Accounting Principles and Practice

Providing depreciation ensures sufficient cash for asset replacement only under non-inflationary conditions. In non-inflationary conditions, the accumulated depreciation funds can purchase equivalent replacement assets. During inflation, replacement costs are higher than original costs, so depreciation provisions fall short. During boom conditions, high demand may also push prices higher.

Under the annuity method, the total charge to P&L (depreciation plus interest on the sinking fund) increases each year. This happens because the sinking fund accumulates more money over time, earning compound interest, while the depreciation component remains constant on the asset's diminishing value. The interest portion grows steadily, causing the net annual charge to rise.

Straight line method allocates the asset's cost (minus salvage value) evenly across its useful life. Each year receives an identical depreciation charge, making it the only method among the options that writes off cost in equal proportions. WDV method declines each year, units-of-production varies with usage, and SYD is accelerated (higher in early years).

All three listed items are fundamental factors in calculating depreciation: (1) cost of the asset establishes the depreciable base, (2) useful/expected life determines how many years the cost is spread over, and (3) estimated residual (salvage) value is subtracted from cost to find the total amount to be depreciated. Together, these determine the annual depreciation charge under any method.

Accounting standards (specifically AS-10 in India) mandate that depreciation methods cannot be changed arbitrarily. Changes are permitted only when: (1) required by statute or law, or (2) required by a professional regulatory body like ICAI. Business owners cannot switch methods at will solely to manipulate profits. This ensures consistency and prevents earnings management through accounting policy changes.

When a sinking fund is established for depreciation, the accumulated funds are regularly invested in securities to earn interest. The journal entry records this investment by debiting Sinking Fund Investment Account (receiving the asset) and crediting Bank Account (making the payment). This captures the transaction where funds move from the sinking fund into investment instruments.

Book value (also called written down value or carrying amount) is the asset's historical cost less accumulated depreciation. It represents the net asset value shown on the balance sheet. Fair value is market-determined selling price, market value is what it could fetch in active markets, and net realizable value is estimated selling price less costs to sell. Book value is the accounting measure after depreciation.

When changing depreciation policy, accounting standards (AS-10) require that the difference arising from the change be adjusted in the year of change itself. This catches the cumulative effect of using different rates/methods immediately, rather than deferring it or restating prior years. The adjustment is made to the asset account and reflected in the current year's P&L, ensuring the impact is transparent and timely.

Under WDV method: (i) The RATE of depreciation remains constant (e.g., 15% each year) - it does NOT reduce. (ii) The AMOUNT of depreciation reduces annually because it's calculated on the diminishing written-down value (a smaller base each year). (iii) Since rate is constant and amount decreases, this statement is false. (iv) In practice, assets rarely reach exactly zero; a small residual value typically remains. Therefore, only statement (ii) is correct.

Outstanding rent represents rent owed but not yet paid - this creates a liability (money owed to landlord). When rent expense is recognized, it reduces the owner's equity/profits. Therefore, outstanding rent increases liabilities while decreasing owner's equity (called 'owner's liability' in some contexts). Option A incorrectly says asset increases. Options C and D have the direction wrong.

When an old building is purchased, repairs and white washing done 'for the first time' are effectively renovation costs to make the building usable. These expenditures bring the asset to proper working condition and provide benefits over multiple years through the building's useful life. Since they create future benefits beyond the current period, they qualify as capital expenditures, not revenue expenditures.

Expenses represent outflows of economic benefits during a period. This happens either through cash outflow (decrease of assets like cash) or by incurring liabilities (increase of creditors). For example, paying rent decreases cash (asset outflow), or purchasing on credit increases accounts payable (liability incurrence). Option A describes revenue, not expenses.

Closing stock is the amount of inventory that a business still has on hand at the end of a reporting period.

The prudence principle requires cautious valuation (lower of cost and NRV). The consistency principle requires using the same method across periods. When you value stock at cost in one year and at lower of cost and NRV in another, you're applying prudence but violating consistency. The two principles conflict in this situation - you must choose which to prioritize.