, and machinery. This method ensures a balanced effect on the profit and loss account of different years because in the initial years, depreciation is more and maintenance charges are less, while in the final years, depreciation is less but repairs and maintenance charges are more. Thus, every year bears almost the same charges regarding depreciation and maintenance.

36. What are the causes of depreciation? Explain each cause briefly.

Answer : The causes of depreciation are: 

(i) By constant use: The loss in the value, efficiency, and utility of fixed assets due to its constant use is termed as depreciation.
(ii) By expiry of time: The effective life of assets goes on decreasing with the passage of time. For example, if a lease has been obtained for 20 years for ₹1,00,000, it will lose ₹5,000 of its value at the end of the first year and so on, becoming valueless at the end of the 20th year.
(iii) By obsolescence: The old assets become obsolete due to new inventions, improved techniques, and technological advancements.
(iv) By depletion: Loss of mineral wealth due to constant working of mines is also depreciation, specifically known as ‘depletion’.
(v) Permanent fall in price: Though fluctuations in the market value of fixed assets are not recorded in the books, sometimes a permanent fall in the value of investments must be accounted for.
(vi) By abnormal factors: Depreciation may also occur due to the loss in the value of assets by accidents and damage.

Additional MCQs

1. Depreciation represents a ______ in asset value.

A. Loss
B. Gain
C. Income
D. Asset

Answer: A. Loss

Q. Depreciation is caused by constant ______.

A. Use
B. Repair
C. Addition
D. Supply

Answer: A. Use

Q. Which of the following is not a cause of depreciation?

A. Usage
B. Time
C. Inflation
D. Obsolescence

Answer: C. Inflation

Q. Obsolescence refers to loss due to ______.

A. New tech
B. Old age
C. Scrap sale
D. High cost

Answer: A. New tech

Q. The loss in mineral wealth is known as ______.

A. Depletion
B. Amortisation
C. Fluctuation
D. Wear

Answer: A. Depletion

Q. Loss in the value of intangible assets is termed ______.

A. Amortisation
B. Depletion
C. Obsolescence
D. Fluctuation

Answer: A. Amortisation

Q. Market value changes due to increases and decreases are called ______.

A. Fluctuation
B. Depletion
C. Wear
D. Scrap

Answer: A. Fluctuation

Q. Depreciation aids in determining ______.

A. Net profit
B. Gross sales
C. Fixed cost
D. Cash flow

Answer: A. Net profit

Q. Charging depreciation helps show assets at a ______ value.

A. Fair
B. High
C. Low
D. Zero

Answer: A. Fair

Q. Depreciation facilitates funds for ______.

A. Replacement
B. Investment
C. Expansion
D. Dividend

Answer: A. Replacement

Q. Depreciation ensures accurate ______ of production cost.

A. Production cost
B. Asset price
C. Market cost
D. Labour cost

Answer: A. Production cost

Q. Depreciation avoids excess payment of ______.

A. Income tax
B. Sales tax
C. Service tax
D. Property tax

Answer: A. Income tax

Q. One factor affecting depreciation estimation is the total ______ of assets.

A. Asset cost
B. Market size
C. Wage bill
D. Brand value

Answer: A. Asset cost

Q. The estimated useful life of an asset is measured in ______.

A. Years
B. Months
C. Hours
D. All above

Answer: D. All above

Q. The estimated scrap value is also known as the ______ value.

A. Residual
B. Profit
C. Cost
D. Asset

Answer: A. Residual

Q. Legal provisions affect both the ______ and method of depreciation.

A. Rate
B. Timing
C. Scale
D. Both

Answer: D. Both

Q. Under the straight line method, depreciation is charged ______.

A. Annually
B. Monthly
C. Weekly
D. Biannually

Answer: A. Annually

Q. The straight line method divides the cost of an asset by its ______.

A. Life years
B. Usage hours
C. Scrap value
D. Tax rate

Answer: A. Life years

Q. Depreciation calculated on the asset’s original cost is done by the ______ method.

A. Straight line
B. Diminishing
C. Averaging
D. Hybrid

Answer: A. Straight line

Q. Under the straight line method, an asset can be written off to ______.

A. Zero
B. One
C. Partial
D. None

Answer: A. Zero

Q. A key advantage of the straight line method is its ______.

A. Simplicity
B. Complexity
C. Inefficiency
D. Variability

Answer: A. Simplicity

Q. A disadvantage of the straight line method is undue ______ on later years.

A. Pressure
B. Depreciation
C. Interest
D. Growth

Answer: A. Pressure

Q. The straight line method lacks provision for asset ______.

A. Replacement
B. Investment
C. Repair
D. Maintenance

Answer: A. Replacement

Q. The diminishing balance method calculates depreciation on the reducing ______.

A. Value
B. Time
C. Cost
D. Life

Answer: A. Value

Q. Under the diminishing balance method, depreciation declines ______.

A. Yearly
B. Constantly
C. Never
D. Randomly

Answer: A. Yearly

Q. Income tax authorities approve the ______ method for depreciation.

A. Diminishing
B. Straight
C. Averaging
D. None

Answer: A. Diminishing

Q. The diminishing balance method is ideal for assets with a long ______.

A. Life
B. Cost
C. Use
D. Profit

Answer: A. Life

Q. A disadvantage of the diminishing balance method is that the asset value cannot reach ______.

A. Zero
B. Full cost
C. Market
D. Residual

Answer: A. Zero

Q. Depreciation under the diminishing balance method is calculated on the ______ balance.

A. Written down
B. Original cost
C. Average cost
D. Market value

Answer: A. Written down

Q. Which method results in equal depreciation every year?

A. Straight line
B. Diminishing
C. Both
D. Neither

Answer: A. Straight line

Q. The straight line method is not ______ by income tax law.

A. Recognised
B. Used
C. Approved
D. Applied

Answer: A. Recognised

Q. Which method shows a declining depreciation amount over time?

A. Diminishing
B. Straight
C. Equal
D. Fixed

Answer: A. Diminishing

Q. Under the diminishing balance method, more depreciation is charged in the ______ years.

A. Initial
B. Final
C. Mid
D. All

Answer: A. Initial

Q. The straight line method is best suited for assets of ______ value.

A. Low
B. High
C. Variable
D. Fixed

Answer: A. Low

Q. The diminishing balance method is ideal for assets with frequent ______.

A. Additions
B. No change
C. Static use
D. Immediate wear

Answer: A. Additions

Q. A fundamental feature of depreciation is its ______ loss.

A. Gradual
B. Sudden
C. Instant
D. Fixed

Answer: A. Gradual

Q. Depreciation is not caused by ______ activities.

A. Maintenance
B. Usage
C. Time
D. Obsolescence

Answer: A. Maintenance

Q. Depreciation allocates the asset cost over its useful ______.

A. Life
B. Price
C. Yield
D. Rate

Answer: A. Life

Q. The cost of an asset includes its purchase price and ______ charges.

A. Installation
B. Salary
C. Rent
D. Interest

Answer: A. Installation

40. Fixed asset depreciation is mandated by standards issued by ______.

A. ICAI
B. ICMA
C. IRS
D. FASB

Answer: A. ICAI