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Fixed Assets Accounts

Fixed Assets Accounts

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Published by: wsenelwa7132 on May 21, 2014
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Accounting for Fixed Assets
Fixed Asset
Every business acquires various types of fixed assets such as land & building, plant & machinery, furniture, vehicles etc. These assets are used to derive production capacity. Therefore, they are also known as earning assets. Fixed assets are purchased for continued and long-term use in earning profit in a business. They are written off against profits over their anticipated life by charging an annual amount calculated so as to eliminate the original cost, less scrap, over that period. The life of fixed assets spans over several years. Therefore, the business needs to make long term investment in fixed assets.
Except land, all fixed assets have a limited life. During such period, due to continuous use and/or lapse of time, the value of some assets starts decreasing. Such a gradual decrement of value of assets is called Depreciation. Hence, depreciation can be defined as a decline in the value of an asset due to constant use. Since these assets have limited life, sooner or later they have to be replaced. At the time of replacement, the business incurs heavy cash outflow which can create liquidity problem in that year. In order to avoid such problem, a fixed amount out of profit is set aside as depreciation account. By the time the fixed asset expires, sufficient amount of fund will be accumulated in depreciation account which, then can be used to buy new asset. Hence, the process of setting aside a fixed amount as expense in depreciation account is called Depreciation.
Characteristics of Depreciation
The following are some of the features of depreciation: 1.
Depreciation may be physical and functional. 2.
Depreciation is a gradual/permanent and continuous decrease in the utility value of a fixed asset and it continues till the end of useful life of an asset. 3.
Depreciation arises due to the use of assets in productive activities. 4.
The primary object of depreciation is to allocate expired cost of fixed assets against a number of accounting periods. 5.
Depreciation is charged in respect of fixed assets only i.e., building, machinery, equipment and furniture etc. 6.
Depreciation is a charge against profit. 7.
Total depreciation of an asset can not exceed its depreciable value (cost less scrap value).
Causes of Depreciation
Depreciation is a measure of reduction in the use-value of an asset. It can be physical deterioration or decrease in the market value. The primary causes of depreciation are as follows: 1.
Wear and Tear:
 Due to constant use, assets get worn or torn out. 2.
 Exhaustion is the depletion of some assets due to continuous use and lapse of time. In case of mines and oil wells, the continuous extraction of minerals or oil, a
 2 stage comes when the mine or well gets completely exhausted an nothing is left. 3.
 Some assets are discarded before they are completely worn out because of changed conditions. This is the case when an asset becomes usefulness because of technological advancement, new invention, change in style etc. in that asset. 4.
Efflux of time:
 Certain assets get decreased in their value with the passage of time. This is true in case of assets like leasehold properties, patents and copyrights etc. 5.
 Accidents can cause depreciation in the value of the asset.
Objectives of making provision for depreciation
Depreciation accounting is a must for every business for attaining the following objectives:
To ascertain net profit
Depreciation is the expense for the business. Hence to ascertain the net profit, it must be included in the total cost of sales.
To depict the true financial position of the business
The balance sheet depicts true financial position of a business at a point of time. To depict the true financial position of the business the assets should be shown in balance sheet not in its original cost but at the depreciated cost. That is all fixed assets should be shown at cost less the amount of depreciation suffered by them till the date of the balance sheet.
To ascertain cost of production
Depreciation is an expense. Hence it is necessary to charge depreciation in the total cost of production to fix true sales price of the goods and service.
Replacement of assets
One of the primary objectives of depreciation is the provision for the replacement cost on the retirement of original assets.
To follow the company act
According to company act, it is compulsory to charge depreciation on fixed assets.
To ascertain income tax
If depreciation is not charged, the operation will show more profit. As a result, the taxable income will be higher. Hence, depreciation is charged for the correct ascertainment of total taxable income.
Accounting Treatment for Depreciation
Since depreciation is an expense it must be charged to Profit & Loss a/c. The entire process  begins with the purchase of fixed asset. In the next step, the following journal entries have to be  passed for recording depreciation on assets.
For purchase of fixed assets
Fixed assets a/c Dr. ……………… To, Cash/Bank a/c ………………
 3 (For purchase of fixed assets)
For charging depreciation at the end of the year
Depreciation a/c Dr. ……………… To, Fixed asset a/c ……………… (For depreciation on asset)
For transferring depreciation to PL a/c
Profit & Loss a/c Dr. ……………… To, Depreciation a/c ……………… (For transfer of depreciation to P/L a/c)
Additional Entries 4.
For sale of fixed assets
Cash/Bank a/c Dr. ……………… To, Fixed asset a/c ……………… (For sale of fixed asset)
For gain on sale of fixed assets
Fixed asset a/c Dr. ……………… To, Profit & Loss a/c ……………… (For gain on sale of fixed asset)
For loss on sale of fixed asset
Profit & Loss a/c Dr. ……………… To, Fixed asset ……………… (For loss on sale of fixed asset)
Methods of Depreciation
There are a number of different methods of providing depreciation for the assets. The method of depreciation depends on a number of factors such as type of asset, life, policy organization etc. The following are the list of methods of depreciation: 1.
Fixed installment method 2.
Diminishing Balance method 3.
Sum of the year digits method 4.
Annuity method 5.
Depreciation Fund method 6.
Insurance policy method 7.
Revaluation method 8.
Depletion method 9.
Machine hour rate method 10.
Double declining methods 11.
MACRS (Modified Accelerated Cost Recovery System) method As per the syllabus of BIM 4
 Semester, we will discuss following 3 methods only:

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