Depreciation Provisions and Reserves Test - 6

In case of a purchase of fixed asset, the expenses incurred upto the installation and usage of the asset are added to the purchase cost of the asset. Hence installation charges, freight and transport expenes form a part of the acquisition cost.

Dividends are issued by a company when they earn profits. In a year when the company incurs a loss and is not able to pay out dividends to its shareholders or when the profits are not sufficient enough to pay same rate of dividend, then dividend equalisation reserve helps in mainitaining the same rate of dividend.

General reserve is the amount set aside of the revenue profits for no specific purpose. They can be utilised for any future contingencies of the business.

Specific reserves are created to meet specific purposes and contingencies. They can be utilised only for that purpose. Example: Dividend equalisation reserve, Capital redemption reserve .

Provision account is a charge on the profits of the business and amount is set aside expecting certain expenses and losses. Since profit and loss account is a nominal account provision account is debited to the profit and loss account.

When a company invests its reserve amount outside it is known as reserve fund. The company will invest outside when ready cash is required at a certain date and when it is not sure about the profitable investment of the reserve in its business itself.

Heavy unforeseen losses of extraordinary nature can be met without disclosing them in the financial statements without affecting  the normal business profit. 

General reserve is created for no specific purpose to meet any unforeseen contingency, specific reserve is created to meet a specific expense and capital reserves are created out of capital profits which may or may not involve cash receipt.

Under straight line method depreciation is calculated as follows:( Cost - residual value)/ No of years of life. In the given sum (6000-1000)/ 5= 1000 

Under written down balance method, depreciation is calculated on the written down value of the asset. In the above example : Cost = 5000, Accumulated depreciation = 3000, and Rate of depreciation = 20%. Amount of depreciation = (5000-3000)*20% = 400.