 In our last session, we have started discussion on accounting standards, gap, IFRS and so on. To begin with, we will talk about accounting principles and then we will go ahead with the new concepts. Last time we have done 5, 6 concepts, we will go ahead with the new concepts. So, what do you understand by accounting principles? All the accounting is based on certain theoretical understanding and that is known as accounting principle. Accounting will present a true and fair view only when it is properly backed by systematically let down principles. They are those rules of conduct and procedures which are adopted by accountants to ensure that there is a uniformity and to ensure that there is fairness in the reporting. Now these concepts are basic to the process of accounting hence they are known as accounting concepts. Some of the important concepts are business entity, going concern, conservatism and so on. Now let us see a business entity concept which we have already discussed last time that the owner is different from the business. That is why we make entries for capital invested. The next is dual aspect concept. In dual aspect concept both aspects of transactions are recorded separately. In accounting terminology they are known as debits and credits, so debits should be equal to credits. We have also seen there is a balance sheet equation where in owners fund plus liabilities is equal to assets. So let us see two examples first when we take loan from bank. Can you imagine what will be the entry which accounts are affected? Obviously, when we get money our bank account balance increases and our liability for loan also increases. So on one hand asset increases on the other hand liability increases. We have already seen this earlier this comes because of business entity concept. The second one is purchase of goods for cash. Here in we are giving cash, so cash balance falls and as cash balance falls our inventory balance rises. So again because of dual aspect the balance sheet equation is maintained. Cost concept it says that the transactions are normally recorded on the basis of cost. Expenses are recorded at an amount which is actually incurred and fixed assets are recorded at acquisition cost less depreciation. We do not consider the market price this is because of the cost concept. Next concept which we are discussing which we already discussed is going concern. Now here it is assumed that business entity has a pretty long life it is going to continue in the foreseeable future and because of this concept we depreciate fixed assets over their useful life. We do not assume that fixed assets have to be written off immediately. Next is accounting period concept which again we have discussed at length last time that the whole business cycle is divided into fixed periods and the financial statements are prepared at the end of this periods. Due to this concept the profit and loss account and balance sheet is prepared and reported periodically. We have also seen that traditionally Diwali has been the financial year which was followed in India. Currently the financial year which is followed is from 1st April to 31st March. In US it is from 1st January to 31st December and so on in different countries different accounting periods are used. This is a new concept I think first time we are dealing with that is money measurement concept. It says that the transactions which are expressed in money term alone are recorded. Now can you imagine a non-monetary transaction for example a very good employee joins the company. Now if the employee joins the company it adds lot of value to the company. The enterprise value has actually increased but that cannot be recorded because it is not a monetary transaction. What accounting system will record is expenses incurred for let us say recruitment selection etcetera but cannot really record the value of person coming in. I can give you one more example suppose we are able to have a very good business contact. The contact is really valuable but since no transaction has been incurred just the contract is developed it cannot be recorded in the books of accounts that is because of the money measurement concept. Next is realization concept in realization concept the revenue is recognized only when an agreement is reached or the sale is made. In other words just because the stock value has increased we will not be able to show the value has it has increased only when the sale is made we will recognize. So all revenues unless they are realized they are not supposed to be recorded in the accounting system. Next is a constant value concept now in constant value concept the assumption of constant value of currency that is in case of India say rupee is assumed. So the value of currency may change especially because of inflation. So what may happen is we are holding some stock the value of stock is rising because of inflation but we will not recording. In case of debtors certain amounts are receivable the value of money is actually falling. So the amount of money which we will recover from debtors is same but its true value may have fallen. But we will not record those rises and falls same thing you find with land generally the land prices rise but we cannot record them. In case of liabilities what happens is if you have taken loan then the value of loan as you repay in absolute terms remain same but the amount is actually lower but we cannot show that lower