Chapter 5 Solutions: Accounting for Fixed Assets and Depreciation
Answers to the Chapter 5 exercises. Each answer is as long as its marks call for: a sentence or two for 1 mark, five clear points or a five-row table for 5 marks, and full working for numerical problems.
Group A: Very Short Answer Questions (1 Mark Each)
1. Define depreciation.
Depreciation is the gradual, continuous and permanent decrease in the book value of a depreciable tangible fixed asset due to wear and tear, passage of time or obsolescence, charged systematically as an expense over the asset’s estimated useful life.
2. Mention any four causes of depreciation.
(1) Physical wear and tear, (2) passage of time (effluxion of time), (3) obsolescence, and (4) depletion or exhaustion of natural resources.
3. State the formula for calculating annual depreciation under the Straight Line Method.
Annual Depreciation = (Total Cost of Asset - Scrap Value) ÷ Estimated Useful Life in Years. When a rate is given instead, Annual Depreciation = Original Cost × Rate ÷ 100, multiplied by months used ÷ 12 for part of a year.
4. Distinguish between Tangible and Intangible Fixed Assets with two examples of each.
Tangible fixed assets have physical substance and can be seen and touched, such as buildings and plant and machinery, while intangible fixed assets have no physical substance but give long-term legal or competitive rights, such as goodwill and patents.
5. What is meant by Scrap Value (Residual Value) of an asset?
Scrap Value (Residual or Salvage Value) is the estimated net realizable value of a fixed asset at the end of its useful life, that is, the amount expected from selling it as scrap. It is deducted from the total cost of the asset to find the amount to be depreciated.
Group B & C: Short and Long Numerical Questions (5 / 8 Marks)
1. Distinguish between the Straight Line Method and Diminishing Balance Method of charging depreciation on any five bases.
Under the Straight Line Method (SLM), a fixed and equal amount of depreciation is charged every year as a fixed percentage of the asset’s original cost. Under the Diminishing Balance Method (DBM), a fixed percentage is charged on the opening book value (written down value) of each year, so the amount charged falls year after year. They differ as follows:
| Basis of Difference | Straight Line Method (SLM) | Diminishing Balance Method (DBM) |
|---|---|---|
| Basis of calculation | Calculated on the original cost of the asset every year | Calculated on the opening book value (written down value) of each year |
| Amount of annual depreciation | Remains constant for every full year of use | Decreases year after year |
| Book value at the end of life | Can be reduced to zero or to the exact scrap value | Never becomes zero, however many years pass |
| Combined charge of depreciation and repairs on the P&L Account | Unequal: the total charge rises in later years, when repairs increase but depreciation stays the same | More even: higher depreciation in the early years offsets higher repairs in the later years |
| Recognition in Nepal | Used for intangible assets (Pool E) and in general financial reporting | Used by the Income Tax Act, 2058 for the tangible asset pools (Pools A, B, C and D) |
For example, on a machine costing Rs. 1,00,000 depreciated at 10% p.a., SLM charges Rs. 10,000 every year, while DBM charges Rs. 10,000 in the first year and Rs. 9,000 (10% of Rs. 90,000) in the second year.
2. Numerical Problem (8 Marks): On 1st Shrawan 2079, Hetauda Cement Co. purchased a machine for Rs. 4,00,000. On 1st Magh 2080, another machine was purchased for Rs. 2,00,000. On 1st Shrawan 2081, half of the machine purchased on 1st Shrawan 2079 was sold for Rs. 1,35,000, and a new machine costing Rs. 1,50,000 was purchased on the same date. Depreciation is charged @ 10% p.a. on the Straight Line Method, and accounts are closed on the last day of Ashadh each year. Prepare the Machinery Account from 2079/80 to 2081/82.
Working Notes (Calculation of Depreciation and Loss on Sale):
Under the Straight Line Method, each year’s depreciation is 10% of the original cost of each machine, reduced in proportion for part of a year.
- Machine I (M-I), purchased on 1st Shrawan 2079 for Rs. 4,00,000:
- 2079/80 (12 months): 10% of 4,00,000 = Rs. 40,000, so the book value at the end of 2079/80 = Rs. 3,60,000.
