Page 235 - DMGT104_FINANCIAL_ACCOUNTING

Unit 10: Accounting and Depreciation for Fixed Assets

Illustration 6: Annuity Method Notes
A Plastic Manufacturing Firm takes a lease costing 4,00,000 for 4 years. It decides to write off
this lease by annuity method. You are given from the annuity table that in order to write off the
lease on Annuity Method at 5 per cent interest per annum, the amount to be written off annually
as depreciation amounts to 1,12,804.

Show lease account for all the four years.
Solution:
Lease Account
Date Particulars ( ) Date Particulars ( )
1 st year To Bank A/c 4,00,000 1 st year To Depreciation A/c 1,12,804
To Interest A/c 20,000 To Balance c/d 3,07,196
4,20,000 4,20,000
2 nd year To Balance b/d 3,07,196 2 nd year By Depreciation A/c 1,12,804
To Interest A/c 15,360 By Balance c/d 2,09,752
3,22,556 3,22,556
3 rd year To Balance b/d 2,09,752 3 rd year By Depreciation A/c 1,12,804
To Interest A/c 10,488 By Balance c/d 1,07,436
2,20,240 2,20,240
4 th year To Balance b/d 1,07,436 4 th year By Depreciation A/c 1,12,804
To Interest A/c 5,368
1,12,804 1,12,804

10.3.4 Depreciation Fund Method or Sinking Fund Method

This method is designed in such a way so that the accumulated amount may be readily available
to replace the assets on the expiry of the useful life of the assets. Under this method a sinking
fund is created with the amount of depreciation on assets. An equivalent amount of the depreciation
is invested in some government or marketable securities each year and the amount of interest
on these securities is also reinvested in same securities. On the expiry of the economic life of the
assets, these securities are sold in the market and from the amount realized, the old assets are
replaced. If there is any profit or loss from the sale of these securities, that is transferred to the
profit and loss account. To adopt this method the following journal entries are passed:
1. At the end of first year, when depreciation (which is calculated with the help of sinking
fund table) is charged and transferred to sinking fund or depreciation fund account -

Depreciation Account Dr.
To Sinking Fund Account
2. When depreciation account is transferred to P&L Account
P&L Account Dr.
To Depreciation Account
Alternatively in the place of above two entries, the following one entry may be passed

P&L Account Dr.
To Sinking Fund Account

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