value. So we have to show the value as is in absolute terms it is not in terms of constant value. The next is accrual concept now let us go for accrual concept by accrual concept what we mean is the effect of transactions are recorded on mercantile basis that is when they occur we record we do not wait till the cash is received or paid for example credit sale. So if a transaction is entered the goods are sold. So the transaction has happened but the cash is yet to be received we do not wait till the cash is received as soon as the sale has happened it gets recorded. Then you have to recognize the outstanding expenses. So it might have happened that salary for this month is not paid at the end of the month it will be paid only in the next month. However at the end of the month the outstanding salary will get recorded again because of the accrual concept. Same thing happens with prepaid expenses. Suppose insurance is paid in advance we will record the insurance because even if it is for the next period and it has been paid now we will treat we will show it as a prepaid expense. So we do not actually wait for cash received and paid in case of prepaid expense what will happen is whatever is insurance for the current period will be transferred to profit and loss of this period whatever is paid for future will be recognized as prepaid will not be charged for this period. So accounting system recognizes the expenses as and when they occur. Same thing is true for income or any other transaction it is not based on receipt or payment of cash and that happens because of the accrual concept. Next is consistency. Now it is very important that whatever the accounting concepts or principles which we are following they need to be consistently followed. If we change them frequently the accounting statements will not be comparable across the periods. For example, suppose the depreciation is being charged at 20 percent this year and next year we charge it at 10 percent then the books will not remain comparable. It is required by the standard setting authorities that you must follow the same accounting policies across all the periods only in the exceptional circumstances the changes are allowed and at that time the proper disclosure is required. This happens because of the consistency principle. Now let us understand fundamental accounting assumptions. Now some of the accounting assumptions though we have seen many concepts and all of them are important certain concepts are deemed to be fundamental accounting assumptions. Why they are called fundamental assumptions? Because even if it is not disclosed it is deemed that these assumptions have been made while making the financial statements. If they are not followed then the disclosure is required if they are followed no separate disclosure is needed. There are three assumptions first is going concern we already discussed it. Second is consistency and third is accrual. So these three concepts or these three fundas should always be followed and any deviation from them will need to be separately disclosed and reported. Now let us do one small exercise. Suppose the land is purchased on 1st April 2010 and the cost of land is 250,000 registration charges paid there on our 5000. As of 31st March 2012 the market value of the land is estimated to be 5 lakhs. Now what is a value that should be shown in the balance sheet as on 31st March 2012 that is question number one. Just think over will that be 250, will it be 255, will it be 5 lakh what is the value shown that is question number one are you able to guess just have a look at data once again. Now suppose management decides to value it at 5 lakh is it a correct decision and if not which are the concepts which they have violated they have if at all they value it at 5 lakh it is not a correct position they have violated number of concepts. The first concept violated is cost concept we have already seen that all transactions need to be recorded at cost here the cost of land is 255,000. If you recorded at 5 lakh the cost concept is violated secondly accrual concept is also violated because the cost of 5000 which was a registration charge which is a one time cost. This should be added to the cost of land if that is not followed accrual concept and matching concept both are violated and the concept of conservatism also is violated because conservatism says that we cannot show the profits unless they are realized. Now there is a appreciation in the value of land from 255,000 to 5 lakh but we cannot show that appreciation unless the sale transaction is realized. So there are 4 concepts just think over and tell me actually which concept or which concepts are violated are all 4 violated or which one are violated. The major violation is towards conservatism because conservatism does not permit you to value the land at selling price when its cost price is 255,000 other concepts also there is slight deviation but major violation is towards concept of conservatism. So what will be the correct value should it be 250 or 255 it should be 255,000 because 5000 which is a registration charge it should be added to the cost of land it cannot be charged as the expense of that year it will violate matching concept. So it needs to be added to the cost of land and land will be shown at 255,000 that is considered as the cost of land is it fine. Now let us go to something which is known as accounting standards. Now we have seen that there