Depreciation Provisions and Reserves Test - 5

A secret reserve is one whose existence is not disclosed in the balance sheet. It can be created by all the methods mentioned above by suppressing sales, by charging over depreciation etc.

Reserves are created out of the profits of the business. Since the profits belong to the propreitor the accumulation of the profits in the form of reserves belong to the owner.

Since fixed assets are continuously used during the normal course of the business they tend to be obselete.Hence the value of the assets are reduced by charging depreciation. Depreciation arises due to the normal wear and tear of the business.

Because by all of this the profits are reduced in the balance Sheet. The existence of the reserve is not disclosed in the balance sheet.

Accumulated depreciation account is shown in the liabilities side of the balance sheet. The depreciation to be charged on a fixed asset is accumulated year after year and shown in a separate account called accumulated depreciation account. This account shows a credit balance.

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.

Prudence concept is to only record a revenue transaction or an asset when it is certain, and record an expense transaction or liability when it is probable. Hence Liability should be created in form of provision.

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.

Revenue reserve is the reserve created out of the profits earned in the normal course of the business. These profits are available for distribution as dividend.

Prudence means being careful........foreseeing that the value of the asset is going to reduce over the useful life of the asset depreciation is charged. It is based on the prudence concept.

Total cost of an asset = Purchase price + Freight + Installation cost. Refundable tax does not form part of the cost of an asset.

The useful life of the asset and the residual value of the asset can only be an estimate.......because the asset may become obselete before the estimated useful life and it may not fetch the estimated residual value. But the Cost of the asset is actual cost incurred in acquistion of the asset.

Residual value of an asset is the scrap value of the asset at the end of its life. Depreciation amount is the total amount written off during the useful life of the asset . Adding both we get the Cost of the fixed asset.

Capital reserves are made out of capital profits. Capital profits may or may not involve cash receipts....ex: Premium on issue of shares or debentures involve cash receipts while profit on forfeiture of shares does not involve cash receipts.

Revenue profits are available for distribution of dividend. Dividend equalisation reserve is one such reserve created out revenue profits.

Depreciation is charged on the assets to show that the valued of the assets keep decreasing year after year. Hence depreciation charged will decrease the book value of the fixed assets.

In the ordinary course land has a value appreciation that is the value of the land increases year after year and hence normally depreciation is not charged on Land.

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

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.

Capital reserves are the reserves which are created out of the capital profits which are not available for distribution as dividend.

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.

Reserves out of profits are required for various purposes. They help in meeting the unforeseen contingencies that may arise in the future, help in the expansion of the business. They may also be used to distribute dividends and pay off the liabilities like debentures.

The debtors are sold goods on credit. If the money is sure to be collected from the debtors.....in other words if the collection of the debt is certain then those debts are known as good debts.

Provision is a charge on the profits of the business created for a specific reason expecting a specific expenditure or loss. But reserves is the amount set aside out of the profits. Reserves may be for a specific purpose or may be for a general purpose.

Under straight line method the value of depreciation is calculated on the (cost - expenses) value of the asset. This amount remains the same throughout the life of the asset.