Unit 5

Depreciation of Fixed assets &

Final Accounts
 What is Asset ?
In financial accounting, assets are economic
resources.
Anything tangible or intangible that is capable of
being owned or controlled to produce value and that
is held to have positive economic value is considered
an asset.
Simply stated, assets represent ownership of value
that can be converted into cash (although cash itself
is also considered an asset).
 Classification of Assets
Two major asset classes are tangible assets
and intangible assets.

ASSET

TANGIBLE ASSETS INTANGIBLE ASSETS

 Tangible assets have physical form & can be
seen with our eyes.

Intangible assets don't have physical form &

cannot seen with our eyes.
 Types of Assets
Current assets
Fixed assets
ASSET

CURRENT ASSETS FIXED ASSETS

 Current assets are those assets, which in the
ordinary course of business, can be converted
into cash within a short period, normally one
accounting year.
Examples of current assets:
Cash in hand and bank balance
Bills receivables or Accounts Receivables
Sundry Debtors (less provision for bad debts)
Short-term loans and advances.
Inventories of stocks, such as:
Raw materials
Work in process
Stores and spares
Finished goods
Temporary Investments of surplus funds.
Prepaid Expenses
Accrued Incomes etc.
 Fixed assets have commercial value but are
not expected to be consumed or converted
into cash in the normal course of business.
They are long-term, more permanent or
"fixed" items, such as land, building,
equipment, fixtures, furniture, and leasehold
improvements.
Examples of Fixed assets:
land
Buildings
Plant & machinery
Leasehold property
Motor van
Furniture, fixtures & fittings
Tools & equipment
 Intangible assets are nonphysical resources
and rights that have a value to the firm
because they give the firm some kind of
advantage in the market place. Examples of
intangible assets are goodwill, copyrights,
trademarks, patents and computer programs,
Intangible assets include things like
Good will
Intellectual property such as
Copyrights
Trademarks
Patents
Leases
Franchises
Permits and so on.
Introduction to Depreciation
Depreciation refers to two very different but
related concepts:
1. Decline in value of assets, and
2. Allocation of the cost of tangible assets to periods
in which the assets are used.
The former affects values of businesses and entities.
The latter affects net income.
Generally the cost is allocated, as depreciation
expense, among the periods in which the asset is
expected to be used.
Such expense is recognized by businesses for
financial reporting and tax purposes.
Methods of computing depreciation may vary by
asset for the same business.
 What is Depreciation ?

Depreciation means fall in the value of an asset.

According to Pickles Depreciation may be defined as the permanent

and continuous diminution in the quality, quantity or value of the asset.

Carter defined Depreciation as gradual & permanent

decrease in the value of an asset from any cause
 DISTINCTION BETWEEN DEPLETION AMORTIZATION & OBSOLESCENSE

Depletion refers to fall in the value of tangible wasting assets

like Coal mines, timber reserves, oil reserves.

Amortization refers to fall in the value of intangible assets like

GOOD WILL.

Obsolescence occurs when an asset becomes out of date or it goes out of

Use due to new or improved technology or invention.

Due to technological change the use of asset may not remain commercially
viable.

In this case, decline in the value of asset is not due to physical deterioration
But due to new invention.
 Accounting treatment

When asset is purchased

Asset A/c.Dr
To Bank A/c

When expenses incurred on asset

Asset A/c.Dr
To Bank A/c

For providing depreciation on the asset

Depreciation A/c.Dr
To Asset A/c
 For transfer of depreciation to profit & loss account
Profit & Loss A/c.Dr
To Depreciation A/c

For the amount realized on the sale of the asset

Bank A/c.Dr
To Asset A/c

For the loss on sale of asset

Profit & Loss A/c.Dr
To Asset A/c
Notes: 1. the above entry will be reversed in case of profit
2. Loss or profit on sale of asset is ascertained by finding the difference
between the Book value of the asset & the amount realised from the Sale
of the Asset.
 Methods of Depreciation

Straight Line Method

Diminishing Balance Method
 Straight Line Method : It is also called as Fixed Installment
Method or Equal Installments Method or Fixed Percentage
On Original Cost.
Under this Method a Fixed Percentage on original cost of the
asset is written off every year so as to reduce the Asset
account to nil.
Depreciation is calculated by the following Formula In Case
of Straight Line Method

Cost of the Asset + Installation Expenses Scrap Value

Estimated Life Of the Asset In Years

While Calculating Depreciation for a particular year the period

for which the asset is used in the year concerned should also
be taken into the account.
 Diminishing Balance Method is also called as
Written Down Value Method or Reducing
Installment Method.
Under this Method Depreciation is charged at
a Fixed Rate of the Reducing Balance of the
Asset every Year.
Under this Method the Percentage at which
Depreciation is charged remains Fixed, but the
Amount of Depreciation goes on decreasing
every year.
 Problems on Depreciation

1. A Firm purchases a plant for a sum of Rs

10,000 on 1st January, 1990. Installation
charges are Rs 2,000. plant is estimated to
have a scrap value of Rs 1,000 at the end of
its useful life of five years. Your are required
to prepare Plant Account for Five years
charging Depreciation according to Straight
Line Method. (Answer 1,000 value
of asset at the end of 5 years)
2.A firm purchases plant & machinery on 1st Jan,
1980 for Rs 10,000. prepare Plant &
Machinery Account for 3 years charging
Depreciation @ 10 % p.a. according to
Diminishing Balance Method.
(Answer 7,290 value of asset at the end of 3
years)
Capital & Revenue items in Final Accounts

The expenditure of the firm has been divided

into Capital expenditure & Revenue
expenditure.
Items of Revenue expenditure are taken in
trading account & Profit & Loss account.
Items of Capital expenditure are considered in
Balance Sheet
 Capital Expenditure is an Expenditure
intended to benefit future periods in contrast
to the Revenue expenditure, which benefits
the current period
The transactions of Capital expenditure give
benefits for more than one accounting period
such as acquisition and improvements of
assets.
Capital expenditure is non recurring in nature.
 Revenue expenditure
In Accounting revenue expenditure is
synonymous with expenses.
It is incurred for generating revenue in the current
accounting period & its benefits expires within such
period.
Revenue expenditure is recurring in nature.
Examples of Revenue expenditure:
Production expenses, selling expenses, financial
expenses etc..