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Module- 4 Depreciation and Inventory valuation

Meaning:Fixed assets such as P& M, furniture,vechicals,tools etc are used in the business for a long period. When they are used for a long period ,they get warnout & gradually diminish in value. Some of the fixe assets like lease,patent right,copy right etc diminish in value due to passage of time even if they are not used in business. some of the fixed assets like computers, vechicals,xerox machine may Therefore all most all fixed assets undergo depriciation for some or other reason. The cost relating to the use of long time assets should be properly calculated & matched against the revenue earned so that periodie net income can be determined. Following are the different names of periodie writeoff for different catogory of assets: 1. Tangible Assets a) Land b)Plants,Blgs equipment,tools,furniture,vechicals } Depriciation c) Natural resources such as oil,timber,coal,ore } Depletion 2. Intangible Assets a) Patents,copyright,trademarks,goodwill }Amortisation in value .

Depreciation : Refers The systematic and rationap allocation of the acquisition cost of natural resources to future periods in which the use of those natural resources contributes to revenue. the tem amortization is used in case of intangible assets, it means systematic & rational collection of the cost of intangible assets to the future period in which the benifit contribute revenue. it is the period write off to expenses over the expected useful life. the term defn refers the periodic allocation of the acquisition cost of a tangible long term assets over its useful life. def: R.G.Williams, defined as a "graphical determination in the value of an assets due to use". L.C.Cropper,deplation is the dimmlation in the financial value of an assets owins to wear & tear,efflux of time, obsolescence or similar causes. Internal accounting standards committee: "deplation is the allocation of the depreciable amt of an assets over its estimated useful life.

Characterstics of Depreciation: 1.It is related to the fixed assets only. 2.determination or fall in the book value of a fixed assets. 3.this dimination is gradual and continous. 4.the decrease is due to the use of the assets in the business,passage of time, obsolescence etc 5.It is a revenue loss. 6.As it is a revenue loss, it is charged against profit.

Causes of Depriciation: 1.Wear and tean due to actual use. 2. Exhaustion or Depletion: Mines,oilweb(reduction in the output). 3. Deterioration. 4. Passage of time. 5. Technological obsolescence. 6. Accidents. 7Permanent fall in the market value.

Facts to be considered for calculation of Depreciation: 1.The cost of an assets . 2.The estimated residreal value or scrap. 3.The estimated useful life of the assets. 4.Intrest on the amt invested on the purchase of the assets. 5.The use to which the assets is put. 6.The amt likely to spent on repairs &renuvals. 7.The possibility of the assets becoming obsolute.

Methods of changing Depriciation: o o o o o o Fixed instalment method or Straight line method. Diminshing balance method or Written down value method. Annuity method. Deprication fund or sinking method. Insurance policy mehtod. Revaluation method.

Fixed instalment method:

This method assumes that depn is a function of time rather than use. This method is based on the assumtion that each accounting period recieves same benefits from using the asset. Under this method the original cost of asset Is written off every year. If the original cost of an asset is Rs,10,000 and the rate of depn is 10% p.a then(10.000*10/100) Rs 1000 will be depn of such asset every year.

NOTE: While changing the depn, the peroid for which the asset is used in particular year should be taken into a/c.For ex: if an asset is used only for six month ina year, then only 6month depn should be changed on that asset in that year. If tha % of depn is not given in the problem,then depn can be calculated by deducting the scrap value of the assset from the cost of theasset and delivery the balance by the no of years the asset is estimated to last. Formula: Depriciation=Cost of asset-Scrap value (no of years) Life of the asset

Advatages: It is simple and easy to understand. Then burden of depn on P&L a/c resnians same every year. This method is recognised under the income tax act.

Drawback: The burden on the P&L a/c in respect of depn and repairs of an asset is not uniform year aften year become, though the amt of depn will be constant year.But the amt of repairs will go on in clearing as the asset become older. Calulation of depn becoms difficult when there are frequent additions. Interest on capital invested on the asset is completely ignored. No fund is created for the replacement of the old assset.

Journal entries: For transferring depn to P&L a/c Profit & loss a/c dr To depn a/c. 2. When provision for depn a/c is maintained . For changing depn. Depriciation a/c dr To provision for depn a/c. If no provision for depn a/c is maintained. For changing depn on the asset Depn a/c dr To Conserned asset a/c For transferring depn to P&L a/c. Profit & Loss a/c dr To depn a/c.

Other important points to be worth noted with this method: 1.Cost of asset: includes purchase price plus commission paid on purchase,plus t ransport change,plus installation changes etc. 2.Period of use:Depn should be changed on the cost of asset at the given rate only f or the actual period for which the assets used,in the absence of clear information, depnshould be changed for full year. 3.Depriciation on addition: If additional asset is introduced during the year,and the date of such asset is given in the question then depn should be changed for the period for which the additional asset is used in the year of If date of aqurisation is not given, then it is better that no depn is changed on such asset on the assumption that the asset may be aquined on the last day of that year. 4.Depriciation on asset sold: If the date of sale is given in the qustion, depn is changed on such asset for the actual period of its use(from the beginning of the year up yo the date of sale otherwise no depn is changed on the asset sold based on the same assumption). 5.Sale of an asset: Sometimes,certain assets may be sold during the year,in such a case the treatment of profit is loss on sale of asset and depn is very important.

a.when the asset is sold cash/bank a/c dr To Concerned asset a/c. b.If there is profit on the sale of asset Asset a/c dr To P&L a/c

c.IF there is loss on tha sale of asset P&L a/c dr TO Asset a/c. Profit or loss on sale of asset can be found out by comparing the wdv of asset on the date of sale with selling price(sp),if sp is more than wdv then it is profitand sp is loss than wdv, then it is treated as loss.

