Uk Unit III Cse Split Up

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SRI MANAKULA VINAYAGAR ENGINEERING COLLEGE DEPARTMENT OF CSE

UNIT III

Replacement and Maintenance AnalysisDepreciationEvaluation of Public alternatives Inflation Adjusted

Decisions

UNITIII

2 MARKS1. WRITE SHORT NOTES ON DEPRECIATION? (Dec 2012), (April2012)

Depreciation is a term used in accounting, economics and finance to spread the cost of an asset over the

span of several years. In simple words we can say that depreciation is the reduction in the value of an asset due

to usage, passage of time, wear and tear, technological outdating, depletion, inadequacy, rot, rust, decay or other

such factors.

In accounting, depreciation is a term used to describe any method of attributing the historical or

purchase cost of an asset across its useful life, roughly corresponding to normal wear and tear.It is of most use

when dealing with assets of a short, fixed service life, and which is an example of applying the matching

principle per generally accepted accounting principles.

Depreciation in accounting is often mistakenly seen as a basis for recognizing impairment of an asset

but unexpected changes in value, where seen as significant enough to account for, are handled through write-downs or similar techniques which adjust the book value of the asset to reflect its current value. Therefore, it is

important to recognize that depreciation, when used as a technical accounting term, is the allocation of the

historical cost of an asset across time periods when the asset is employed to generate revenues.

This process of cost allocation has little or no direct relationship to the market value or current selling

price of the asset, it is simply the recognition that a portion of the asset's cost--the portion that will never be

recuperated through re-sale or disposal of the asset--was "used up" in the generation of revenues for that time

period.

2.DEFINE DEPRECIATION?

"Depreciation may be defined as the permanent continuous diminution in the quality, quantity or value on anasset." (By Pickles)

"Depreciation is the gradual permanent decrease in the value of an asset from any cause." (By Carter)

"Depreciation may be defined as a measure of the exhaustion of the effective life of an asset from any cause

during a given period." (By Spicer & Pegler)

Depreciation is the diminution in intrinsic value of an asset due to use and/or the lapse of time."

(By Institute of Cost and Management Accountants, England)

3. WHAT IS SALVAGE VALUE?

Salvage value is the estimated value of an asset at the end of its useful life. In accounting, the salvage value of

an asset is its remaining value after depreciation. This is also known as residual value or scrap value. It is the

net cash inflow that occurs when the asset is liquefied at the end of its life. Salvage value can be negative if the

residual asset requires special treatment to terminatefor example, used nuclear materials or CRT's containing

lead.

4. WRITE SHORT NOTE ON CHARACTERISTICS OF DEPRECIATION?

Characteristics of Depreciation:

1. Depreciation is charged in case of fixed assets only. e.g., building, plant and machinery, furniture etc. Thereis no question of depreciation in case of current assets - such as stock, debtors, bills receivable etc.


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2. Depreciation causes perpetual, gradual and continual fall in the value of assets.3. Depreciation occurs till the last day of the estimated working life of the asset.4. Depreciation occurs on account of use of asset. In certain cases, however, depreciation may occur even if

the assets are not used, e.g., leasehold, property, patent, copyright etc.

5. Depreciation is a charge against revenue of an accounting period.6. Depreciation does not depend on fluctuations in market value of assets (seedifference between depreciation

and fluctuationpage).

7. The amount of depreciation of an accounting year cannot be determined precisely - it has to be estimated. Incertain cases, however, it may be ascertained exactly, e.g., leasehold property, patent right, copyright etc.

8. Total depreciation of an asset cannot exceed its depreciable value (cost less scrap value).5. WRITE SHORT NOTE ON DEPRECIATION IN ACCOUNTING?

A company needs to report depreciation accurately in its financial statements in order to achieve two main

objectives:

1. Matching its expenses with the income generated by means of those expenses, and

2. Ensuring that the asset values in the balance sheet are not overstated. (An asset acquired in Year 1 is

unlikely to be worth the same amount in Year 5.)Depreciation is an estimated or expected view of the decline in value of an asset.

For example, an entity may depreciate its equipment by 15% per year. This rate should be reasonable in

aggregate (such as when a manufacturing company is looking at all of its machinery), and consistently

employed. However, there is no expectation that each individual item declines in value by the same amount,

primarily because the recognition of depreciation is based upon the allocation of historical costs and not current

market prices.

Accounting standards bodies have detailed rules on which methods of depreciation are acceptable, and auditors

will express a view if they believe the assumptions underlying the estimates do not give a true and fair view.

6. WHAT ARE THE BASIC FACTORS OF DEPRECIATION DETERMINATION?For calculation depreciation the basic factors are:

1. The original cost of the asset.2. The estimated working life of the asset or the number of years the asset is expected to last.3. The estimated residual or scrap value at the end of its life. It is the value which the asset will fetch when

discarded as useless.

