Depreciation, Reserve & Provision MCQ Quiz - Objective Question with Answer for Depreciation, Reserve & Provision - Download Free PDF

The correct answer is Straight line method

Key Points

• Depreciation: The fall in the monetary value of an asset due to its constant use, wear, and tear, obsolescence is termed as Depreciation. It is considered a yearly non-cash expense of a company.
• Depreciation in accounting only involves the allocation of the cost of the asset as revenue during the useful life of the asset. Depreciation represents how much of an asset's value has been used over the years of its life. 

Important Points 

• Under the Straight-line method of depreciation, the depreciation on any asset is charged on the original cost of the assets, which was paid at the time of purchasing of the asset. The value of depreciation is fixed and equal for all years.
• It is calculated by deducting the salvage value of the asset from the cost and then dividing it by the total estimated life of the asset.
• The formula for calculating depreciation charged using the Straight-line method-
  • (Original Cost - Salvage Value) / (Useful life of the asset)

The correct answer is All I, II, III, and IV above.

Key Points

Obsolescence:

• Obsolescence of a depreciable asset refers to the situation when an asset becomes outdated, less useful, or less valuable due to various factors.
• These factors can include technological changes, improvement in production methods, changes in market demand, or legal and other restrictions.

Important Points

• Technological changes: Technological changes can make a depreciable asset obsolete by making it less efficient or less effective than newer models. For example, a computer that was once state-of-the-art may become obsolete as newer models with more features are released.
• Improvement in production methods: Improvements in production methods can also make a depreciable asset obsolete by making it less cost-effective to produce. For example, a manufacturing plant that was once efficient may become obsolete if a new production method is developed that is more efficient.
• Change in market demand: Changes in market demand can also make a depreciable asset obsolete by making it less desirable to consumers. For example, a car that was once popular may become obsolete if consumer preferences shift towards a different type of car.
• Legal or other restrictions, such as changes in environmental regulations, can also lead to obsolescence. However, these are less common causes of obsolescence than technological changes, improvements in production methods, and changes in market demand.

The correct answer is To charge the cost of fixed assets against profits

Key Points

• Depreciation: The fall in the monetary value of an asset due to its constant use, wear, and tear, obsolescence is termed as Depreciation. It is considered as a yearly non-cash expense of a company.
• Provision for Depreciation: This account is used to accumulate depreciation that is provided against a fixed asset every year.

Important Points

•  Every year the amount of Depreciation is transferred to the Provision for Depreciation account and is deducted from profits in order to ascertain the true profit of the firm. So, the purpose of making a provision for depreciation is to charge the cost of fixed assets against profits.

The correct answer is Intangible asset

Key Points

• Amortization: The allocation of the cost of an intangible asset over its useful life is called amortization. It is similar to depreciation charged on tangible fixed assets.

Additional Information

• Wasting asset: A wasting asset is an item that has a limited life span and whose value declines over time.
• Intangible assets: These are the assets of the business that do not have a physical existence. For example- Goodwill, Patents, Trademarks, etc.
• Fictitious assets: These are assets that have no physical existence but are expenditures that are not written off in one accounting period. These are referred to as deferred revenue expenditures. For example- advertisement expenses

The correct answer is Rs. 20,000 Loss

 Key Points

• Depreciation: The fall in the monetary value of an asset due to its constant use, wear, and tear, obsolescence is termed as Depreciation. It is considered a yearly non-cash expense of a company.
• Depreciation in accounting only involves the allocation of cost of the asset as revenue during the useful life of the asset. Depreciation represents how much of an asset's value has been used over the years of its life. 

Important Points

• Profit/Loss = Sale Price - Purchase Price - Accumulated Depreciation
• Profit/Loss = 80,000 - 9,00,000 - 8,00,000 
• Profit/Loss = (20,000)

Key PointsDepreciation: Depreciation is an accounting strategy used to spread out the cost of an item over time, often during its useful life, which is determined by making an estimate of the number of years the asset is likely to be in use and producing income.

Straight-line depreciation: This is the most common method and is used to split the value of an asset evenly during its useful life.

To calculate using the straight-line depreciation method:

1. Subtract the salvage value from the asset cost.
2. Divide that number by its useful life.
3. The formula looks like this:
4. (Asset cost - salvage value) / useful life = depreciation value per year.        

Important Points

In the above question,

• The cost of machinery is given = Rs. 5,00,000
• Salvage Value =Rs. 50,000 (given)
• Useful Life = 10,000 hrs.(Given)
• Depreciation value per hour = (5,00,000 - 50,000)/10,000 = 45 
• Hence, Depreciation value for 2,000 hours = 45 x 2,000 = 90,000.

Hence, depreciation to be charged for the year would be 90,000.

