Depreciation Concepts and Methods
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Questions and Answers

What is the primary reason for creating a provision for doubtful debts?

  • To provide a cushion for unexpected expenses related to debt recovery efforts.
  • To reduce the company's tax liability by creating a reserve for future losses.
  • To ensure the accuracy of the company's balance sheet by reflecting potential losses from uncollectible debts. (correct)
  • To increase the company's net income by offsetting anticipated bad debts.

    • Which of the following is a key factor included in calculating the original cost of a resource (asset)?

  • The cost of transportation and installation related to the asset. (correct)
  • The amount of depreciation accrued over the asset's useful life.
  • The expected future value of the asset based on market conditions.
  • The estimated salvage value of the asset at the end of its useful life.

    • The depreciated cost of an asset represents the:

  • The value of the asset at the time of its initial purchase.
  • The estimated market value of the asset at the end of its useful life.
  • The remaining value of the asset after deducting accumulated depreciation. (correct)
  • The total amount of depreciation recorded on the asset.

    • Which of these entities can legally create secret reserves as per the Companies Act?

    <p>Financial institutions like banks and insurance companies. (C)</p> Signup and view all the answers

    What is the main characteristic of the disposal of an asset?

    <p>Removing the asset from the accounting records and the business. (B)</p> Signup and view all the answers

    Which depreciation method charges a fixed amount of depreciation each year, regardless of the asset's book value?

    <p>Straight Line Method (D)</p> Signup and view all the answers

    What is the term used to describe the reduction in the value of natural resources due to extraction?

    <p>Depletion (D)</p> Signup and view all the answers

    Which of the following factors can cause an asset to become obsolete?

    <p>Availability of a newer, more efficient asset (C)</p> Signup and view all the answers

    What is the term used to describe the period during which an asset is considered productive and cost-effective?

    <p>Useful Life (B)</p> Signup and view all the answers

    Which method of depreciation charges depreciation on the remaining book value of the asset each year?

    <p>Written Down Value Method (A)</p> Signup and view all the answers

    What is the primary reason for depreciation of fixed assets due to 'Wear and Tear'?

    <p>Regular Use and Maintenance (A)</p> Signup and view all the answers

    Which of the following factors is NOT a significant cause of depreciation in fixed assets?

    <p>Expansion of Business Operations (B)</p> Signup and view all the answers

    In the context of depreciation, what does 'book value' refer to?

    <p>The remaining value of the asset after subtracting accumulated depreciation (B)</p> Signup and view all the answers

    Which of the following is NOT a characteristic of a provision in accounting?

    <p>Can be considered as savings for the company (D)</p> Signup and view all the answers

    What is the primary difference between a reserve and a provision?

    <p>Reserves are used for business growth and expansion, while provisions are used to cover future liabilities (B)</p> Signup and view all the answers

    Which type of reserve is created from the net profit earned by a company during a financial year, and is not distributed to shareholders as dividends?

    <p>Revenue Reserve (B)</p> Signup and view all the answers

    What is the primary function of a general reserve?

    <p>To offset future losses and enhance working capital (A)</p> Signup and view all the answers

    Which statement is accurate regarding specific reserves?

    <p>They can only be used for the specific purpose for which they were created (D)</p> Signup and view all the answers

    What is the distinguishing feature of a capital reserve?

    <p>They are permanently invested and cannot be used for other purposes (A)</p> Signup and view all the answers

    What is the 'book value' of an asset?

    <p>The total value of the asset minus intangible assets and liabilities (B)</p> Signup and view all the answers

    Which statement accurately describes the 'scrap value' of an asset?

    <p>The amount of money that can be recovered from selling the asset as scrap (D)</p> Signup and view all the answers

    Which of the following best describes the 'salvage value' of an asset?

    <p>The estimated value of the asset at the end of its useful life. (C)</p> Signup and view all the answers

    Which of the following is a common use of the 'salvage value'?

    <p>Calculating the annual depreciation expense (B)</p> Signup and view all the answers

    What is the main purpose of a secret reserve?

    <p>To hide the true financial position of the company (D)</p> Signup and view all the answers

    A company creates a reserve from its profit to meet a potential future liability, but the exact amount of the liability is uncertain. What type of reserve is this?

    <p>Provision (A)</p> Signup and view all the answers

    Which of the following is a key distinction between a general reserve and a specific reserve?

    <p>General reserves can be used for any purpose, while specific reserves have a specific purpose (A)</p> Signup and view all the answers

    Which type of reserve is created from the profits earned when a company sells its fixed assets?

    <p>Capital Reserve (C)</p> Signup and view all the answers

    Which of the following best describes the 'Diminishing Balance Method' of depreciation?

    <p>Depreciation is calculated as a fixed percentage of the asset's depreciable value each year (A)</p> Signup and view all the answers

    Flashcards

    Depreciation

    Reduction in the cost of a fixed asset due to wear and tear until it becomes obsolete.

    Depletion

    Reduction in the stock value of natural resources like oil or minerals when extracted.

    Wear and Tear

    Deterioration of an asset's value due to its use in business operations.