4. The amount to be spent periodically for repairs and renewals. If the repairs necessary to keep the asset ina proper state of efficiency are regularly carried out, the life of the asset is prolonged and the amount of

annual depreciation is proportionately lowered.

5. The possibility of the asset becoming obsolete. If there are great chances of improvements being madein a particular asset on account of inventions, higher depreciation should be written off such an asset.

6. WHAT ARE THE SEVERAL METHODS OF ACCOUNTING DEPRECIATION FUNDS?(Apr 2011)

1.Straight-Line Depreciation

2. Decliningbalance method

3. Sum-of-the-years-digits methods of depriciation

4. Sinking fund method of depreciation

5. Service output method of depriciation
http://www.accounting4management.com/difference_between_depreciation_and_fluctuation.htmhttp://www.accounting4management.com/difference_between_depreciation_and_fluctuation.htmhttp://www.accounting4management.com/difference_between_depreciation_and_fluctuation.htmhttp://www.accounting4management.com/difference_between_depreciation_and_fluctuation.htm


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7. WRITE SHORT NOTES ON REPLACEMENT AND MAINTENANCE ANALYSIS?

Organizations providing goods/services use several facilities like equipment and machinery which are directly

required in their operations. In addition to these facilities, there are several other items which are necessary to

facilitate the functioning of organizations.

All such facilities should be continuously monitored for their efficient functioning; otherwise, the quality of

service will be poor. Besides the quality of service of the facilities, the cost of their operation and maintenance

would increase with the passage of time. Hence, it is an absolute necessity to maintain the equipment in good

operating conditions with economical cost. In certain cases, the equipment will be obsolete over a period of

time.

If the firm wants to be in the same business competitively, it has to take decision on whether to replace the old

equipment or to retain it by taking the cost of maintenance and operation into account.

There are two basic reasons for considering the replacement of equipment physical impairment of the

various parts or obsolescence of the equipment.

Physical impairment refers only to changes in the physical condition of the machine itself. This would lead to

a decline in the value of the service rendered, increased operating cost, increased maintenance cost or a

combination of these.Obsolescence is due to improvement of the tools of production, mainly improvement in technology.

Sometimes, the capacity of existing facilities may be inadequate to meet the current demand. Under such

situation, the following alternatives will be considered.

Replacement of the existing equipment with a new one. Augmenting the existing one with additional equipment.

8. WHAT ARE THE DIFFERENT TYPES OF REPLACEMENT PROBLEM?

Replacement study can be classified into two categories:

Replacement of assets that deteriorate with time (Replacement due to gradual failure, or wear andtear of the components of the machines).

This can be further classified into the following types: Determination of economic life of an asset. Replacement of an existing asset with the new asset. Simple probabilistic model for assets which fail completely (replacement due to sudden failure).

9. HOW WILL YOU DETERMINE OF ECONOMIC LIFE OF AN ASSET?

Any asset will have the following cost components:

Capital recovery cost (average first cost), computed from the first cost (purchase price) of themachine.

Average operating and maintenance cost (O & M cost) Total cost which is the sum of capital recovery cost (average first cost) and average maintenance

cost.

It is clear that the capital recovery cost (average first cost) goes son decreasing with the life of the machine

and the average operating and maintenance cost goes on increasing with the life of the machine. From the

beginning, the total cost continues to decrease upto a particular life and then it starts increasing. The point

where the total cost is minimum is called the economic life the machine.

If the interest rate is more then zero percent, then we use interest formulas to determine the economic life


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The replacement alternatives can be evaluated based on the present worth criterion and annual equivalent

criterion.

Average total cost= First cost (FC) +Summation of maintenance cost/ Replacement Period

Total annual equivalent cost= [Cumulative sum of present worth as of beginning of year1 Operation and

maintenance costs + First costPresent worth as of beginning of year1 of salvage value] * (A/P, 15%, n)

10.WRITE SHORT NOTES OR OBJECTIVES ON EVALUATION OF PUBLIC ALTERNATIVES

(April2011)

In evaluating alternatives of private organizations, the criterion is to select the alternative with the

maximum profit. The profit maximization is the main goal of private organizations while providing

goods/services as per specifications to their customers. But the same criterion cannot be used while evaluating

public alternatives. Examples of some public alternatives are constructing bridges, roads, dams, establishing

public utilities, etc.