are some accounting fundamentals which are known as accounting concepts which should be kept in mind based on the accounting concept the accounting policies are wrong. Now are companies free to choose any concepts they like or any policies they like it is not so because if companies follow some concepts if they do not follow some concepts or if their policies are matching with some concepts and not matching with some concepts it will create lot of problems. Because as users of statements when we read balance sheet and we see that say land is shown at 255,000 we know that this must be at cost. If some other company shows it at 5 lakhs and if they have accounting policy to value the land at market price it will be improper representation. So it is necessary that there should be some laid down rules there should be some standardized practices which all companies must follow and those practices are known as accounting standards. As you can see here they are written policy documents issued by the expert body or by government or by regulatory authority which cover the aspect of recognition treatment measurement presentation and disclosure of accounting transactions and events in the financial statement. So some standardization in the policies are made then it is called as accounting standards. Now they provide a framework so that different companies follow the same pattern and their balance sheets or their financial statements are comparable. And they also ensure that you follow correct principles so that the true and fair view is disclosed both in terms of financial position and also the working results. Now accounting concepts do not necessarily force a particular policy because there may be different business conditions there may be different business scenarios. So they do not laid down that all the time you must follow this. However apart from laying down some concepts or some principles they ensure that there is more transparency and market discipline. So they do give some leeway sometimes that companies may follow policy A or policy B within the prescribed permitted deviation so that you follow the correct principle at the same time they foster greater transparency and market discipline. Why greater transparency because they make it mandatory that certain disclosures must be made. So the users are aware and they get lot of info. Secondly market discipline because all the companies are forced to follow a particular pattern. These are the four things which accounting standards typically promote. They promote uniformity, rationalization, comparability and transparency. I hope these terms are clear to you. Now let us come to Indian accounting standards. We have already seen that accounting standards are the standardized norms for accounting which are laid down by regulatory bodies. In case of India ICAI, Institute of Chartered Accountants of India is the apex accounting body. So they have constituted a board which is known as accounting standard board which has the basic responsibility of laying down the accounting standards in India. The board was constituted on 21st April 1977 with the same purpose that there should be a harmonization of policies and to formulate the standard. While formulating the standards it is not just the accounting requirements ASB also looks at the applicable laws, customs, usages and the business environment as prevailing in India. Apart from these things as you may be aware currently there is lot of need from the companies that you should have uniform standards across the globe because there are lot of cross border transactions. There are investors investing from one country to another. There is export, import, rise of global trade. So it is necessary that at international level also the transactions are recorded in fairly the same manner. That is why ASB gives due consideration to international standards like IFRS and IS and tries to integrate Indian standards to those standards. We are going to discuss those IFRS and IS in detail in some more time like. Now ASB till October 2011 has issued 34 accounting standards. Since now there is a need to converge Indian standards with the international standards ASB is coming out with new set of standards which are closer to international standards and they are known as IND AS. So currently India has two standards one are AS which are the existing accounting standards and there is IND AS which are new set of Indian standards but which are closer to international standards. Let us have a look at IND AS. Now the Ministry of Corporate Affairs has also notified this IND AS as on 21st February 2011. However, new set of standards that is IND AS is not mandatory to all the companies from day one. They are being implemented in phased manner. So currently all the business entities or all entities are following AS but the larger corporates or those companies which are listed abroad are required to use IND AS in the first phase. Gradually more and more companies will be covered by IND AS. There are some requirements of IND AS which are dissimilar with the current practices because IND AS is more closer to international standards. So there is some difference between IND AS and current AS. So some time is given to companies to shift from AS to IND AS. Now what standards setters have done for formulating IND AS is one is they have looked at individual IFRS and they have also seen the conditions as in India. So make those standards