 Additional InformationMethods of calculating Depreciation

1. Double-declining balance depreciation: This method is used to depreciate more of an asset's value immediately after you buy it and less value later in its life.
2. Sum-of-the-year digits depreciation: This method is used to depreciate more of an asset's cost in the earliest years of its useful life.
3. Units of production depreciation: This method is used to depreciate a piece of equipment based on how much work it does or can do.

The correct answer is allocating the cost.

Key Points

• Depreciation is the process of allocating and claiming a tangible asset's cost each financial year that is spread over its predicted economic life.
• As time passes, the value of any given asset decreases, and there needs to be a way for businesses to account for this loss in value.

Important PointsCalculation of Depreciation:

The depreciation of an asset can be calculated using the following formula:

(Cost – Salvage Value) / Useful Life of the Asset

Methods of Depreciation

• Straight-Line Depreciation: Under this method, an equal amount is charged for depreciation of every fixed asset in each of the accounting periods. 
  Annual Depreciation Expense = (Cost of an asset – Salvage Value)/Useful life of an asset
• Diminishing Balance Depreciation: A fixed percentage of depreciation is charged in each accounting period to the net balance of the fixed asset under this method. This net balance is nothing but the value of asset that remains after deducting accumulated depreciation.
  Depreciation Expense = (Book value of asset at beginning of the year x Rate of Depreciation)/100

Hence, it can be concluded that Depreciation is a process of allocating the cost of a fixed asset over its useful life.

The diminishing method of depreciation provides more depreciation in the initial years.

Key Points

Diminishing Balance Method

• According to the Diminishing Balance Method, depreciation is charged at a fixed percentage on the book value of the asset.
• As the book value reduces every year, it is also known as the Reducing Balance Method or Written-down Value Method.
• Since the book value reduces every year, hence the amount of depreciation also reduces every year. Under this method, the value of the asset never reduces to zero.
• This method is based on the assumption that in the earlier years the cost of repairs to the assets is low and hence more amount of depreciation should be charged. Also, in the later years, the cost of repairs will increase and therefore less amount of depreciation shall be provided. Hence, this method results in an equal burden on the profit every year during the life of the asset.

Additional Information

Depreciation can be defined as a continuing, permanent, and gradual decrease in the book value of fixed assets. This type of shrinkage is based on the cost of assets utilized in a firm and not on its market value.

 1. Straight Line Method (SLM)​

• Under the depreciation Straight Line Method, a fixed depreciation amount is charged annually, during the lifetime of an asset. The amount of annual depreciation is computed on the Original Cost, and it remains fixed from year to year. This method is also known as the ‘Original Cost method’ or ‘Fixed Instalment method’.

2. Written Down Value Method (WDV)

• ​Under the Written Down Value method, depreciation is charged on the book value (cost –depreciation) of the asset every year. Under the WDV method, book value keeps on reducing so, annual depreciation also keeps on decreasing. This method is also known as the ‘Diminishing Balance Method’ or ‘Reducing Instalment Method’.

Key Points

Depreciation - A continuing, permanent, and steady decline in the book value of fixed assets is referred to as depreciation.

Important PointsDepletion method - 

• Wasted assets include coal, mines, wells, and others, depletion method of depreciation is applied for these types of assets.
• By dividing an asset's cost by the expected amount of potentially accessible goods, one may get the rate of depreciation. When multiply the entire output for the fiscal year by the rate of depreciation, may determine the amount of depreciation.

Straight line method - 

• The simplest and most user-friendly depreciation approach is the straight-line method.
• It is the depreciation method that is most frequently utilized. It's also known as the original cost approach.
• According to this procedure, the residual value is subtracted from the asset's cost before the sum is divided by the number of years the asset was in use or its useful life.

Annuity method - 

• The annuity method of depreciation is a technique used to determine the rate of depreciation on an asset, precisely as if it were an investment.
• It is frequently applied to assets with high initial costs, lengthy useful lives, and fixed (or at least consistent) rates of return.

Diminishing balance method - 

• The Diminishing Balance Method charges depreciation as a fixed proportion of the asset's book value.
• It is sometimes referred to as the Reducing Balance Method or Written-Down Value Method because the book value declines annually.

Thus, Depletion method of depreciation is most appropriate for a copper mine.

Key Points

Reserve -  refers to a quantity or portion of profit that a business preserves or sets aside at the conclusion of a fiscal year to cover potential future unforeseen expenses. The business is strengthened using it as well.

Important PointsOption 1: A reserve is an appropriation of profit - The sums set aside from profits are known as reserves. It is the appropriation of profits or accumulated gains to improve the company's financial standing. It is not an accusation of profiteering. Thus, option 1 is correct.

Option 2: is created to cover a known liability or expected future loss - Provision is created to cover a known liability or expected future loss. Thus, option 2 is incorrect.

