Question

State whether the following Statements are True or False

1. There is need to provide depreciation if it is maintained with care.
2. Depreciation cannot be provided in case of loss in a financial year.
3. A Specific reserve can be created for any purpose.
4. Capital Reserves are not freely distributed as profits.
5. Under the written down value method depreciation is calculated on the original cost of an asset.
6. Depreciation is the process of valuation of asset.
7. Depreciation is a non-cash expense.
8. Secret reserves are disclosed in Balance Sheet.
9. General reserves is created to meet contingency liability.
10. Depreciation is charged only on fixed asset.

Answer 1

(1) False

Explanation:
Depreciation is the fall in the value of fixed assets due to their continuous use in the business. Hence, depreciation is charged every year as a charge on the profits. It is necessary to charge depreciation to calculate the true profit and loss of a business.

(2) False

Explanation:
Depreciation is a charge on profits because it has to be provided every year to know the true profit and loss as well as the correct cost of production. Thus, depreciation has to be provided even in the case of losses.

(3) True

Explanation:
Specific reserves are the reserves that are created out of the revenue profits for a specific purpose. They can be created for any purpose but they can be utilised only for the purpose for which they have been created.

(4) True

Explanation:
Capital reserves are usually not available for distribution as profits. They can be used to write-off capital losses and for the issue of fully-paid bonus shares. Some capital reserves can, however, be utilised to distribute dividends, subject to fulfilment of the following conditions:
• Articles of company must not prohibit such dividends.
• Capital profits must have been realised in cash.
• Such profits remain after a fair revaluation of assets and liabilities.

(5) False

Explanation:
Under the written down value method, depreciation is calculated on the book value or the diminished value of an asset. Every year, depreciation is deducted from the cost of the asset and in the next year, depreciation is charged on the reduced balance of the asset. Thus, depreciation is charged on the diminished value of the asset and not on the original cost of the asset.

(6) False

Explanation:
Depreciation is the reduction in the value of fixed assets associated with their continuous use in business. When the total cost of an asset is spread over its useful life in a business, then this allocation of cost is regarded as depreciation. Thus, it can be said that depreciation is an allocation of the cost of an asset over its useful life and is not a valuation process of the asset.

(7) True

Explanation:
Depreciation is the fall in the value of a fixed asset, allocated to the useful life of the asset. It is an expense and is debited to the Profit & Loss A/c. It is a non-cash expense, as it is not paid in cash like other expenses. Hence, the amount of depreciation is retained in the business and used for replacement of fixed assets after the expiry of the estimated useful life of the assets.

(8) False

Explanation:
Secret reserves exist in a business to strengthen the financial position but are not disclosed in the Balance Sheet. As these reserves are not apparent in the Balance Sheet, they are also known as 'Hidden Reserves' or 'Inner Reserves'.

(9) True

Explanation:
General reserves are created out of the revenue profits to meet future unforeseen liabilities of the business. Thus, these reserves are meant for meeting the incidental or contingent liabilities of the business. Generally, companies do not distribute the entire profits as dividends but keep aside a part of profits in the form of general reserves. Such reserves are also called 'Contingency Reserves' or 'Free Reserves' because these are not created for any specific purpose and can be freely used for any purpose.

(10) True

Explanation:
Depreciation is the decrease or fall in the value of fixed assets. It is charged only on fixed assets because these assets are continuously used in daily business operations and due to normal wear and tear, their value may decrease. The value of fixed assets may also decrease due to fast technological innovations and inventions that lead to the obsolescence of fixed assets. Hence, depreciation is charged on the fixed assets.