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Depreciation, Provisions and Reserves


Q.N.1 Define Depreciation? What are its characteristics? Explain its causes?

Ans.   Depreciation:-Depreciation may be defined as permanent decrease in the value of assets due to Use and /or the lapse of the time.

         According to Carter,”Depreciation may be defined as the permanent and gradual decrease in the Value of an assets from any cause.’’


         Characteristics of Depreciation:-

(1) Depreciation may be physical and Functional.

(2) It is a charge against Profit.

(3) Depreciation is charged in respect of fixed assets only.


         Causes of Depreciation:-

(1)    Wear and tear

(2)    Exhaustion

(3)    Obsolescence

(4)    Efflux of time or passage of time

(5)    Accident


Q.N.2 Mention three important causes of providing depreciation?

Ans.   Causes or objects of providing depreciation:-

(1)    Recovery of cost incurred on fixed assets over their useful life.

(2)    To find out correct profit for the year.

(3)    To provide for replacement of assets.

(4)    To find out correct financial position.

(5)    To reduce tax burden.


Q.N.3 Define the following terms:-


 Depletion: - Depletion implies removal of available resources e.g. Coal from Coal mine, Oil out of Oil well.

Amortisation: - The process of writing off intangible assets such as goodwill, pateats, and trademarks etc.is called Amortisation.

Dilapidation: -   The term Dilapidation reduces to damage done to a building or other property during tendency.

Obsolescence: - When an asset becomes out dated due to new or improved technology or invention, this is called obsolescence.


Q.N.4 Explain the basic factors on which the calculation of depreciation depends?

Ans.   For determining the amount of depreciation on fixed assets, following factors should be considered: -

(1) Original cost of assets.

(2)Estimated scraps value of assets.

(3)Estimated useful life of assets.


Q.N.5 what are various method of Depreciation?

Ans.   Methods of Depreciation classified under the following groups:-

                (1)Uniform charge methods:-

(a) Fixed installment method.

(b) Depletion method

(c) Machine hour rate method


                (2)Declining charged method:-

(a)Diminishing balance method

(b)Sum of years Digit method.

(c)Double Declining method


(3)Others method:-

(a)Group Depreciation method

(b)Annuity method

(c)Inventory system of Depreciation

(d)Insurance policy method


Q.N.6 Explain fixed installments and Diminishing balance method.

Ans.   Fixed installments method: - Under this method depreciation is charged on original cost of the assets on uniform basis. The value of the assets can be reduced to ‘O’ under this method.


Merits: -             

(1) It is simplest to understand and easy to apply.

(2)The value of the assets can be reduce to zero under this method.

Demerits: -

(1) Under this method, same amount of Depreciation is charged from year to year, irrespective of use of the assets.

(2)With the passage of time efficiency of assets decreases but the amount of Depreciation remains the same.


        Diminishing Balance method:-Under this method a fixed rate of depreciation is charged each year on the diminishing value of the assets till the amount is reduced to scrap value.


Merits: -

(1) The amount of depreciation decreases continuously with the decrease in the life of assets.

(2) High amount of Depreciation is provided in earlier year thus reducing the impact of Obsolescence

 Demerits: -       

(1) The book value of assets can never be zero.

(2)The determination of a suitable rate of Depreciation is also difficult.


Q.N.7 Distinguish between Fixed installment method and reducing Installment method (Diminishing Balance method).


(1)The rate and amount of depreciation remains the same each year under fixed installment method. But The rate remains the same, but amount of Depreciation reduces each year under reducing balance method.

(2)Depreciation is calculated on original cost under fixed installment method. But, Depreciation is charged on the diminishing value of assets under reducing Balance Method.

(3)The book value of assets reduces to zero under straight line method. But, The book value of assets can never be zero under reducing balance method.


Q.N.8 Define the following terms:-


                (1)Reserve: - Reserve is an amount set aside out of profits which are not designed to meet any obligation .It is an appropriation of profits.

(2)Capital Reserve: - Profits which may arises from a source other than normal trading activities are called capital reserve e.g. profit on sale of fixed assets.

(3)Revenue Reserve :-( same as reserve)

(4)General reserve:-Reserve which is created out of not for any specific purposes but for strengthening financial position is called General Reserve.

(5)Special Reserve:-Reserves created for any special purpose is known a specific reserve i.e. dividend equalisation fund.

(6)Sinking Fund: - It is a fund that is created for the purpose of replacement of a long term liability either charged against profit or by way of appropriation of profits.

(7)Provisions:-Provision means provided for there possible less or liability which cannot be determined exactly e.g. provision of doubtful debts.

(8)Secret Reserve: - A reserve which is not disclosed on the face of balance sheet but is hidden in various items of balance sheet is called "SecretReserve”.e.g.creating more provision, charging more depreciation


Q.N.9 Distinguish between Provision and Reserve.


Ans.       (1)Provision is a charged against profits. But,  Reserve is an appropriation of profit.

                (2)Provisions must be created irrespective of whether there is profit or loss. But, Reserve cannot be created unless there is sufficient profit.

                (3)Dividend cannot be paid out of provisions. But, Dividend can be paid out of reserve.


Q.N.10 Short questions :-( Fill in the blanks.)      


(1)Under the straight line method of charging depreciation, Depreciation remains the same every year.

(2)The amount of Depreciation charged on machinery will be debited to Depreciation A/C.

(3) The lesson of plant and Machinery should be written off against Depreciation fund account.

(4)Depreciation is process do valuation.

(5)The sale value of an asset after it becomes useless is called Scrap value.

(6)Temporary rise or fall in the price of an asset is called fluctuation.

(7)Depletion method of depreciation is used for wasting assets.

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