Objectives for providing depreciation

1. For the replacement of assets: The fund equal to the amount of the depreciation is created which will remain in the firm. After the expiry of the life of asset, the same fund can be utilized to replace the new asset.
2. For the determination of true profit or loss: Depreciation is also an expense like repair and maintenance which must be included in profit and loss account to ascertain the correct profit or loss of a business for the year.
3. For the presentation of assets in the balance sheet at their proper value: Depreciation must be charged to each fixed asset for the true and fair presentation of assets in the balance sheet. The depreciation is deducted from the cost or book value of assets each year.
4. For the determination of correct cost of production: Correct cost of production can not be ascertained if the depreciation is not charged to the fixed assets. Thus, it is necessary to include amount of depreciation in the calculation of cost of each product.

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Factors affecting the amount of Depreciation

a) Original cost of the assets: Original cost includes the purchase price of the asset plus freight and installation expenses. Depreciation is charged on cost of asset so, it is found as:

Cost of Asset = Purchase price + Freight (Transportation expenses) + Installation (erection) expenses

b) Estimated working life of the asset: All the fixed assets have their working life which can be estimated but not predetermined. After this period, the assets will be worthless or scrap. The working life of asset plays vital role in the determination of depreciable amount.

c) Scrap value: Scrap value is also called as salvage or residual or terminal value which means to the value that will be realized by selling the asset after the expiry of the estimated working life. Such amount must be deducted in cost of assets in the calculation of depreciation.

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Causes of Depreciation

1. Wears and Tears: The value of an asset declines due to its constant use in the business. Generally, fixed assets are depreciated due to wear and tears which means reduction in the efficiency and value of an asset caused from vibration, friction, accident, movement, erosion etc.
2. Innovation: Due to the development of science and technology, the new and improved automatic machines may be invented. Such invention reduces in the value of old and existing machinery.
3. Expiry of Time: The value of some assets like patent right, copy-right, lease hold property etc. decrease with the passage of time. The right of such assets is predetermined for certain duration. After its expiry, there is no value even it is not used.
4. Exhaustion: The value of some assets like mines and quarries go on declining with the continuous use.
5. Fall in market price: Another reason of depreciation is permanent fall in the price of an asset. The value of asset reduces as the market price of an asset continuously goes on declining.

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Additional notes while prepaing Final Accounts & Depreciation

1. Any reserves or fund account given in the in the trial balance should be shown in the balance sheet only.
2. Any transfer to Employees Provident Fund and other Staff Welfare Fund like pension fund should be debited to P/L account as a charge to profit rather than an appropriation and shown in the balance sheet as "Provision".
3. Declaration of dividend at a certain percentage should be calculated on the paid up capital.
4. Premium paid on redemption of preference share should be written off against the existing share premium account. In its absence, the profit and loss account should be debited.
5. Investment should be shown at cost price.
6. Interest on investment should be calculated on face value of investment.
7. No dividend is paid on calls in advance and call-in-arrears.
8. In case of the transfer of amount from reserve or funds to P/: appropriation account i.e., withdrawl of reserve, should be shown in credit side of P/L Appropriation Account.
9. In case of preference and equity shares, only proposal to pay dividend on preference shares is made before making any proposal for equity dividend.
10. Provision for tax of current year may be shown in P/L Appropriation Account.
11. Tax paid in the current year represents either tax paid of previous year or advance (prepaid) tax paid of current year.
12. Finished goods must always be valued at the lowest of the cost, or replacement or market price. However, raw materials and stores are valued at cost price.
13. Domestic and household expenses of proprietor as rent for the dwelling house, drawing etc, are not debited to the profit and loss account and they should be debited to the capital account.
14. Income tax paid by the proprietor on his income is also his private expense and should not be debited to the profit and loss account and should be debited to capital account. (The treatment is different in case of the final account of company). 

 

1. Depreciation

The non-trading fixed assets of a business like land, building, machinery, furniture etc. may be get depreciated in value due to various reasons. In other words, the value of such assets reduces each year due to use. Such gradual ad permanent reduction in the value of the assets due to wear and tear or from any other causes is called Depreciation. The word depreciation is derived from a Latin work 'Depretium' which is composed of two words 'De' and 'Pretium', where 'De' denotes decrease and 'Pretium' denotes price. Thus, the word depreciation means decrease in the price. It indicates a fail in the value of an asset which is a loss or an expense for a business and shown in the debit side of profit and loss account. It must be deducted from the respective assets in the balance sheet.

According to J.R. Batliboi,"Depreciation means permanent decline in the value of assets due to wear and tear or from any other cause."
According to R.G. Williams,"Depreciation may be dfined as a gradual deterioration in value of assets due to use."

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Marshalling of Assets and Liabilities

The arrangement of assets and liabilities in the balance sheet is known as marshalling of assets and liabilities. The marshalling of assets and liabilities can be done either in order of liquidity or in order of permanency.

In order of liquidity, liquid assets and current liabilities are shown first in the balance sheet. But in order of permanency, those assets and liabilities which are permanent nature are shown first. 

List of Important Adjustments

1. Outstanding Expenses
2. Prepaid Expenses
3. Accrued Income
4. Advance Income
5. Closing Stock
6. Depreciation on Fixed Assets
7. Interest on Capital
8. Interest on Drawing
9. Bad Debts
10. Provision for Bad Debts
11. Provision for Discount on Debtors
12. Provision for Discount on Creditors
13. Goods Lost by Accident
14. Drawing in Goods
15. Goods used in Business
16. Interest on Loan
17. Commission Payable to Managers
18. Taxation

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