Competitive Exams Accountancy Cycles
Sometime, you read this term in any book about accounting cycle, But you would not research of this term. Actually accounting cycle is very simple term. It means that all the activities in accounting will absorb in first point and then it make accounting cycle. This term is very useful for an accountant because an accountant is man who maintain accounts.
Suppose Ram purchases goods from any company this transaction when comes in the front of an accountant, he records it after this he see its result on his final accounts but in last automatically it support to completing the whole accounting cycle. In other words any financial transaction is the beginning point of accounting cycle and an accountant must give importance to each transaction of business.
Depreciation and effect on final account
Depreciation is just decrease the value of any fixed asset. When you will use it, then the value of fixed asset will be decreased. So calculating of net profit and correct financial position, it is the duty of accountant to show it in profit and loss account. Rates of depreciation may differ according to the nature of fixed asset some assets depreciation rate is low and other is high because high decreasing value due to expiry. In balance sheet, we deduct depreciation from fixed asset
After deducting we can calculate net value of fixed asset which can be show in balance sheet.
Depreciation account can also be made by accountant but every year it must send to profit and loss account because this is nominal account.
Different law like income tax law and corporate law fix this depreciation rate so we must see the reference of depreciation rate from these laws but calculating correct amount of depreciation. Also, account manager should decide when a fixed asset will buy. For replacement purpose, it is duty of accountant and account manager to calculate and transfer and written off depreciation every year from fixed asset. Some business entity makes also provision for depreciation.
Depreciation: It is a gradual deterioration or decrease in the value of asset after using that asset in our day to day work or after spending of time. In this world, everything is perishable, so making true profit and calculates true value of any asset at present time, it is very necessary to depreciate on fixed asset and deduct from it.
Fluctuation: If you are doing business or linked with any business, you know that prices are always up and down due to changing in the condition of business environment. Fast changing in market prices is called fluctuation. It is not called depreciation because, it is not related to use of fixed asset. Fluctuation can also increase the price of fixed asset but after deducting depreciation, value of fixed assets will be decreased. Fluctuation is fully ignored and there is no accounting treatment. But we show depreciation as a loss of business.
Obsolescence: When new fixed assets quality, efficiency and capacity decrease the value and usability of old fixed assets, then it is called obsolescence of old fixed assets.
The main example, we can look in different machines or technical equipment especially in medical field. Every new equipment decreases the value of previous equipment. Because of it is not related to the nature and use of fixed asset, so it is also not depreciation. Obsolescence is not important in field of accounting but it is important in technology research and marketing of product.
How to make fixed asset account under fixed installment method
Before making of fixed asset account, we must know following journal entries:
1st for providing depreciation on asset at the end of the year
Depreciation account Debit
Fixed asset account credit
2nd For transferring of depreciation to profit and loss account
Profit and loss account debit
Depreciation account credit
In this method fixed asset account is very simple T shaped. There is not fixed Proforma for making fixed asset account
Methods of providing depreciation
There are many methods of calculation of depreciation. No one apply on the all assets, because, different assets have different nature and according to management policy and effect of laws specially tax laws, different methods are used for providing depreciation. There are 10 methods of calculation of depreciation. Out of which approximate 5 are the most important and it should be learned.
1st method of providing depreciation
Fixed installment method
- Fixed installment method is that method, in which we calculate fixed rate of depreciation and then with this rate we deduct every year from fixed asset.
- Original cost of asset-scrape value of asset
- Depreciation = ___________________________________
- Effective working life of asset
- For example Satifsan purchased an asset of $20000 and he can use it for 4 years and after four year its scrape value will be $4000. Calculate depreciation with fixed installment method
- Depreciation = 20000 − 4000/4 = $4000
- Rate of depreciation = 4000/20000X 100 = 20%
- every year we provide $4000 and deduct from original cost of fixed asset. So its other name is original cost method
- or straight line method of providing depreciation.
Benefits of this method
It is easy to calculate
It show zero value of fixed asset at the end of its life.
It divides all weight of total depreciation equally in all period of life of asset.
After providing depreciation, balance will shows correct value of fixed asset.
Disadvantage of this method
After showing zero value of expiry of fixed asset in books, but it is possible that asset is in good position. Then what provision will show in books, this method does not tell to accountant.
Some assets value will increase after spending of time at there we can not use this on that assets.
There is no provision in this method for buying new asset after scrap of old assets.
What is provision of depreciation account?
Provision of depreciation account is the account of provision of depreciation. First of all we should understand
provision of depreciation. Provision of depreciation is the collected value of all depreciation. With making of this
account we are not credited depreciation in asset account. But transfer every year depreciation to provision of
depreciation account. Every year we adopt this procedure and when assets are sold we will transfer sold assets total
depreciation to credit side of asset account. For calculating correct profit or loss on fixed asset. This provision
uses with any method of calculating depreciation.
There are following feature of provision for depreciation account
Fixed asset is made on its original cost and every year depreciation is not transfer to fixed asset account.
Provision of depreciation account is Conglomerated value of all old depreciation.
Entry of depreciation will change also
Depreciation account Debit Provision for depreciation account credit
This system can be used both in straight line and diminishing method of providing depreciation.
