Mid-Year Sale and a Proposed Switch in Depreciation Method
Radhika Industries, a small manufacturer in Agra, closes its accounts on 31 March. It bought Machinery A on 1 July 2022 for ₹8,00,000 and paid ₹50,000 for freight, foundation and installation; the asset was ready for use on that date. Machinery B, bought on 1 April 2021 for ₹2,00,000, was sold on 1 October 2024 for ₹1,10,000. The firm's written policy is: Machinery A - straight line at 10% p.a. on original cost including installation, pro-rata from the month of use; Machinery B - written-down value at 15% p.a., full year's depreciation in the year of purchase and none in the year of sale. The accountant has (i) charged a full year's depreciation on B for 2024-25 and (ii) credited the ₹1,10,000 sale proceeds straight to the Machinery B account without computing any profit or loss. He has also proposed switching the whole block to the written-down value method from 1 April 2024, applying the new rate only to future years and making no other adjustment.
1. Compute depreciation for 2024-25 on both machines and the profit or loss on sale of Machinery B, showing the written-down value working.
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Machinery A (straight line, 10% of ₹8,50,000)
Depreciation for 2024-25 = ₹8,50,000 × 10% = ₹85,000 (used throughout the year; ₹63,750 was charged in 2022-23 for nine months).
Machinery B (written-down value, 15%)
| Year | Opening WDV (₹) | Depreciation (₹) | Closing WDV (₹) |
|---|---|---|---|
| 2021-22 | 2,00,000 | 30,000 | 1,70,000 |
| 2022-23 | 1,70,000 | 25,500 | 1,44,500 |
| 2023-24 | 1,44,500 | 21,675 | 1,22,825 |
| 2024-25 (6 months to date of sale) | 1,22,825 | 9,212 | 1,13,613 |
Depreciation for 2024-25 = ₹1,22,825 × 15% × 6/12 = ₹9,212 (rounded).
Loss on sale = WDV ₹1,13,613 − sale proceeds ₹1,10,000 = ₹3,613.
Total charge to the profit and loss account for 2024-25 in respect of these two assets = ₹85,000 + ₹9,212 + ₹3,613 = ₹97,825.
2. Show the correct journal entries on sale (no provision for depreciation account is kept) and quantify how the accountant's treatment misstates profit and the balance sheet.
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Correct entries
- Depreciation A/c Dr 9,212 - To Machinery B A/c 9,212
- Bank A/c Dr 1,10,000
Loss on Sale of Machinery A/c Dr 3,613 - To Machinery B A/c 1,13,613 - Profit and Loss A/c Dr 12,825 - To Depreciation A/c 9,212 - To Loss on Sale A/c 3,613
Effect of the accountant's treatment
- Full-year depreciation charged = ₹1,22,825 × 15% = ₹18,424, i.e. ₹9,212 more than the six months actually required.
- WDV after that charge = ₹1,04,401. Crediting ₹1,10,000 to the asset leaves a credit balance of ₹5,599 in the Machinery B account, which is not a loss account and cannot be shown as an asset.
- Total charge to profit under the accountant's method = ₹18,424 (depreciation only), against the correct ₹12,825. Profit is therefore understated by ₹5,599, while the balance sheet carries a negative asset of ₹5,599 instead of recognising a ₹3,613 loss.
- Netting sale proceeds against the asset also conceals both the disposal and the loss, defeating disclosure.
The two errors do not offset each other in the accounts, even though the rupee difference is the same ₹5,599.
3. Advise on the proposed change in the method of depreciation from 1 April 2024, applied only prospectively. Is the accountant's approach acceptable?
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A change from straight line to written-down value is a change in the method of depreciation, i.e. a change in accounting policy, not a change in estimate. The accountant's proposal to apply it only to future years is not acceptable, because the carrying amounts brought forward were computed on a basis that is now abandoned; the assets would then be carried at a figure that is neither old-basis nor new-basis.
The correct treatment is:
- Recompute depreciation on the new (WDV) basis from the date each asset was put to use.
- Compare the recomputed written-down value with the book value actually carried; the deficiency or surplus is charged or credited to the profit and loss account in the year of change.
- Disclose the change, the reason for it, and its effect on depreciation and profit for the current year and, where practicable, the expected effect in future years.
There is an exception in substance: if what has changed is the estimated useful life or residual value, that is a change in estimate, applied prospectively over the remaining life, with disclosure. The firm must be clear about which it is doing. Since the rate itself is also being changed, the note should quantify both effects separately so that comparability with earlier years is preserved.