suitable to India that is why there are some differences which are known as carve outs difference between IND AS and parallel IFRS. Let us look at these things now in detail. First have a look at the list of various accounting standards which are very similar to IFRS. Their numbers are like this IND AS 101 is for first time adoption of IND AS and accounting standards. Then IND AS 102 it takes care of share base payments, IND AS 103 about business combinations, 104 is about insurance contracts, 105 non-current assets held for sale and discontinued operation and so on. 108 is operating segments. These 8 standards from 101 to 108 match closely with IFRS 128 that is why their names are being 101 to 108. Then there are some other standards which are closer to IAS international accounting standards we will discuss them IFRS and IAS in some time. But those standards are named as IND AS 1, IND AS 2 and so on. You can see on the screen IND AS 1 is presentation of financial statement, IND AS 2 is about inventories, then IND AS 7 is statement of cash flows, IND AS 8 is accounting policies changes in accounting estimates and errors and so on. So you can see they are not actually numbered as 1, 2, 3, 4 it is 1, 2, then 7, 8 because these standards have exact matching with the corresponding IAS that is an international accounting standard their numbers are also kept in that way. So next is IND AS 10 for events after reporting period, IND AS 11 for construction contracts, IND AS 12 for income tax, then IND AS 16, 17, 18, 19, IND AS 20 is about government grants, 21 is about forex rates, 23 about borrowing cost related party disclosures, 27 is for consolidation. So you can glance through. So IND AS 40 that is investment property is a last in this series. Let us have a look again. So if you go back to current AS you can see that IND AS first is IND AS 108 to 10, 10, 1, 2, 1, 0, 8 these are 8 standards which are in close correspondence with IFRS. Then you have other set of standards which are IND AS 1 to IND AS 40 of course they are not 40 in number, but they are numbered from 1 to 40. There are gaps in between which correspond to IAS. Now let us understand what is actually this IAS and IFRS. Now international accounting standards to there was a need as we saw from the business community, from the accountants, from the investing community that there should be harmonization at international levels. So you need some global accounting norms and you cannot have a situation where one countries balance sheet are not compared with other countries balance sheet. Because with rising international trade and rising cross border investments there was a need to have some common practices. That is why a body known as international accounting standard committee was constituted in 1973 that was the first effort to have global accounting standards. Now the standards which are issued by this IAC are more or less followed by or they are being closely linked to their local standards by most of the countries, but countries like Canada, Japan and US have still not accepted these standards. US accounting body which is known as FASB financial accounting standard board is in the process of eliminating the differences. So that the standards are US standards are very close to international standards. Now followed by this 1973 formation by of IAC one more committee known as standard interpretation committee was formed in 1997 because number of standards need to be properly understood and interpreted. Now as a next step IASB international accounting standards board was created in 2001 to prescribe norms for items on preparation and presentation of financial statements. Now this was a major step for making new set of standards which are mandatory for all the global entities. Now IASB has adopted all the 41 standards which are issued by IAC that is the international accounting standard committee and these are now known as IAS international accounting standards. Then IASB has also come out with new set of standards which are known as IFRS international financial reporting standards. So now at an international level there are two set of standards one are IAS which are old standards, but which are now adopted by IASB and then there are new standards which are called as IFRS. Let us have a look at the list of IAS, IAS one is presentation of financial statements, IAS two is inventories, IAS seven is cash flow. Now you can remember that we had this IND AS 1, IND AS 2, IND AS 3 sorry IND AS 7 which actually correspond to the concerned IAS. So have a look at the list I do not think I have to read everything you can yourself see this list. So currently we have got up to IAS 41 agriculture list of standards which are issued by erstwhile IASC now adopted by IASB that is international accounting standard board. Now IASC has also come out with new standards of its own which are known as international financial reporting standards. I have not shown the list because you have already seen this IND AS 101 to 108 they are same as concerned IFRS. So IFRS 1 is actually first time adaptation of Indian standards, IFRS 2 is first time adoption of IFRS is IFRS 1, IFRS 2 is for share based payment, IFRS 3 is for business combination and so on. So there are 8 standards and IND AS 101 to 108 actually correspond to those respective IFRS. Now many times you might have heard the term known as GAP GAAP. Now what is this GAP? This is the term which is