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.passage of time. 6. Characterstics of Depreciation: 1.efflux of time.C. L.Cropper.this dimination is gradual and continous.deplation is the dimmlation in the financial value of an assets owins to wear & tear.the decrease is due to the use of the assets in the business.It is related to the fixed assets only. .It is a revenue loss.G. 4. 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. defined as a "graphical determination in the value of an assets due to use".As it is a revenue loss. Internal accounting standards committee: "deplation is the allocation of the depreciable amt of an assets over its estimated useful life. obsolescence etc 5.determination or fall in the book value of a fixed assets. 2. def: R. it is charged against profit. 3. the term defn refers the periodic allocation of the acquisition cost of a tangible long term assets over its useful life.Williams. it is the period write off to expenses over the expected useful life. obsolescence or similar causes.

The use to which the assets is put. Revaluation method. Deterioration. 6.The cost of an assets .The estimated residreal value or scrap. 3. 7. 2.The amt likely to spent on repairs &renuvals. Insurance policy mehtod. 5. Accidents.Causes of Depriciation: 1. 7Permanent fall in the market value.The estimated useful life of the assets. Passage of time. 3. 6. 4. 4. Methods of changing Depriciation: o o o o o o Fixed instalment method or Straight line method. Deprication fund or sinking method. Diminshing balance method or Written down value method. . Facts to be considered for calculation of Depreciation: 1.Wear and tean due to actual use. Annuity method. Exhaustion or Depletion: Mines.oilweb(reduction in the output).The possibility of the assets becoming obsolute. Technological obsolescence.Intrest on the amt invested on the purchase of the assets. 2. 5.

Then burden of depn on P&L a/c resnians same every year. Formula: Depriciation=Cost of asset-Scrap value (no of years) Life of the asset • • • Advatages: • • • It is simple and easy to understand.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. then only 6month depn should be changed on that asset in that year. If tha % of depn is not given in the problem.10.000*10/100) Rs 1000 will be depn of such asset every year. the peroid for which the asset is used in particular year should be taken into a/c. This method is recognised under the income tax act. If the original cost of an asset is Rs.For ex: if an asset is used only for six month ina year.000 and the rate of depn is 10% p.’ Under this method the original cost of asset Is written off every year. • • • • NOTE: While changing the depn. This method is based on the assumtion that each accounting period recieves same benefits from using the asset.a then(10. .Fixed instalment method: • This method assumes that depn is a function of time rather than use.

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. 2.But the amt of repairs will go on in clearing as the asset become older. When provision for depn a/c is maintained . No fund is created for the replacement of the old assset. For changing depn on the asset Depn a/c dr To Conserned asset a/c For transferring depn to P&L a/c. Depriciation a/c dr To provision for depn a/c. . If no provision for depn a/c is maintained. Calulation of depn becoms difficult when there are frequent additions. For changing depn. • • • Journal entries: • • • • • • • • • • • • • • • • For transferring depn to P&L a/c Profit & loss a/c dr To depn a/c. Profit & Loss a/c dr To depn a/c. Interest on capital invested on the asset is completely ignored. though the amt of depn will be constant year.

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.certain assets may be sold during the year.Depriciation on asset sold: If the date of sale is given in the qustion. 4.when the asset is sold cash/bank a/c dr To Concerned asset a/c.Sale of an asset: Sometimes.Cost of asset: includes purchase price plus commission paid on purchase. 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.Other important points to be worth noted with this method: 1. 3. 5. depnshould be changed for full year.in such a case the treatment of profit is loss on sale of asset and depn is very important.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.plus t ransport change.Depriciation on addition: If additional asset is introduced during the year.in the absence of clear information.If there is profit on the sale of asset Asset a/c dr To P&L a/c . 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). a. b.plus installation changes etc.

2. 3. 4.such as machinary.but in later years.if sp is more than wdv then it is profitand sp is loss than wdv.000 . Diminshing Balance method: Under this method diminishing is changed at fixed percentage on the diminishing value or (WDV)written down value of the asset. No fund is created for the replacement of asset. Thidsmethod is recognised by income tax act.this will be reverse. then it is treated as loss.a.For ex: If the original cost of the asset is Rs.c. It is simple and easy to calculate. buildings. Interest on capital is invested on asset is ignored. because in earlier years the amt of depn is more and amt of repairs will be less.000 and rate of depn 10%p. Advantages: 1. .10. The total burden on P&L a/c in respect of depn and repairs of an asset will be family uniform. 3.IF there is loss on tha sale of asset P&L a/c dr TO Asset a/c.in second year depn is changed on 9000(ie 10000-1000) in third year 8100(9000-900). 2. 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). Depn is more in earlier years and less in later years. Drawbacks: 1. then the first year depn will be changed on Rs.10. The value of asset can not be zero. This method is fallowed in the case of asset having long life.

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

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

There are two systems: • • Periodical inventory /Physical inventory system. The total value of inventories should be ascertained System of Inventory records and Valuation. . Pilferage etc.S.G. (2) Correct discloser of the financial positions of the business. Specific item price should be assigned to every item.S=Opening Stock + Purchases minus closing stock. (3) Locating deficiency.O.Inventory Valuation Meaning: Inventory Valuation means calculation of the value of inventory or stock in a business at the close of the accounting period.P will not be correct. As such . Generally three steps involved. • • • Various inventories(items) should be physically verified and counted to ascertain the quantities.(1) Determination of profit or loss of a business.G. G. Perpetual /continuous inventory system. C. Steps involved in Inventory Valuation. Objectives:. The Gross Profit of business is the net sales minus C.O.P=Cost of goods sold is deducted from the Net Sales.unless inventory is properly valued the G.

The quantity of each item in multiplied by the specific unit price of that item of inventory . 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.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. then specific unit prices are assigned to the various items of closing inventory.finally the value of each item of closing inventory once added to know the value of closing inventory. . Principle governing valuation of inventories: Cost is the basic on which the valuation of inventories is made. At the end of the year . Historical cost means the cost incurred At the time of aquaisiation.inventories valued at cost price or market price. if the market price falls below the cost price. Continues inventory system: “According to charteterd institute of management accounts.the quantities of the various items of closing invention are physically counted.the material price is the basis for the valuation of inventories. However. Standard cost means pre-determined cost that should be incurred at a given level of efficiency and utilization.Periodical Inventory System: Under this method .the valuation of inventory is generally taken up only at the end of the accounting period.so as a rule. • • Current replacement cost means replacement price on the data its consumption.

Storage cost unless those are necessary for further production stage. 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. Administrative overhead that do not contribute to bringing the inventory to that present location and condition.cost of conversion and other cost incurred in the inventories to their present location and condition. Historical cost of inventories is the aggregate of cost of purchase.Historical cost basis is the almost inventorily accepted and used. . Selling and distribution costs.

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