Elements of Accountancy · Ch 8 — Depreciation, Provisions and Reserves
Summary
Summary
- Depreciation is the systematic allocation of the depreciable cost of a fixed asset over its useful life. It is not a valuation exercise but a process of cost apportionment, driven by factors like wear and tear, obsolescence, and the passage of time.
- Depreciable amount = Cost of asset – Estimated scrap value. The book value of an asset is its original cost minus accumulated depreciation to date.
- Straight Line Method (SLM): Depreciation = (Cost − Scrap Value) ÷ Useful Life. Charges equal depreciation each year; book value declines uniformly to scrap value. Suitable for assets with constant utility (e.g., leasehold buildings).
- Written Down Value Method (WDV): Depreciation = Book Value at start of year × Fixed Rate. Charges higher depreciation in early years and lower in later years. Suitable for assets with high obsolescence (e.g., machinery, computers).
- Change in method is permitted only if it results in better presentation; the effect of the change (with cumulative adjustment) is disclosed in the Profit & Loss Account.
- Provision is a charge against profit for a known liability of uncertain amount (e.g., provision for doubtful debts, provision for depreciation). It is created by debiting the Profit & Loss Account and shown on the liabilities side of the Balance Sheet.
- Reserve is an appropriation of profit (not a charge) created to strengthen financial position or meet future contingencies. It is shown under ‘Reserves and Surplus’ on the liabilities side.
- Revenue Reserve (e.g., General Reserve, Dividend Equalisation Reserve) is created from revenue profits and is freely distributable as dividend. Capital Reserve (e.g., Securities Premium, Revaluation Reserve) arises from capital profits and cannot be distributed as cash dividend. …