The main objective of any public alternative is to provide goods/services to the public at the minimum

cost. In this process, one should see whether the benefits of the public activity are at least equal to its costs. Ifyes, then the public activity can be undertaken for implementation . Otherwise, it can be cancelled. This is

nothing but taking a decision based on Benefit-Cost ratio(BC) given by

Equivalent benefits

BC ratio= ---------------------------

Equivalent costs

The benefits may occur at different time periods of the public activity. For the purpose of comparison, these are

to be converted into a common time base (present worth or future worth or annual equivalent). Similarly, the

costs consist of initial investment and yearly operation and maintenance cost. These are to be converted to a

common time base as done in the equivalent benefits. Now the ratio between the equivalent benefits andequivalent costs is known as the Benefit-Cost ratio. If this ratio is at least one, the public activity is justified;

otherwise, it is not justified. Let

Bp = present worth of the total benefits Bf = future worth of the total benefits Ba = annual equivalent of the total benefits P = initial investment Pf = future worth of the initial investment Pa = annual equivalent of the initial investment C = yearly cost of operation and maintenance Cp = present worth of yearly cost of operation and maintenance Cf = future worth of yearly cost of operation and maintenance

Bp Bf Ba

BC ratio = ---------- = --------- = ----------

P+CpPf+CfPa+C

11. WHAT ARE THE TYPES OF REPLACEMENT ANALYSIS?


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For the actual replacement analysis: given that you have a piece of equipment and want to figure out whether or

not you should replace it, you will analyze the old equipment (called the Defender) versus the best new machine

option (called the Challenger). Very critical to these types of problems is that you know how to find the book

value of an asset by using depreciation, can differentiate book value and market value, and can identify a sunk

cost.

Sunk cost:something you paid in the past, and should not be considered any longer (i.e. the amount I paid for

car maintenance last year should not factor in when I consider paying for an overhaul now versus trading in for

a new car)

Market Value: selling price of the asset in the marketplace, or what you can actually get for the asset (should

already by determined)

The challenger and defendercan always be considered to have different lives (unless explicitly told otherwise

in a problem statement) so, you will want to use the annual worth methodin fact, repeatability really doesnt

apply to the defender because you cant repeat having it, its not something new you are buying at the same price

again, so just stay away from present worth method here.

Now for the most part you are simply going to be doing after-tax incremental analysis with two options: keep

the defender or sell it and buy the challenger.

11 MARKS1. EXPLAIN THE REASONS OR CAUSES OF DEPRECIATION?

The main causes of depreciation may be divided into two categories, namely:

1. Internal Cause and2. External Causes

I nternal Causes:

Depreciation which occurs for certain inherent normal causes, is known as internal depreciation. The main

causes of internal depreciation are:Wear and Tear:

Some assets physically deteriorate due to wear and tear in use. More and more use of an asset, the greater would

be the wear and tear. Physical deterioration of an asset is caused from movement, strain, friction, erasion etc

An obvious example of this is motor car which rapidly wears out. Other assets like this are building, plant,

machinery, furniture, etc. The wear and tear is general but primary cause of depreciation.

Depletion:

Some assets declines in value proportionate to the quantum of production, e.g. mine, quarry etc. With the

raising of coal from coal mine the total deposit reduces gradually and after sometime it will be fully exhausted.

Then its value will be reduced to nil.

External Causes:

Depreciation caused by some external reasons is called external depreciation. The main external causes are as

follows:

Obsolescence:

Some assets, although in proper working order, may become obsolete. For example, old machine becomes

obsolete with the invention of more economical and sophisticated machine whose productive capacity is

generally larger and cost of production is therefore less. In order to survive in the competitive market the

manufacturers must must install new machines replacing the old ones. Again, it may happen that the articles


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produced by old machine are no longer saleable in the market on account of change of habit and taste of the

people. In such a case the old machine, although in good working condition, must be discarded and the new one

purchased.

Efflux of Time:

Some assets diminish in value on account of sheer passage of time, even though they are not used e.g.,

leasehold property, patent right, copyright etc. Suppose we take a lease of a house for 10 years for $10,000. Its

annual depreciation will be $1,000 (10,000/10), irrespective of the the whether the house has been used or not

Because with the end of lease after 10 years, the house will go out of possession.

Accident:

Assets may be destroyed by abnormal reasons such as fire, earthquake, flood etc. In such a case the destroyed

asset must be written off as loss and a new one purchased.

2. EXPLAIN THE NEED FOR DEPRECIATION OR REASONS FOR CALCULATING

DEPRECIATION.

The Need for depreciationarises for the following reasons:

1. Ascertainment of True Profit or Loss:Depreciation is a loss. So Unless it is considered like all other expenses and losses, true profit or loss cannotbe ascertained. In other words, depreciation must be considered in order to into out true profit or loss of a

business.

2. Ascertainment of True Cost of Production:Goods are produced with the help of plant and machinery which incurs depreciation in the process of

production. This depreciation must be considered as a part of the cost of production of goods. Otherwise, the

cost f production would be shown less than the true cost. Sales price is fixed normally on the basis of cost of

production. So, if the cost of production is shown less by ignoring depreciation, the sale price will also be

fixed at low level resulting in a loss to the business.

3. True Valuation of Assets:Value of assets gradually decreases on account of depreciation, if depreciation is not taken into account, thevalue of asset will be shown in the books at a figure higher than its true value and hence the true financial

position of the business will not be disclosed through balance sheet.