- 2080/81 (12 months): 10% of 4,00,000 = Rs. 40,000, so the book value at the end of 2080/81 = Rs. 3,20,000.
- Sale of half of M-I on 1st Shrawan 2081:
- Cost of the half sold: 4,00,000 ÷ 2 = Rs. 2,00,000.
- Depreciation already charged on it for two years (2079/80 and 2080/81): 10% of 2,00,000 × 2 = Rs. 40,000.
- Book value on the date of sale: 2,00,000 - 40,000 = Rs. 1,60,000.
- Sale price: Rs. 1,35,000, so the loss on sale = 1,60,000 - 1,35,000 = Rs. 25,000 (credited as By Profit & Loss A/c).
- The half was sold on the first day of 2081/82, so no depreciation is charged on it for 2081/82.
- Remaining half of M-I (cost Rs. 2,00,000): 2081/82 depreciation = 10% of 2,00,000 = Rs. 20,000, so its book value at the end of 2081/82 = 1,60,000 - 20,000 = Rs. 1,40,000.
- Machine II (M-II), purchased on 1st Magh 2080 for Rs. 2,00,000:
- 2080/81 (Magh to Ashadh = 6 months): 2,00,000 × 10% × 6 ÷ 12 = Rs. 10,000, so the book value at the end of 2080/81 = Rs. 1,90,000.
- 2081/82 (12 months): 10% of 2,00,000 = Rs. 20,000, so the book value at the end of 2081/82 = Rs. 1,70,000.
- Machine III (M-III), purchased on 1st Shrawan 2081 for Rs. 1,50,000: 2081/82 (12 months): 10% of 1,50,000 = Rs. 15,000, so the book value at the end of 2081/82 = Rs. 1,35,000.
In the Books of Hetauda Cement Co.
Machinery Account
| Dr. Date | Particulars | J.F. | Amount (Rs.) | Cr. Date | Particulars | J.F. | Amount (Rs.) |
|---|---|---|---|---|---|---|---|
| 2079 Shrawan 1 | To Bank A/c (M-I) | 4,00,000 | 2080 Ashadh end | By Depreciation A/c (M-I) | 40,000 | ||
| 2080 Ashadh end | By Balance c/d (M-I) | 3,60,000 | |||||
| Total | 4,00,000 | Total | 4,00,000 | ||||
| 2080 Shrawan 1 | To Balance b/d (M-I) | 3,60,000 | 2081 Ashadh end | By Depreciation A/c (M-I: 40,000 + M-II: 10,000) | 50,000 | ||
| 2080 Magh 1 | To Bank A/c (M-II) | 2,00,000 | 2081 Ashadh end | By Balance c/d (M-I: 3,20,000 + M-II: 1,90,000) | 5,10,000 | ||
| Total | 5,60,000 | Total | 5,60,000 | ||||
| 2081 Shrawan 1 | To Balance b/d (M-I: 3,20,000 + M-II: 1,90,000) | 5,10,000 | 2081 Shrawan 1 | By Bank A/c (Sale of half of M-I) | 1,35,000 | ||
| 2081 Shrawan 1 | To Bank A/c (M-III) | 1,50,000 | 2081 Shrawan 1 | By Profit & Loss A/c (Loss on sale of half of M-I) | 25,000 | ||
| 2082 Ashadh end | By Depreciation A/c (Half of M-I: 20,000 + M-II: 20,000 + M-III: 15,000) | 55,000 | |||||
| 2082 Ashadh end | By Balance c/d (Half of M-I: 1,40,000 + M-II: 1,70,000 + M-III: 1,35,000) | 4,45,000 | |||||
| Total | 6,60,000 | Total | 6,60,000 | ||||
| 2082 Shrawan 1 | To Balance b/d | 4,45,000 |
Answer: Loss on sale of half of M-I on 1st Shrawan 2081 = Rs. 25,000 (book value Rs. 1,60,000 - sale price Rs. 1,35,000); total depreciation for 2081/82 = Rs. 55,000; closing balance of the Machinery Account at the end of 2081/82 = Rs. 4,45,000.
Check: 2081/82 Credit side 1,35,000 + 25,000 + 55,000 + 4,45,000 = 6,60,000, equal to the Debit side 5,10,000 + 1,50,000 = 6,60,000.