Diminshing Balance method: Under this method diminishing is changed at fixed percentage on the diminishing value or (WDV)written down value of the asset.For ex: If the original cost of the asset is Rs.10,000 and rate of depn 10%p.a. then the first year depn will be changed on Rs.10,000 ,in second year depn is changed on 9000(ie 10000-1000) in third year 8100(9000-900). Advantages: 1. It is simple and easy to calculate. 2. Thidsmethod is recognised by income tax act. 3. Depn is more in earlier years and less in later years. 4. The total burden on P&L a/c in respect of depn and repairs of an asset will be family uniform, because in earlier years the amt of depn is more and amt of repairs will be less,but in later years.this will be reverse.

Drawbacks: 1. The value of asset can not be zero. 2. Interest on capital is invested on asset is ignored. 3. No fund is created for the replacement of asset. This method is fallowed in the case of asset having long life,such as machinary, buildings.

Journal Entries: 1. If no provision for depn a/c is maintained. A.For changing depn Depn a/c dr To asset a/c B.For transferring the depn to P&L a/c Profit &loss a/c dr To Depn a/c. 2.If provision for depn a/c is maintained A.Depn a/c dr To provision for depn a/c. B.For transfer P&L a/c dr To depn a/c.

INVENTARY VALUATION: The term Inventory refers to stock of finished goods purchased and held for resale. Stock of finished goods produced and held for resale.Work-in-process held for conversion into finished goods for sale. Stock of Raw material to be consumed in the production of finished goods for sale & stock of consumable stores etc In short Inventory means Stock of materials or goods held by a concern to meet its future requirements of production & sale. According to International Accounting standard-2, Inventory means tangible properties which Are held for sale in the ordinary course of business. Are in the process of production for such sale. Are to be currently consumed in the production of goods or series for sale including main supplies & consumables other than machinary spares. Types of Inventory: The types of Inventory depends upon the nature of the business. In the case of trading concern :Inventory primarily consists of finished goods. In the case of a manufacturing concern:Inventory consists of (a) Raw materials & components to be converted in to finished goods. (b) work-in-progress (c) Stock-in-trade(finished goods) (d) Consumable stores & supplies to be consumed into production. It may be noted that inventory include Computer software held for resale, land & property held for sale. However ,inventory do not include machinary spares which can be used only in connection with an item of finished goods.

Inventory Valuation Meaning: Inventory Valuation means calculation of the value of inventory or stock in a business at the close of the accounting period. Objectives:- (1) Determination of profit or loss of a business. The Gross Profit of business is the net sales minus C.O.G.S. G.P=Cost of goods sold is deducted from the Net Sales. C.O.G.S=Opening Stock + Purchases minus closing stock. As such ,unless inventory is properly valued the G.P will not be correct. (2) Correct discloser of the financial positions of the business. (3) Locating deficiency, Pilferage etc.

Steps involved in Inventory Valuation. Generally three steps involved. Various inventories(items) should be physically verified and counted to ascertain the quantities. Specific item price should be assigned to every item. The total value of inventories should be ascertained System of Inventory records and Valuation.

There are two systems: Periodical inventory /Physical inventory system. Perpetual /continuous inventory system.

Periodical Inventory System: Under this method ,the valuation of inventory is generally taken up only at the end of the accounting period. At the end of the year ,the quantities of the various items of closing invention are physically counted, then specific unit prices are assigned to the various items of closing inventory. The quantity of each item in multiplied by the specific unit price of that item of inventory .finally the value of each item of closing inventory once added to know the value of closing inventory.

Continues inventory system: According to charteterd institute of management accounts,London PIS refers a system of records maintained by the controlling dept which reflects the physical moments of stocks and their current balance Wheldon: PIS is a method of recording invalentory balanceaften every recipt and issue the facilitate regular charging and to obiate closing down for stock taking. Meaning:PIS is a system of inventory under which inventory or stock records are maintained insuch a way that the value of closing inventory can be ascertained continuously. Principle governing valuation of inventories: Cost is the basic on which the valuation of inventories is made. However, if the market price falls below the cost price,the material price is the basis for the valuation of inventories.so as a rule,inventories valued at cost price or market price.

Historical cost means the cost incurred At the time of aquaisiation, Current replacement cost means replacement price on the data its consumption. Standard cost means pre-determined cost that should be incurred at a given level of efficiency and utilization.

Historical cost basis is the almost inventorily accepted and used. Historical cost of inventories is the aggregate of cost of purchase,cost of conversion and other cost incurred in the inventories to their present location and condition. Exclusion from the cost of inventories: The fallowing cost should be exclude in deterning the cost of inventories. Abnormal amt of wasted materials labour and other production cost. Storage cost unless those are necessary for further production stage. Administrative overhead that do not contribute to bringing the inventory to that present location and condition. Selling and distribution costs.