Option 3: is a charge against profits - As a reserve is only generated when a corporation is profitable, it is an appropriation of profit. When a corporation doesn't make a profit, it can't build up reserves to use in the future. It doesn't come out of the profit. Thus, this option is incorrect. 

Option 4: is meant to strengthen the financial position of the business - A reserve is a sum of retained earnings that a corporation has set aside to strengthen its financial position, pay off debt and credit, purchase fixed assets, expand the business, and fund other activities. Thus, this option is correct. 

Hence, both (ii) and (iii) options are INCORRECT.

The correct answer is Rs. 20,000 Loss

 Key Points

• Depreciation: The fall in the monetary value of an asset due to its constant use, wear, and tear, obsolescence is termed as Depreciation. It is considered a yearly non-cash expense of a company.
• Depreciation in accounting only involves the allocation of cost of the asset as revenue during the useful life of the asset. Depreciation represents how much of an asset's value has been used over the years of its life. 

Important Points

• Profit/Loss = Sale Price - Purchase Price - Accumulated Depreciation
• Profit/Loss = 80,000 - 9,00,000 - 8,00,000 
• Profit/Loss = (20,000)

Accounting Standard- A set of concepts, standards, and procedures that constitute the foundation of financial accounting policies and practices are known as accounting standards.

Key Points

Depreciation - Depreciation is an accounting method for allocating the cost of a tangible or physical asset over its usable life or expected life. In simple terms, it can be referred to as a reduction in the value of tangible fixed assets over time due to its wear and tear.

As per accounting standard 6 on depreciation accounting, there is various method of calculating depreciation such as straight-line method, written down value method, unit production method, etc. 

As per IAS 8 on Accounting Policies, Changes in Accounting Estimates and Errors, a company is allowed to change its accounting policy:

• Only if the change is mandated by a standard or interpretation.
• when the adoption is mandated by law.
• financial statement results in more accurate and timely information on the effects of transactions, other events, or conditions on the entity's financial position, financial performance, or cash flows.

The correct answer is Book value.

Key Points

The value of a fixed asset after deducting depreciation from the historical cost is called Book value.

• ​It is also called Salvage value.
• It is based on what a company expects to receive in exchange for selling or parting out the asset at the end of its useful life.

Additional Information

Fair value

• It is the estimated price at which an asset is bought or sold when both the buyer and seller freely agree on a price.​
• Individuals and businesses may compare current market value, growth potential, and replacement cost to determine the fair value of an asset.
• Fair value accounting is the practice of measuring a business's liabilities and assets at their current market value.

Market value

• It is usually used to describe how much an asset or company is worth in a financial market.
• It is mutually determined by market participants and is interchangeably used for market capitalization when dealing with assets and companies.​
• It can be expressed in the forms of mathematical ratios such as P/E ratio, EPS, market value per share, book value per share, etc.

Net realisable value

• ​It is the value for which an asset can be sold, minus the estimated costs of selling or discarding the asset.
• It is commonly used in the estimation of the value of ending inventory or accounts receivable.
• It is used in both generally accepted accounting principles (GAAP) as well as international financial reporting standards (IFRS).

Key Points

Depreciation: The monetary value of an asset decreases over time due to use, wear, and tear, or obsolescence. Accounting estimates the decrease in value using the information regarding the useful life of the asset.

Sinking Fund Method:

• The sinking fund method is a technique that depreciates an asset while generating enough money to replace it at the end of its useful life.
• Since depreciation is charged to reflect the declining value of the asset, a matching amount of cash is invested.
• These funds sit in a sinking fund account and generate interest.
• The sinking fund method is a depreciation technique used to finance the replacement of an asset at the end of its useful life. As depreciation is incurred, a matching amount of cash is invested, usually in government-backed securities.

Calculating Depreciation under Sinking Fund method:

Reference to sinking fund table =  0.180975

The amount to be charged to the Profit and Loss account = 20,000* 0.180975 = 3619.5

Therefore, Depreciation incurred = Rs. 3619.5

Given: Machinery costs Rs. 30,000. Scrap value Rs. 10,000. Life 5 years. Rate of interest 5%. Reference to sinking fund table 0.180975. The depreciation per year will be Rs. 3619.50

The correct answer is ₹70,000

Key Points

• Depreciation: It means a decline in the value of fixed assets due to use, the passage of time, or obsolescence or diminution in the intrinsic value of the asset due to use and/or lapse of time.

Important Points

Calculation of depreciation: 

1. Depreciation on Plant & Machinery = ₹2,00,000*20% = ₹40,000
2. Depreciation on Furniture = ₹50,000*10% = ₹5,000
3. Depreciation on Building = ₹5,00,000*5%= ₹25,000
4. Total Depreciation = 40,000+5,000+25,000= ₹70,000