Page 227 - DMGT104_FINANCIAL_ACCOUNTING

Unit 10: Accounting and Depreciation for Fixed Assets

balance sheet depicts the true and fair view of the financial position of the business. If we Notes
do not make a provision for depreciation for fixed assets it would be incorrect and the
balance sheet would not show the true value of assets.
2. To ascertain the correct profits or losses: The true profit can be ascertained only after
deducting the all costs from the revenue of a period. As the assets are used in the business
to earn revenues. The value of assets falls due to such use in the business. Therefore, such
a fall in the value should be treated as a cost and should be charged against the profit.
Payment for the purchase of assets should be treated a prepaid expenses and it should be
spreaded over a period of time in order to ascertain the true profit.

3. To create a fund for the replacement of assets: If the depreciation on fixed assets is provided
and charged against the profit every year, there will be reduction in the profit by the amount
of depreciation. If the amount is transferred into a fund account, on the expiry of the life of
the machine, there will be creation of depreciation fund to replace the fixed assets.
Thus we see that depreciation plays an important role in the determination of the true amount
of profit, presentation of true and fair financial view of the business and the replacement of
assets on the expiry of the life of the assets.

10.2.3 Methods of Recording of Depreciation

There are two methods to record the depreciation on fixed assets in the books of owner:

1. When provision for depreciation account is maintained: Under this method, the amount
of depreciation each year is transferred to the provision for depreciation account and the
assets are shown in the books at their original cost. And when assets are sold on the expiry
of its useful life, sales proceeds of the assets and the amount of provision for depreciation
is transferred to the assets account. Profit or loss arises from the sale of the assets is carried
to profit and loss account. Under this method the following journal entries are passed in
the books of owner:
(i) When depreciation is charged on Assets:
Depreciation Account Dr.
To Provision for Depreciation Account

(ii) When depreciation is transferred to P&L Account:
P&L Account Dr.
To Depreciation Account

(iii) When assets are sold on the expiry of useful life of the Assets:
Provision for Depreciation Account Dr.
To Assets Account
(iv) If there is any profit on the sale of Assets:
Assets account Dr.

To P&L Account
(v) If there is any loss on the sale of Assets:
P&L Account Dr.

To Assets Account

LOVELY PROFESSIONAL UNIVERSITY 221