slightly wider than accounting standard the purpose is same that we should have a certain conceptual framework to ensure uniformity and proper recording by the accounting system. So that framework is known as generally accepted accounting principles or GAAP gap in short. Now financial statements of the entity cannot be shown to be considered to be showing a true and fair view unless they are drawn up as per the gap. Now GAP actually has 4 components the first are requirement of law. So if there is any particular legal provision that certain items are to be recorded in certain way there will be a part of GAP. I will give you an example in case of banking regulation act certain format for balance sheet of bank is prescribed. So it is a form of it is a part of GAP as far as India is concerned same way companies act we have already seen that there is a schedule 6 which lays down the balance sheet format. So it is a part of Indian GAP though it is not a part of standard but company law since has prescribed a format for balance sheet it is a part of law. The second one the judgment by the courts of law so in certain cases court gives certain judgment that a particular item must be recorded in a particular way. So that will also becomes a part of GAP the third is the pronouncement by governing bodies say ICAI in India we have already discussed that ICI comes out with Indian accounting standards and they are mandatory in India and they are a part of Indian GAP. In case of US we have a body known as FASB that is financial accounting standard board so the pronouncement by FASB become a part of GAP. The last one is the requirement of regulatory authorities for example RBI is a regulatory authority for all the banks. Now RBI stipulated norms for recognizing non-performing assets popularly known as NPAs. So what item should be recognized as NPA? How much provision should be made? How you should record interest received from NPA? All these things are laid down by RBI so they become a part of Indian GAP same way sometimes SEBI lays down certain disclosure norms they also are part of RBI. In case of US there is a body known as SEC securities exchange commission their requirements also become part of GAP. So overall GAP consists of legal requirements regulatory requirements and of course the main component is the accounting standards. As you can easily imagine each country has its own GAP since law since laws are different so Indian GAP will be naturally governed by Indian accounting standards and Indian laws. So there is a requirement I mean there is a set of guidelines which are in together known as Indian GAP. In US again there is certain set of requirements which are known as US GAP. This GAP forms the backbone of all the accounting information system without GAP it will be senseless and it will be incomparable it will be meaningless that is why it is considered as a backbone of the accounting system. This term GAP is predominantly used in US because US authorities make it mandatory for all the companies to follow US GAP if they want to list their securities in US and so on. So US GAP is the term which is commonly used but actually there is a GAP for each country. So with the current effort of harmonization in accounting standards what we can hope is in times to come say around by 2015 most of the countries will converge their accounting standards with the global standards that is may be IIS or IFRS etcetera. And all the larger business entities will make their financial statements which are in conformity with international standards. Now the benefit of this internationalization is suppose we are studying the balance sheet of say reliance industries and we want to compare them with a US company Exxon both are in petroleum business. If the gaps are different then their balance sheets are not comparable but if both Indian and US companies follow similar accounting norms their balance sheets become comparable. Same way suppose an Indian company let us say wants to invest in China so it is looking for a trading partner and it asks for the financial statement of a Chinese company. If the accounting norms are completely different then Indian decision makers will not be able to understand and read that Chinese financial statements carefully. However, when the accounting norms are standardized it becomes far more simple to understand the financial statements of each other. So these are the benefits of internationalization. So I hope you have more or less understood the fundamentals of accounting in the form of accounting standard IIS, GAP, IFRS and the accounting concepts which form the base of all these regulatory requirements. Is it fine? Let us go to the next module. In this module we are going to discuss about depreciation and inventory. In any balance sheet depreciation and inventory are very important things to understand. You must be knowing that in this particular thing we are going to discuss these two things we will start with the concept of conservatism and then we will look at depreciation and other provisions. We have seen some of the concepts wherein we have also seen that conservatism is a important concept. Let us deal with little more detail in here. So conservatism states that accountant should not anticipate any income but should provide for all possible losses. As per this concept it is not prudent to count unrealized gain but it is necessary to guard against all possible losses. Now