Depreciation, Provisions and Reserves

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Test Your Understanding – I
1. You are looking at the profit and loss account of three business enterprises. You find the term depletion in first case and amortisation in third case. State the type of businesses, the three enterprises are into. (Exhaustion of natural resources, Fixed assets and specific contract business.)
2. A pharmaceutical manufacturer has just developed and registered a patent for a rare medicine. Which term will appear in its profit and loss account regarding the cost of patent written-off. (Amortization)
Test Your Understanding – II
State whether the following statements are true or false:

  1. Depreciation is a non-cash expense. (✔ True)
  2. Depreciation is also charged on current assets. (❌ False)
  3. Depreciation is decline in the market value of tangible fixed assets. (❌ False)
  4. The main cause of depreciation is wear and tear caused by its usage. (✔ True)
  5. Depreciation must be charged so as to ascertain true profit or loss of the business.(✔ True)
  6. Depletion term is used in case of intangible assets. (❌ False)
  7. Depreciation provides fund for replacement. (✔ True)
  8. When market value of an asset is higher than book value, depreciation is not charged. (❌ False)
  9. Depreciation is charged to reduce the value of asset to its market value. (❌ False)
  10. If adequate maintenance expenditure is incurred, depreciation need not be charged. (❌ False)
Test Your Understanding – III
There are two dentists Dr. Aggarwal and Dr. Mehta in your locality who are competitors. Both of them have recently bought an equipment for treatment of patients. Dr. Aggarwal has decided to write-off an equal amount of depreciation every year while Dr. Mehta wants to write-off a larger amount in earlier years. They do not know anything about the methods of depreciation. Who is wise in your opinion? Give reasons in support of your answer. (Written down value method is more appropriate because this method is suitable for those assets which are affected by technological changes. Moreover, this method is recognised by income tax hand.)
Test Your Understanding – IV
Basaria Confectioner bought a cold storage plant on July 01, 2014 for Rs.1,00,000.
Compare the amount of depreciation charged for first three years using:

  1. Rate of depreciation @ 10% on original cost basis;
  2. Rate of depreciation @ on written down value basis;
  3. Also, plot the computed amount of depreciation on a graph.
Accounting Period Ending Basis
Original Cost Written Down Value
31 March, 2015 7,500 7,500
31 March, 2016 10,000 9,250
31 March, 2017 10,000 8,325

Test Your Understanding – V
  1. State with reasons whether the following statements are True or False ;
    • Making excessive provision for doubtful debits builds up the secret reserve in
      the business. (✔ True)
    • Capital reserves are normally created out of free or distributable profits. (❌ False)
    • Dividend equalisation reserve is an example of general reserve. (❌ False)
    • General reserve can be used only for some specific purposes. (❌ False)
    • ‘Provision’ is a charge against profit. (✔ True)
    • Reserves are created to meet future expenses or losses the amount of which is not certain. (❌ False)
    • Creation of reserve reduces taxable profits of the business.(❌ False)
  2. Fill in the correct words :
    • Depreciation is decline in the value of ……….. (Assets)
    • Installation, freight and transport expenses are a part of ……….. (Acquisition Cost)
    • Provision is a ……….. against profit. (Charge)
    • Reserve created for maintaining a stable rate of dividend is termed as……….. (Dividend equilization fund)