4. Replacement of Assets:After sometime an asset will be completely exhausted on account of use. A new asset must then be

purchased requiring a large sum of money. If the whole amount of profit is withdrawal from business each

year without considering the loss on account of depreciation, necessary sum may not be available for buying

the new asset. In such a case the required money is to be collected by introducing fresh capital or by

obtaining loan or by selling some other assets. This is contrary to sound commerce policy.

5. Keeping Capital Intact:Capital invested in buying an asset, gradually diminishes on account of depreciation. If loss on account of

depreciation is not considered in determining profit or loss at the year end, profit will be shown more. If the

excess profit is withdrawal, the working capital will gradually reduce, the business will become weak and its

profit earning capacity will also fall.

3. EXPLAIN THE DIFFERENT METHODS OF DEPRICIATION OR TOOLS OR TECHNIQUES

METHODS TO IDENTIFY DEPRECIATION OF AN ASSET? (Dec12)/ (April2010)

There are several methods for calculating depreciation, generally based on either the passage of time or the level

of activity (or use) of the asset.


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1.STRAIGHT-LINE DEPRECIATION:

Straight-line depreciation is the simplest and most-often-used technique, in which the company estimates the

salvage value of the asset at the end of the period during which it will be used to generate revenues (useful life)

and will expense a portion of original cost in equal increments over that period. The salvage value is an estimate

of the value of the asset at the time it will be sold or disposed of; it may be zero or even negative. Salvage value

is scrap value, by another name.

Let

P=first cost of the asset F=salvage value of the asset N=life of the asset Bt=book value of the asset and end of the period t, Dt=depreciation amount for the period t.

Formula:

Dt=(P-F)/n Bt=Bt-1-Dt=P-t*[(P-F)/n]

2. DECLININGBALANCE METHOD:Depreciation methods that provide for a higher depreciation charge in the first year of an asset's life and

gradually decreasing charges in subsequent years are called accelerated depreciation methods. This may be a

more realistic reflection of an asset's actual expected benefit from the use of the asset: many assets are most

useful when they are new. One popular accelerated method is the declining-balance method. Under this method

the Book Value is multiplied by a fixed rate.

Let

P=first cost of the asset F=salvage value of the asset N=life of the asset ; Bt=book value of the asset at the end of the period t K=a fixed percentage Dt=depreciation amount at the end of the period t.

The formula for depreciation and book values are as follows:

Dt=k*Bt-1 Bt=Bt-Dt=Bt-1-k*Bt-1 =(1-K)*Bt-1

The formula for depreciation and book value in terms of P are as follows:

Dt=K(1-K)t-1*p Bt=(1-K)t*p

While availing income-tax exception for the depreciation amount paid in each year, the rate K is limited to at

the most 2/n,If this rate is used, then the corresponding approach is called double declining balance method of

depreciation.

3. SUM-OF-THE-YEARS-DIGITS METHODS OF DEPRICIATION:

Sum-of-Years' Digits is a depreciation method that results in a more accelerated write-off than straight line

but less than declining-balance method. Under this method annual depreciation is determined by multiplying the

Depreciable Cost by a schedule of fractions.

Sum of the years=1+2+3+4+5+6+7+8

=36=n (n+1)/2


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In some situations, it may not be realistic to compute depreciation based on time period. in such cases, the

depreciation is computed based on service rendered by an asset

Let

P=first cost of the asset F=salvage value of the asset X=maximum capacity of service of the asset during its lifetime x=quantity of service rendered in a period

Then, the depreciation is defined per unit of service rendered:

Depreciation/unit of service= (P-F)/X Depreciation of x units of service in a period =P-F(x)/X

4. EXPLAIN STRAIGHT LINE METHOD

Fixed installment methodis also know as straight line methodor original cost method. Under this method

the expected life of the asset or the period during which a particular asset will render service is the calculated.

The cost of the asset less scrap value, if any, at the end f its expected life is divided by the number of years of its

expected life and each year a fixed amount is charged in accounts as depreciation. The amount chargeable in

respect of depreciation under this method remains constant from year to year. This method is also know asstraight line method because if a graph of the amounts of annual depreciation is drawn, it would be a straight

line.

Formula:

The following formula or equation is used to calculate depreciation under this method:

Annual Depreciation = [(Cost of Assets - Scrap Value)/Estimated Life of Machinery]

Scope of Application:

On account of the above mentioned advantages and disadvantages of fixed installment method, it is generally

applied in case of those assets which have small value or which do not require many repairs and renewals forexample copyright, patents, short leases etc.

Example for straight line method:

On 1st January 1991 X purchased a machinery for $21,000. The estimated life of the machine is 10 years. After

it its break up value will be $1,000 only. Calculate the amount of annual depreciation according to fixed

installment method (straight line method or original cost method) and prepare the machinery account for the

first three years.

Machinery Account

Debit Side Credit Side

$ $

1991

Jan. 1

To Bank account 21,000 1991

Dec.

31

By Depreciation account 2,000

1991

Dec.