what does it mean? Suppose I have purchased inventory for 5 lakhs and the current value of inventory goes up to 7 lakhs. So in my financial statements it is at 5 lakhs that is my purchase price. Current value has gone up to 7 lakhs. At what rate I should record the inventory? At 5 lakhs or at 7 lakhs? The answer is I should record it at only 5 lakhs because you know there is a cost concept I cannot record the unrealized profits. So it is in violation of cost as well as realization concept. Now suppose the cost of the stock is 5 lakh but its current market value falls to 4 lakh 20,000. Now should I record 5 lakh or 420? Now I will not record 5 lakh, I will record it at 420, why? Now I do not mind giving up the cost concept because concept of conservatism actually overrides the cost concept. So here since it is desirable to guard against possible loss my cost is 5 lakhs when the market price increases I do not record unrealized profit but when the market price falls say from 5 lakh to 420 there is a very high probability that I will be able to sell the stock only at 4 lakh 20,000 which is less than the market price that is why I should record this loss as soon as it is anticipated are you getting? So because of the concept of conservatism I do not record unrealized profits which is in tune with realization concept. But I do record losses even when they are yet to be realized I immediately show a reduction in the value. It also says that when there are various methods to value the stock accountant should prefer the method which shows lesser value because that is a more conservative approach instead of showing asset at an inflated rate it is better to show it rather at a lower rate. There are three important qualitative characteristics of the concept of conservatism first is known as prudence that is we should make judgment about possible losses which are to be guarded as well as gains which are uncertain. So there should be a fair judgment the next is neutrality accountant is required to an unbiased outlook to identify and record the possible losses and at the same time exclude the uncertain gains. Here you can understand that person in charge let us say CEO of the company may be interested in showing more gains and he will also be interested in not showing or not recording certain losses because it will give a slightly higher profit position. And as far as the accountant is concerned accountant is required to be neutral and he should see that the losses are properly identified and recorded whereas whenever the gains are being recorded they should not be uncertain in nature. The third is alternative value should be faithfully represented. So these are the two examples when we have already seen that the closing stock is required to be valued at cost or market value whichever is lower. The second example is about depreciation now many times what happens is I might have purchased a new land a new machinery for 1 lakh it has a useful life of 5 years. Now at the end of one year the machinery remains almost as good as new because I have maintained it properly. Now I show it at 1 lakh or I need to charge a depreciation on it the answer is you need to charge depreciation because useful life of the machinery is 5 lakh 5 years. So 1 lakh needs to be written off over the period of 5 years let us say 20,000 each year. So from 1 lakh I will reduce 20,000 and at the end of the year the value of machinery will be shown at 80,000. A third of depreciation can vary but it is necessary that asset should be shown at a depreciated value and depreciation should be charged every year along the useful life of the asset. Now this need to charge depreciation comes because of concept of conservatism that is why before learning about the depreciation and inventory we have started with the concept of conservatism. Now let us understand the depreciation little more in depth. Now what do you understand by depreciation? You know that the fixed assets like plant and machinery as and when they are used the value of such assets is bound to decrease and assets have certain useful life they are not there forever. So it is necessary that the value of the asset or the cost of asset is gradually reduced and completely shown I mean brought down to the scrap value at the end of its useful life. So value of portion of fixed asset which is used for generating revenue it charged during a particular year and this portion of the cost is known as depreciation. This is another definition of depreciation that depreciation means reduction in the value of asset or in the utility due to passage of time, natural wear and tear and or exhaustion you got it. So due to any of this causes the value of asset keeps on falling sometimes the value of asset also falls because of obsolescence that is also a part of depreciation. Now though in the example I have talked about plant and machinery you should understand that the depreciation is also applicable for intangible assets say goodwill or softwares. Because of the improvements in the technology the value of software may fall we will need to record it. So here the causes of depreciation are shown that is lapse of time, natural wear and tear, exhaustion of subject matter and obsolescence. Usually in case of tangible assets like say plant the natural wear and tear is a very important cause and also the time is a important cause while the items like software there is no question of wear and