Ch 7Depreciation, Provisions and Reserves — Class 11 Accountancy, concept-first.

The matching principle requires that the revenue earned in a given period be matched against the expenses of that same period, so that profit or loss can be worked out correctly.

When a business buys a fixed asset — a machine, a building, furniture, a vehicle — that asset is not consumed in one year. It gives service for several accounting periods.

Depreciation is not a loss of market value. It is a permanent, continuing, and gradual shrinkage in the book value of fixed assets.

Depreciation is not a single, simple idea — it is a bundle of related characteristics that together define how accountants treat the wearing out of long-lived assets.

Depreciation, depletion, and amortisation are all terms that describe the same fundamental idea: the gradual loss of usefulness of an asset over time.

Depletion is the term used specifically for natural resources — assets like mines, quarries, oil wells, and timber tracts.

Amortisation is the term used for writing off the cost of intangible assets. Intangible assets have no physical substance but provide economic benefits to the business for a limited period.

Depreciation is not a single event but the result of several distinct forces that act on an asset over time. Accounting Standard 6 (Depreciation Accounting) spells out these causes clearly.

Wear and tear is the physical deterioration of a fixed asset caused by its use in business operations.

A business can own an asset even when it does not physically hold it. Some assets are valuable only because of a legal agreement — a patent, a copyright, a lease.

Obsolescence is a factor that causes a fixed asset to lose value even when it is still physically in good working condition.

Depreciation is normally thought of as a gradual, predictable wearing out of an asset over its useful life. That is the normal factor.

The need for depreciation is not just a matter of accounting convenience; it arises from three distinct pressures: conceptual logic, legal compulsion, and practical business reality.

The central idea of depreciation is rooted in the matching principle of accounting. A business buys fixed assets — machinery, buildings, vehicles — not to resell them, but to use them over several yea…

Depreciation is treated as a deductible expense when computing taxable profit. This means a business can reduce its tax liability by claiming depreciation on its fixed assets.

A balance sheet is meant to show what a business owns (assets) and what it owes (liabilities) on a particular date.

Beyond tax regulations, there are specific legislations that indirectly compel certain business organisations — particularly corporate enterprises — to provide depreciation on fixed assets.

The amount of depreciation charged each year is not an arbitrary figure. It is determined by three fixed parameters: the cost of the asset, its estimated useful life, and its estimated residual (scrap…

The cost of an asset — also called its original cost or historical cost — is the foundation on which depreciation is calculated.

Depreciation is meant to spread the cost of an asset over its working life. But you don't lose the entire purchase price.

The depreciable cost of an asset is the portion of its total cost that will actually be consumed over its useful life and therefore needs to be written off as depreciation.

Depreciation is not about wearing out until the asset breaks. It is about using up the asset's economic value. That is why the concept of useful life exists.

Before you pick a method, you must understand what you are actually calculating. Depreciation is not a guess or a tax trick — it is the systematic allocation of an asset's depreciable amount over its…

The Straight Line Method is the oldest and most widely used way to charge depreciation. Its core idea is that the asset gives equal service or benefit in each year of its useful life.

The Straight Line Method is popular largely because it is the simplest depreciation method to understand and apply.

The straight line method is simple, but its simplicity comes at a cost. The method assumes that an asset provides exactly the same amount of service or utility in each year of its life.

Under this method, depreciation is charged on the book value of the asset at the beginning of each accounting period.

The Written Down Value (WDV) method is not just a different way to calculate depreciation — it rests on a fundamentally different view of how an asset behaves over its life.

The Written Down Value (WDV) method is widely used because it matches depreciation with the actual decline in an asset's efficiency — higher depreciation in early years, lower in later years.

The two most common methods for calculating depreciation in practice are the Straight Line Method (SLM) and the Written Down Value Method (WDV).

The core idea is simple: depreciation is an expense that must be allocated each year. But on what amount do you calculate that year's depreciation? The answer depends on which method you choose.

The annual amount of depreciation charged to the profit and loss account each year is not the same under the two main methods of depreciation.

The key idea in this section is that the total burden on the Profit and Loss account each year is not just depreciation — it is depreciation plus the cost of repairs and maintenance.

The Income Tax Act does not accept the Straight Line Method for computing depreciation on fixed assets. For tax purposes, only the Written Down Value Method is recognised.

The choice between the Straight Line Method (SLM) and the Written Down Value Method (WDV) is not arbitrary — it depends on the nature of the asset, the pattern of its benefits, and the behaviour of re…

When a business records depreciation, it can follow one of two arrangements in the books of account. The choice affects which accounts appear in the ledger and how the fixed asset's book value is pres…

This method treats the asset account itself as the place where depreciation is accumulated. Instead of creating a separate "Accumulated Depreciation" or "Provision for Depreciation" account, the depre…

When you charge depreciation directly to the asset account, the asset's book value keeps falling each year.

When an asset is sold — whether at the end of its useful life or earlier due to obsolescence or damage — the asset account must be closed.

When you sell an asset, several things happen at once: the original cost leaves the books, the accumulated depreciation on that specific asset is removed, cash comes in, and a profit or loss emerges.

When a business spends money to add to or extend an existing asset, that spending is not a routine repair. It is a capital expenditure — it increases the asset's capacity, efficiency, or useful life.

A provision is an amount set aside out of the current period's profit to cover a known expense or loss whose exact amount is uncertain.

A provision is an amount set aside out of profits to cover a known liability or an expected loss whose exact amount is uncertain but can be reasonably estimated.

A business does not always distribute all its profit to the owners. A part of the profit may be set aside and retained in the business to provide for certain future needs.

The single most important distinction between a provision and a reserve lies in how each relates to profit.

A reserve is created by retaining a portion of the business's profit. The purpose of this retention can be either general or specific.

The distinction between revenue reserve and capital reserve is not about what the reserve is called — it is about the nature of the profit from which it was created.

A business does not exist only to earn profit in the current year. It must also prepare for the future — for unexpected losses, for growth, and for repaying long-term debts.

A secret reserve is a reserve that does not appear in the balance sheet. It is hidden from the view of outsiders — shareholders, creditors, and the general public — because the financial statements do…

The key terms introduced in this chapter, with a short meaning for each.

- Depreciation is the systematic allocation of the depreciable cost of a fixed asset over its useful life.