By Balance c/d 19,000


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31

21,000 21,000

1992

Jan. 1

To Balance b/d 19,000 1991

Dec.

31


1991

Dec.

31

17,000

15,000 15,000

1993

Jan. 1


Dec.

31


1991Dec.

31


17,000 17,000

Advantages of straight line method:

Over the period of useful life of the fixed asset, the total burden of depreciation and repairs cost s aredisproportional over the effective life on the asset. Using this straight line basis of depreciation, the

burden will be light in the initial period and will be heavy in later stage of the useful life of the fixed

assets.

Any additions of fixed assets item will need to be computed separately Value of asset appear to be zero but asset is still in existence even after its useful life. Simple depreciation method to use This method is useful for assets having small intrinsic value like furniture & fittings, patents, trade mark

where the depreciation can be written off within their estimated , legal or commercial life.

Disadvantage straight line method:

Straight line basis of depreciation is not a suitable method for assets like Plant and machinery asdepreciation is constant while the repairs on such assets will be heavy in later years.

5. EXPLAIN DIMINISHING VALUE METHOD

Diminishing balance method is also known as written down value method or reducing installment method.

Under this method the asset is depreciated at fixed percentage calculated on the debit balance of the asset which

is diminished year after year on account of depreciation.



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Diminishing balance method of depreciation is most suited to plant and machinery where additions and

extensions take place so often and where the question of repairs is also very important. Written down value

method or reducing installment method does not suit the case of lease, whose value has to be reduced to zero.

Advantages of written down value method:

Amount charged to the profit & loss account towards depreciation and repairs will remain more or lessuniform year after year

Any addition of fixed asset, there is no need to have fresh calculation unless the purchase is made in themiddle of the year

Simple to useDisadvantages of written down value method:

Interest lost due to the capital investment in the asset is not taken into account Book value of the asset cannot be brought down to zero Though this method charges uniformly to the profit & loss account year on year, in many cases, this may

not happen either due to low rate of depreciation or due to excessively repair charges in later stages.

Example for diminishing balance method:

On 1st January, 1994, a merchant purchased plant and machinery costing $25,000. It has been decided to

depreciate it at the rate if 20 percent p.a. on the diminishing balance method (written down value method).

Show the plant and machinery account in the first three years.

Plant and Machinery Account

Debit Side Credit Side

Date $ Date $

1994

Jan. 1

To Cash 25,000 1994

Dec.

31

By Depreciation 5,000*

" By Balance c/d 20,000

25,000 25,000

1995

Jan. 1


Dec.

31

By Depreciation 4,000**

" By Balance c/d 16,000

20,000 20,000

1996

Jan. 1


Dec.

31

By Depreciation 3,200***


16,000 16,000


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Formula or equation for the depreciation calculation may be written as follows:

*First year: 25,000 20% = 5000

**Second Year: (25000 - 5000) 20% = 4,000

***Third Year: [25000 - (5,000 + 4,000)] 20% = 3,200

6. EXPLAIN ANNUITY METHOD

According to this method, the purchase of the asset concerned is considered an investment of capital, earning

interest at certain rate. The cost of the asset and also interest thereon are written down annually by equal

installments until the book value of the asset is reduced to nil or its bread up value at the end of its effective life

The annual charge to be made by way of depreciation is found out from annuity tables. The annual charge for

depreciation will be credited to asset account and debited to depreciation account, while the interest will be

debited to asset account and credited to interest account.

Example for annuity method:

A firm purchased a 5 years' lease for $40,000 on first January. It decides to write off depreciation on the annuity

method. Presuming the rate of interest to be 5% per annum.

Show the lease account for the first 3 years. Calculations are to be made to the nearest dollar.

Annuity Table

Amount required to write off $1 by the annuity method.

Years 3% 3.5% 4% 4.5% 5%

3 0.353530 0.359634 0.360349 0.363773 0.367209

4 0.269027 0.272251 0.275490 0.278744 0.2820125 0.218355 0.221418 0.224627 0.227792 0.230975

6 0.184598 0.187668 0.190762 0.193878 0.197017

7 0.160506 0.163544 0.166610 0.169701 0.172820

8 0.142456 0.145477 0.148528 0.151610 0.154722

Solution:

According to the annuity table given above, the annual charge for depreciation reckoning interest at 5 percent

p.a. would be:

230975 40,000 = $9,239

Lease AccountDebit Side Credit Side

Date $ Date $

1st

Year

1st

Year

Jan. 1 To Cash 40,000 Dec.

31

By Depreciation 9,239

Dec.

31

To Interest 2,000 By Balance c/d 32,761


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42,000 42,000

2nd

Year

2nd

Year

Jan. 1 To Balance b/d 32,761 Dec.

31


Dec.

31


34,399 34,399

3rd

Year

Jan. 1 To Balance b/d 25,160 Dec.

