Q.M/s Digital Studio bought a machine for ₹8,00,000 on April 01, 2013. Depreciation was provided on straight-line basis at the rate of 20% on original cost. On April 01, 2015 a substantial modification was made in the machine to make it more efficient at a cost of ₹80,000. This amount is to be depreciated @ 20% on straight line basis. Routine maintenance expenses during the year 2013-14 were ₹2,000. Draw up the Machine account, Provision for depreciation account and charge to profit and loss account in respect of the accounting year ended on March 31, 2016.

The correct option is (a) Expenses.

Depreciation is the gradual, permanent and continuing fall in the value/usefulness of a fixed asset on account of use, wear and tear, efflux of time or obsolescence. Since it represents the cost of the asset's benefit consumed during the accounting period, it is treated as a business expense and is debited to the Profit and Loss Account while reducing the value of the asset in the Balance Sheet.

The correct option is (c) Depreciation Fund A/c.

Under the Depreciation Fund (Sinking Fund) Method, the firm invests an amount equal to the annual depreciation charge in outside securities (Depreciation Fund Investments). When these investments are realised (sold) at the time the original asset needs replacement, any profit or loss arising on their sale is transferred to the Depreciation Fund Account itself (increasing or decreasing the fund that will be used to replace the asset) — it is not routed through the ordinary Profit & Loss Account, because the fund exists specifically to accumulate the resources for replacement.

Profit on sale of a fixed asset is shown as an income/gain in the Profit and Loss Account.

When a fixed asset is sold for more than its book value (written down value), the excess is a profit on sale of asset. Since it is not an operating/trading profit but still increases the net result of the business for the period, it is transferred to and shown on the credit side of the Profit and Loss Account as a non-operating gain/income.

'Amortisation' is the term used for the systematic write-off of Intangible Assets (patents, copyrights, goodwill, trademarks), just as 'Depreciation' is used for tangible fixed assets.

The terms used for writing off the cost of different classes of assets are:

• Depreciation — for tangible fixed assets (machinery, furniture, building).
• Depletion — for wasting assets such as mines, quarries, oil wells (assets that physically diminish as they are extracted/used).
• Amortisation — for intangible assets such as patents, copyrights, trademarks, leases and goodwill.
• Writing off fictitious assets (like preliminary expenses) is simply called 'writing off,' not amortisation in the strict technical sense used here.

So amortisation refers to writing off Intangible Assets.

Residual value (also called scrap value or salvage value) is the estimated amount that an asset is expected to fetch when sold or disposed of at the end of its useful life, after deducting any expected disposal/removal costs.

Explanation: When a business buys a fixed asset (say machinery), the asset is used for a number of years (its useful life). At the end of that useful life, the asset may still be sold — as scrap, as second-hand equipment, or for its material value. The net amount the business expects to realise at that point (sale value less any costs of removal/disposal) is called the residual value.

Residual value is important because it directly affects the amount of depreciation charged every year:

Depreciable Cost = Original Cost − Residual (Scrap) Value

A higher expected residual value means a lower amount needs to be depreciated over the asset's life, and vice versa.

Depreciable Cost is the total amount of an asset's cost that is to be spread (depreciated) over its useful life.

Explanation: Not the entire cost of a fixed asset is depreciated — only the part of the cost that is actually "used up." This is because, at the end of its useful life, the asset may still have some residual (scrap) value that can be recovered. So:

Depreciable Cost = (Original Cost of Asset + Expenses incurred to put the asset to use, e.g. installation, freight) − Estimated Residual Value

For example, if a machine costs Rs. 60,000 and is expected to have a scrap value of Rs. 5,000 at the end of its life, the Depreciable Cost is Rs. 55,000 — it is this Rs. 55,000 that gets spread over the asset's useful life as annual depreciation (under the Straight Line Method).

Residual value (also called scrap value or salvage value) is the estimated amount a business expects to recover by selling or disposing of a fixed asset at the end of its useful life, after deducting any disposal/removal costs.

When a business estimates depreciation on a fixed asset, it must first estimate what the asset will be worth when it is finally retired from use — this estimated amount is the residual value. For example, a machine bought for ₹1,00,000 with an expected useful life of 10 years might be expected to sell as scrap metal for ₹10,000 at the end of that period; ₹10,000 is its residual value. Residual value is subtracted from the original cost to arrive at the Depreciable Cost, which is the amount actually written off as depreciation over the asset's useful life. If no realizable value is expected at all, residual value is taken as nil.

Depreciable Cost is the total amount of an asset's cost that is systematically allocated (written off) as depreciation expense over its estimated useful life.

It is calculated as:

Depreciable Cost = Historical (Acquisition) Cost of the asset − Estimated Residual (Scrap) Value

Here, the acquisition cost includes the purchase price plus any cost incurred to bring the asset to its present location and working condition (freight, installation, taxes, etc.). This Depreciable Cost is the base figure on which a chosen method (Straight Line, Written Down Value, etc.) is applied to determine the periodic depreciation charge. For example, if a machine costs ₹60,000 (including installation) and its estimated scrap value at the end of its useful life is ₹5,000, the Depreciable Cost is ₹55,000 — this is the amount that will be charged to the Profit and Loss Account, in instalments, over the asset's useful life.

AS-10 ('Accounting for Fixed Assets') prescribes the method of accounting for Fixed Assets. The correct option is (C) Fixed Assets.

Accounting Standard 10 (AS-10), issued by the ICAI, lays down the principles for recognising a fixed asset, determining its cost (purchase price, duties, and any cost directly attributable to bringing the asset to its working condition), and deciding how it should be shown and disclosed in the financial statements. It does not deal with Inventories (covered by AS-2), nor does it deal exclusively with Depreciation (covered by AS-6, since withdrawn and merged elsewhere) or Revenue Recognition (AS-9) — those are separate standards.