Calculation of loss on sale is very important where is provision of depreciation account is kept.
Which we can calculate with following way
- Cost of sale of fixed asset XXXX
- Less total depreciation up to the date
- Of sale XXXX
- Written Down Value of sold asset XXXX
- Less Sale price XXXX
- Loss on sale of Asset XXXX
- This loss will show in the credit side of asset account
- At the sale total depreciation on of sold asset from its purchasing will transfer from provision of depreciation
- account to fixed asset account, its journal entry will
Provision for depreciation account Debit
To fixed asset Account Credit
Diminishing balance method of providing depreciation
Diminishing balance method of providing depreciation is very important from accounting point of view. In this method.
accountant calculates depreciation on the asset from which he deducts all previous depreciation from asset. So, every
year amount of depreciation will go down:
Suppose we purchase a machinery at $50000 and if we fix 10 % depreciation on machinery with diminishing balance method, then first year depreciation will $5000, next year will calculate depreciation $50000-$5000 = $45000 X 10 % = $4500
Third year depreciation will apply on $45000-$4500 = $40500
So, we calculate depreciation on written down value of asset so, its other name is written down method or reducing
Now we are seeing the value of depreciation is decreasing
- Ist year = $5000
- 2nd year = $4500
- 3rd year = $4050
Benefit or advantages of this method
This is also very easy method.
This is very scientific method and provides logic that which asset is abolish due to spending of time at that portion of depreciation is not included in asset.
Income tax officer prefers this method for assessment of business and professional income. If we buy any asset after first year, we need not to calculate depreciation from beginning.
Disadvantages of this method
In this method we also ignore interest on capital which is used for purchasing such asset.
All new and old assets are mixed with each other, for an auditor, it is so difficult to differ among them.
It is difficult to calculate optimum rate of depreciation
But we can use following formula for calculating depreciation in W. D V method.
R = 1 S/C 1/n
- R = rate of depreciation
- S = S is scrape value
- n = n is the working life of an asset
- c = c is cost of asset
Reserves are accounting terms. In general, it is saving of money, but in accounting terminology, it has different
According to accounting technician, Reserves are that funds which withdraw from general or special profit of business
and keep it in safe pocket of company. This sum is used when any loss happens in business.
Accounting Experts always in favor to keep some money or retain some fund for future losses, because future is
uncertain and for increasing working capital of business, accountant should retain some money out of total profit
before distribution it to shareholders. It is shown in profit and loss appropriation account. Indian company law has
fixed it and in other countries, their company laws fix it and from time to time change it due to changing business
Types of Reserves
There are two main types of reserves which I am explaining with following way:
Open reserves may be defined all reserves which shows in the balance sheet. Every person or public can know such
reserves of company. Those reserves provide full information to shareholders about which amount has gone to reserves or
why they are not getting all amount of dividend. This type can also divide in sub parts
Capital reserves are main type of open reserves. It is not created out of profit of company. This reserve is not used
for distributing the dividend to shareholders of company. The main sources of these reserves are following:
profit earned prior to incorporation
Premium on the issue of shares and debentures.
Profit on reissue of forfeited shares
Profit set aside for the purpose of redemption of preference shares.
Profit on sale of undertaking or part of it.
Surplus on revaluation of assets and liabilities.
Revenue reserves are that part of open reserves which are created out of profit of company. It is showed in profit and
loss appropriation account. It can be used for dividend to shareholders. There are following benefits of revenue
- Extension of business
- Set off unknown losses of business.
- Used to create strength in the financial position of business.
- To make stability in the dividend rate.
- These revenue reserves can also divide into two parts.
- general reserves
- Specific reserves = Specific reserves includes dividend equalization reserve, debenture redemption reserve, staff reserve. Investment fluctuation reserve, taxation reserve and contingency reserves.
Secret reserves may be defined as that type of reserves which is not shown in final account of company. Means it has
neither been shown in profit and loss appropriation account nor in balance sheet. These reserves can easy created by
showing less value of assets and more value of liabilities in balance sheet. If a company has created such secret
reserves for the benefits of company, it will be surely strong his financial position. These secrete reserves can be
created by following ways:
- showing heavy depreciation value
- Showing the less value of goodwill and closing stock of business.
- Secrete of sale value of business.
- Showing heavy liabilities which is not of company.
- Showing capital expenses as revenue expenses.
- Grouping of free reserves with creditors.
- Current asset not shown in balance sheet.
Calculation the credit purchase
Write creditor account on any excel sheet with making two sides one side is debit and other side is credit
Write your businesss creditors opening balance in credit side with giving by balance b/d name
Write the amount that you have given to your creditors in the current year in the debit side of creditor account
Write closing balance of your creditors in the end of this year this amount shows unpaid amount which is payable to your creditor at the end of this year in the debit side of this account
You will see that debit side is more than credit side of this account, the difference will be credit purchase and it should be written in the credit side of this account
Now you are seeing your credit purchase.
This credit purchase is very necessary when you will calculate the net consumption of your stock because for calculating net consumption for stock, we always add purchase in the opening stock and deduct closing stock. This net consumption will show in profit and loss account or income and expenditure account.