31


Dec.31


26,418 26,418

3rd

Year

Jan. 1 To Balance b/d 17,170

Advantages:1. This method takes interest on capital invested in the asset into account.2. It is regarded as most exact and precise from the point of view of calculations; and is therefore most

scientific.

Disadvantages:

1. The system is complicated.2. The burden on profit and loss account goes on increasing with the passage of time whereas the amount

of depreciation charged each year remains constant. The amount of interest credited goes on diminishing

as years pass by, the ultimate consequence being that the net burden on profit and loss account grows

heavier each year.3. When the asset requires frequent additions and extensions, the calculation have to be changed

frequently, which is very inconvenient.


This method is best suited to those assets which require considerable investment and which do not call for

frequent additions e.g., long lease.

7. EXPLAIN SINKING FUND DEPRECIATION.


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Depreciation fund methodis also know as sinking fund methodor amortization fund method.Under this

method, a fund know as depreciation fund or sinking fund is created. Each year the profit and loss account is

debited and the fund account credited with a sum, which is so calculated that the annual sum credited to the

fund account and accumulating throughout the life of the asset may be equal to the amount which would be

required to replace the old asset. In order that ready funds may be available at the time of replacement of the

asset an amount equal to that credited to the fund account is invested outside the business, generally in gilt-

edged securities. The asset appears in the balance sheet year after year at its original cost while depreciation

fund account appears on the liability side.

The amount of annual depreciation to be provided for by the depreciation fund method will be ascertained from

sinking fund table.

Sinking Fund Table

Annual sinking fund installment to provide $1.

Years 3% 3.5% 4% 4.5% 5%

3 0.323540 0.321934 0.320349 0.318773 0.317208

4 0.239027 0.237251 0.235490 0.233741 0.232012

5 0.188350 0.186481 0.184627 0.182792 0.180975

6 0.154598 0.152668 0.150762 0.148878 0.147017

7 0.130506 0.128544 0.126610 0.124701 0.122820

8 0.112446 0.110477 0.108528 0.106610 0.104722

Example:

On 1st January, 1990 a four years lease was purchased for $20,000 and it is decided to make provision for the

replacement of the lease by means of a depreciation fund, the investment yielding 4 percent per annum interest

Show the necessary ledger account.

Solution:

To get $1 at the end of 4 years at 4 percent an annual investment of $2,35,490 is necessary. Therefore, for

$20,000 an annual investment of $4,709.80 i.e., 2,35,490 20,000 will be necessary.

Lease Account

1990 1990

Jan.1 To Cash 20,000 Dec.

31

By Depreciation fund 20,000

Depreciation Fund Account1990 1990

Dec.

31

To Balance c/d 4,709.80 Dec.

31

By P & L account 4,709.80

1991 1991

Dec.

31

To Balance c/d 9607.99 Jan. 1 By Balance c/d 4709.80

Dec. By Depreciation fund investment 188.39


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31

" By P&L account 4709.80

9607.99 9607.99

1992 1992

Dec.

31

To Balance c/d 14702.11 Jan. 1 By Balance b/d 9607.99

Dec.

31

By Depreciation fund investment 384.32

" By P & L account 4709.80

14702.11 14702.11

1993 1993

Dec.

31

To Lease account 20,000 Jan. 1 By Balance b/d 14702.11

Dec.

31

By Depreciation fund investment 588.9

By P & L 4,709.80

20,000 20,000

Depreciation Fund Account

1990 1990

Dec.31

To Cash 4709.80 Dec.31

By Balance c/d 4709.80

1991 1991

Jan. 1 To Balance b/d 4709.80 Dec.

31

By Balance c/d 9,607.99

Dec.

31

To Depreciation fund 188.39

Dec.

31

To Cash 4,709.80

9,607.99 9,607.99

1992 1992

Jan. 1 To Balance b/d 9,607.99 Dec.

31

By Balance c/d 14,702.11

Dec.

31

To Depreciation fund 384.32


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Dec.

31

To Cash 4709.80

1993 1993

Jan. 1 14,702.11 Dec.

31

By Cash 20,000.00

Dec.

31

588.9

Dec.

31

4709.80

20,000 20,000

Note:The cash installment at the end of the last year will not be invested because there is no point in buying the

investment and selling them on the same date.

Advantages of Depreciation Fund Method Or Sinking Fund Method:The most important advantages of this method is that it makes available a sum of money for the replacement of

the asset, which has become useless. If separate provision was not made, the sum required to purchase the new

asset will have to be drawn from the business which might effect the financial position of the concern adversely

Disadvantages of the Depreciation Fund Method Or Sinking Fund Method:

1. The burden on profit and loss account goes on increasing as years pass by since the amount ofdepreciation every year remains same but the amount spent on repairs goes on increasing as the asset

becomes old.

2. It can also be said that the work of investing money is complicated.3. Prices of securities may fall at the time when they are to be realized as a result of which loss may have

to be suffered.


This method is found suitable wherever it is desired not only to charge depreciation but also to replace the asset

as happens in the case of plant and machinery and other wasting assets.