tear but the obsolescence and the lapse of time become important causes. In case of assets like mines the exhaustion is a important cause. Now why do we need to provide depreciation? What are the objectives? First is to ascertain the true value of the operations, true results of the operation because depreciation is a hidden expense you do not pay for it but the value of machinery which is being used is actually getting reduced. So unless you account for that reduction the true results of operation will not be known. Second as far as the value of assets are concerned at the end of the year we need to present their true and fair value. So the assets should be depreciated and the third objective is you also need to provide fund for replacement. So let us assume that we have purchased a machinery it has a useful life of 5 years at the end of 5 years we will have to replace it with a new machine. So every year we should accumulate some money so that we have no we have enough funds at the end of 5 years to buy new machinery. So because of all these 3 objectives it is necessary that the depreciation is provided. Now how do you measure or calculate the depreciation? There are 2 important aspects one is the estimation of the amount of depreciation is not so easy because it is based on estimate. It is not like I have paid salary 1 lakh so I will show it 1 lakh. The value of asset is falling not exactly every day it may fall sometimes it may remain constant again it may fall but we have to have some formula some way for estimating depreciation systematically. Now what are the aspects considered? First is of course the cost of asset and when we cost of consider the cost of asset we need to include the items like expenses of installation. The second is useful life of the asset third is estimated the estimated scrap value at the end of that useful life. Now there are various methods of depreciation first method is straight line method. The second method is reducing balance method. Reducing balance method is one of the most popular methods which is generally accepted by most of the laws. The third is machine hour method and fourth is production units method. Now let us discuss these methods little more in detail and when we solve the problem you will also understand how the depreciation is measured or estimated based on these 3 factors. Now the first method as the name suggests it is known as straight line method because the same amount of depreciation is charged every year. So suppose the value of asset is 10 lakhs it has a life of 5 years we will simply divide by 10 lakhs by 5 and charge 2 lakhs as depreciation every year and the end of its working life that the end of 5 years the value will fall from 10 lakhs to 0. So it is called as straight line method of course at the end of useful life its value may not be 0 if it has some scrap value we will consider that but whatever is depreciable amount we will write it off or we will show it equally over its useful life that is a straight line method. So you can see the formula that the cost of asset minus scrap value divided by useful life. Now the underlying assumption is that over the period of useful life we have more or less equal utility from the asset. So we are going to charge depreciation equally over its useful life. You can see a simple example if the cost of machinery is 18,000 installation charges are 2000 useful life is 5 years what will be the depreciation under straight line method. So how much is depre it is 18 plus 12 we have 20,000 distributed over the period of 5 years. So 20 upon 5 so you can see the calculation 20,000 minus 0 because scrap value is 0 20,000 minus 0 upon 5 so depreciation comes to 4,000 per annum. Next is reducing balance method now this method is slightly different from SLM because here the value of asset as is falling the amount of depreciation also falls. So we arrive at a particular depreciation rate and each year's value is written down value which is equal to acquisition cost minus depreciation and the depreciation for that year is charged as WDV into depreciation rate. Now the main advantage of RBM method is the value of depreciation goes on falling. So in as the asset becomes older the repairs rise the depreciation falls the total cost of asset use is going to be more or less constant. So here you can see in the first year the depreciation is charged on acquisition value so acquisition value minus into rate from second year onwards it is written down value into rate. So let us see a small example the cost of machinery is 5 lakh, scrap value is 5,000 useful life is 10 years company has decided depreciation rate at 15 percent. So how much will be depreciation each year calculate it for the first two years. So in this case we will not worry about the scrap value or the life the cost of the asset is 5 lakhs. So on 5 lakhs depreciation will be charged at 15 percent. So depreciation for year 1 becomes 7,500 in year 2 the depreciation will not remain at 7,500 it is not a straight line method. Here what we will do is at the end of year 1 50,000 minus 7,500 so the value of asset or WDV is now 42,500 the depreciation will be charged on 42,500. So second year depreciation is 42,500 into 15 percent so it is 6,3,75 I hope you have understood. So these two are the important methods of depreciation straight line and reducing balance. In the next session we will see some more methods of depreciation thank you so much.