    Obsolescence

    An asset becoming outdated due to the availability of better alternatives.

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    Useful Life

    The estimated time an asset can function efficiently before it becomes ineffective.

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    Straight Line Method

    A depreciation method where a fixed amount is charged annually based on original cost.

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    Written Down Value Method

    A depreciation method where depreciation is charged on the reduced book value each year.

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    Abnormal Factors

    Permanent drops in asset use caused by accidents or disasters like floods or earthquakes.

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    Secret Reserves

    Reserves maintained by institutions like banks and insurance companies, exempt from Companies Act regulations.

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    Provision for Doubtful Debts

    An adjustment for expected bad debts from good debtors after trial balance preparation.

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    Original Cost

    Total cost of acquiring an asset including purchase price, installation, and other related expenses.

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    Depreciable Cost

    Value of an asset minus accumulated depreciation; indicates its worth after useful life ends.

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    Disposal of Assets

    Complete removal of an asset from the business and its accounting records when no longer needed.

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    Diminishing Balance Method

    A depreciation method where the asset's value decreases over time, often faster in early years.

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    Scrap Value

    The estimated residual value of an asset after it is no longer usable.

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    Book Value

    Total estimated value of a company's assets minus liabilities and intangible assets.

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    Salvage Value

    The estimated value of an asset at the end of its useful life.

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    Provisions

    Amounts set aside for probable future expenses or asset reductions.

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    Reserves

    Retained earnings used for financial stability or future purposes.

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    General Reserves

    Reserves set aside for unspecified business needs, created from profits.

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    Specific Reserves

    Reserves earmarked for specific purposes, cannot be easily repurposed.

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    Revenue Reserves

    Reserves created from net profit to meet future business needs.

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    Capital Reserves

    Reserves made from capital profits, used for specific long-term purposes.

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    Net Book Value

    The total value of a company's assets, accounting for depreciation and liabilities.

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    Intangible Assets

    Non-physical assets like patents and brand names that add value to a company.

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    Liabilities

    Financial obligations or debts that a company owes to outside parties.

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    Depreciation Expense

    The accounting method of allocating the cost of tangible assets over their useful lives.

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    Study Notes

    Depreciation Concepts

    • Depreciation: Reduction in cost of a fixed asset due to wear and tear over its useful life. It reflects the period during which the asset is productive.
    • Depletion: Reduction in the value of natural resources (e.g., oil wells, mines) as they are extracted.
    • Wear and Tear: Deterioration and decrease in an asset's value from its use in generating revenue.
    • Expiration of Legal Rights: Loss of asset value when the agreement allowing its use expires.
    • Obsolescence: Asset becomes outdated due to newer, better assets becoming available.
    • Abnormal Factors: Accidental losses (e.g., fire, flood) leading to permanent but non-recurring asset value reductions.
    • Useful Life: Estimated time an asset functions efficiently. Estimated by vendor or professional based on current condition and usage.

    Depreciation Methods

    • Straight-Line Method: Fixed depreciation amount charged annually throughout the asset's life. Based on original cost. Also known as original cost method or fixed instalment method.
    • Written-Down Value Method: Depreciation charged on the asset's book value (cost - depreciation) each year. Book value decreases, and depreciation also decreases annually. Also known as diminishing balance method or reducing installment method.

    Asset Valuation

    • Scrap Value: Salvage value of an asset at the end of its useful life when it's no longer functional.
    • Book Value: Estimated value shareholders would receive if the company liquidated the asset. Calculated by total assets minus intangible assets and liabilities. An important metric for evaluating whether stock is undervalued or overvalued.
    • Salvage Value: Estimated value of an asset at the end of its useful life. Used in depreciation calculations and for tax deductions.
    • Depreciable Cost: Asset's worth minus accumulated depreciation.
    • Disposal of Assets: Complete removal of an asset from business operations and accounting records.

    Reserves and Provisions

    • Provisions: Amounts set aside for probable future expenses or asset value reductions, even if the amount is uncertain.
    • Reserves: Retained earnings used to strengthen financial position, clear debt, fund expansion, or meet legal requirements. Not restricted in use.
    • General Reserves: Profit set aside without a specific purpose. Used to meet contingencies, offset losses, enhance capital, or pay dividends.
    • Specific Reserves: Created for a specific business purpose; cannot be used for other purposes unless allowed by articles of association and board approval.
    • Revenue Reserves: Created from net profit for meeting future business needs. Not distributed as dividends.
    • Capital Reserves: Created from capital profits, often for inflation, expansion, or new projects. Permanently invested; not usable for other purposes.
    • Secret Reserves: Undisclosed reserves (hidden or internal) often used by insurance companies or banks. Illegal for most other companies because of accounting/reporting obligations.

    Specific Accounting Items

    • Provision for Doubtful Debts: Amount set aside to cover expected bad debts.
    • Original Cost: Price and related expenses (installation, testing, commissions) involved in purchasing and putting asset into use.

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    Description

    Test your knowledge on depreciation concepts and methods. This quiz covers essential principles like wear and tear, obsolescence, and various depreciation methods, such as the straight-line method. Perfect for those studying asset management or accounting.

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