8. CLASSIFY MAINTENANCE OR TYPES OF MAINTENANCE ANALYSIS

Types of Maintenace

Maintenance operations have been categorized based on their frequency and their motivating factors. Four of

the most common designations are described below - predictive, preventative, corrective and fault-finding.

Predictive maintenance involves a series of steps prior to actually performing maintenance. It begins withsampling physical data over time, such as vibration or particulate matter in oil. Analysis is then performed on

the collected data to create an appropriate maintenance schedule, and maintenance is performed according to the

schedule. This type of maintenance analysis works well for mechanical systems because the failure modes are

well understood. Additionally there is historical data useful for creating and validating performance and

maintenance models for mechanical systems.

Preventative maintenancerefers to maintenance performed when a system is functioning properly to prevent a

later failure. Generally, it is performed on a regular basis and the maintenance will be performed regardless of

whether functionality or performance is degraded. The frequency of the maintenance is generally constant, and


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is usually based on the expected life of the components being maintained, but there is not necessarily any

monitoring occurring at the same time (as there would be in predictive maintenance). One common example is

lubrication of mechanical systems after a certain number of operating hours. Another is replacement of

lightning arresters in jet engines after a certain number of lightning strikes.

Corrective maintenance refers to maintenance done to correct a problem when something has failed, or is

failing. The need for corrective maintenance can be beneficial or detrimental depending on the product and the

profit model used during the design phase of the product. On the most obvious level, corrective maintenance is

detrimental to operation because it means that something failed, and the system is (probably) not available

during the time needed to perform the maintenance. On the other hand, it may be that the economics and

planned functionality of a system are such that using a cheaper, replaceable device for which failure is

anticipated, makes sense.

Failure-finding maintenanceinvolves checking a (quiescent) part of a system to see if it is still working. This

is most often performed on portions of a system dedicated to safety -- protective devices. This is an important

type of maintenance check to perform because failures in safety systems can have more catastrophic effects, if

other parts of the system fail.

9) EXPLAIN THE TYPES AND ADVANTAGES OF MAINTENANCE ANALYSIS.MAINTENANCE TYPES:

1. BREAKDOWN MAINTENANCE:

Characteristics of Break-down Maintenance System:

* No services except occasional lubrication unless failure occurs

* No maintenance men on regular basis

* Maintenance done by sub-contractors

* No organised efforts to find out reasons

* No stock of spares

* No budget

* No records* Initially it looks economical

* Problems in case of B/D

- Who is to do repair?

- From where to get parts?

- How do we pay for them?

- Who is to go to buy parts?

Results of Breakdown Maintenance System:

* Increased Down Time

* Increased costs & Pressures

2. ROUTINE MAINTENANCE

A procedure followed regularly i.e.,., A cyclic operation recurring periodically. maintenance engineering and

management

Advantages

1. Simple to establish & follow

2. Little or no clerical work

3. High degree of prevention by intercepting developing faults.


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A more advanced stage of routine maintenance calls for 'service instructions on a pre-printed schedule and

checklists'.

Examples:

* Check all compressors first on Mondays.

* Lubricate completely two machines daily.

Disadvantages

* Routine maintenance may not provide the service specified by the manufacturer

* We may ignore information regarding preceding breakdowns

* Service required for a machine at different frequencies may be ignored

* All similar machines may be serviced at same frequency

irrespective of working hours.

3. PLANNED MAI NTENANCE

In this type of service, the emphasis is placed on the machines.

What does the manufacturer prescribe?

Is the unit utilised for two, or three shifts per day?

Is it working under normal load?Are the conditions as good as those envisaged by the manufacturer?

Do we allow for extra attention owing to corrosion-including

conditions?

Characteristics of Planned Maintenance

* Instructions are more detailed than in routine maintenance maintenance engineering and management

* Calls for differently timed service for the same unit

* Schedule is drawn with dates

* Need for establishing the work-load for the crew

* Entails considerable planning effort, faithful implementation and recording

* Initial list of planned maintenance will be in detail andAdvantages of Planned Maintenance

* Will take into consideration the changes in conditions of use and increased wear of parts

* Inspections, replacement of parts and adjustments are included in the overall plan

* Detailed instructions reduce the chance of missing any activity. Unforeseen work is greatly reduced

* Provides as much attention as the equipment requires - to the best judgement and ability of the planner

4. PREVENTIVE MA INTENANCE

System which strives to reduce the likelihood of failures. To achieve prevention of break-downs Planned

service is carried out with the explicit additional objective of detecting wear points and ensuring perfect

functioning by replacing parts which could still be used were it not for the assurance that is required. Occasiona

use of statistical analysis/methods for determining life expectancies of parts. The system employs Measuring &

Inspection Devices. This phase is Predictive maintenance.

Preventive Maintenance System is more expensive due to more of planning and replacement of parts before

failing.

PM increases reliability

PM reduces total work-load

PM reduces total down time

PM reduces unplanned work


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PM reduces total maintenance cost

Preventive maintenance could be grouped as under:

- Fixed-time Maintenance

- Condition-based Maintenance

- Opportunity Maintenance maintenance engineering and management

CORRECTIVE MAI NTENANCE:

Services carried out to restore an item to an acceptable working condition.

Services arising out of

- Break-downs

- Malfunctioning &

- Deteriorating conditions

PRODUCTIVE MAINTENANCE

An effort to set up the function on a planned and measured production pattern. The output relates to the number

of servicing tasks completed, e.g., lubrication, inspection, overhaul, etc. Originally used in USA.

TOTAL PRODUCTIVE MAINTENANCE (TPM)

Efforts with the total participation of employees.

Used in Japan.

10. EXPLAIN INFLATION ADJUSTED DECISION OR REAL RATE OF RETURN

A measure of return that accounts for the return period's inflation rate. Inflation-adjusted return reveals the

return on an investment after removing the effects of inflation. It is calculated as follows

Also, a simple approximation for inflation-adjusted return is given by subtracting the inflation rate from the rate

of return.

Inflation-adjusted return:Also referred to as real rate of return, this form of return accounts for inflation and

provides what an investor is going to earn keeping inflation into consideration. And it is suggested that if an

investment instrument does not earns a return at par with likely rate of inflation in future course, it hardly makes

sense to deploy money towards it. And with rate of inflation in a country like India standing at approximately

10% on an year-to-year basis, any instrument or asset with less than 10% return should not qualify for

investment. Bank fixed deposits that on an average provide a pre-tax rate of return of 9.5% p.a in the currentscenario when the CPI inflation for the month of November stands at 11.24% yields negative real rate of return.

Real rate of return or inf lation adjustment

The real rate of return formula is the sum of one plus the nominal rate divided by the sum of one plus the

inflation rate which then is subtracted by one. The formula for the real rate of return can be used to determine

the effective return on an investment after adjusting for inflation.

The nominal rate is the stated rate or normal return that is not adjusted for inflation.

The rate of inflation is calculated based on the changes in price indices which are the price on a group of goods

One of the most commonly used price indices is the consumer price index(CPI). Although the consumer price


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index is widely used, a company or investor may want to consider using another price index or even their own

group of goods that relates more to their business when calculating the real rate of return.

For quick calculation, an individual may choose to approximate the real rate of return by using the simple

formula of nominal rate - infl ation r ate.

Example of Real Rate of Return Formula

An example of the real rate of return formula would be an individual who wants to determine how much goods

they can buy at the end of one year after leaving their money in a money market account that earns interest.

For this example of the real rate of return formula, we must assume that the individual wants to purchase the

exact same goods and same proportion of goods that the consumer price index uses considering that it is used

often to measure inflation.

For this example of the real rate of return formula, the money market yield is 5%, inflation is 3%, and the

starting balance is $1000. Using the real rate of return formula, this example would show

which would return a real rate of 1.942%. With a $1000 starting balance, the individual could purchase

$1,019.42 of goods based on today's cost. This example of the real rate of return formula can be checked by

multiplying the $1019.42 by (1.03), the inflation rate plus one, which results in a $1050 balance which would bethe normal return on a 5% yield.

INFLATION ADJUSTMENT

For some program areas, cost estimates, which provide the basis for the amount of financial assurance required,

must be increased annually to account for inflation. Programs requiring inflation adjustments include:

Industrial and Hazardous Waste Municipal Solid Waste Underground Injection Control Wells Used Oil Recycling Class A or B Petroleum-Substance Contaminated Soil Storage, Treatment, and Reuse Facilities Scrap Tire Sites Public Drinking Water Systems and Utilities Radioactive Material - Burial Radioactive Waste - Low Level Near-Surface Land Disposal

If applicable, the inflation adjustment must be made using an inflation factor derived from the most recent

annual Implicit Price Deflator for Gross National Product published by the United States Department of

Commerce. The preliminary and final inflation factors are generally available by the first week of February and

April of each year, respectively. Once the cost estimate has been adjusted, then you must ensure that your

financial assurance mechanism dollar amount sufficiently covers the revised cost estimate.

(UNI T II I COMPLETED)

11 MARK UNIVERSITY QUESTIONS

1. Explain replacement and maintenance analysis. (Dec2012) (Refer P.No: 3 &17)2. Explain the causes of inflation. (Dec2012, April 2010) (Refer P.No:54, Unit I )3. Explain the methods of providing depreciation. (April2012) ( Refer P. No: 7)4. Explain inflated adjusted decisions. (April2012) ( Refer P. No: 19)


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5. Explain the advantages of maintenance analysis. (April2010 ( Refer P. No: 19)6. Explain the causes of depreciation.(April2010) ( Refer P. No: 5)7. Explain the types of replacement analysis. (April2010) ( Refer P. No: 5 )

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