Depreciation, Provisions and Reserves
Define Depreciation? What are its characteristics? Explain its causes?
may be defined as permanent decrease in the value of assets due to Use and /or
the lapse of the time.
According to Carter,”Depreciation may
be defined as the permanent and gradual decrease in the Value of an assets from
Depreciation may be physical and Functional.
It is a charge against Profit.
Depreciation is charged in respect of fixed assets only.
Wear and tear
Efflux of time or passage of time
Mention three important causes of providing depreciation?
or objects of providing depreciation:-
Recovery of cost incurred on fixed assets over their useful life.
To find out correct profit for the year.
To provide for replacement of assets.
To find out correct financial position.
To reduce tax burden.
Define the following terms:-
- Depletion implies removal of available resources e.g. Coal from Coal mine,
Oil out of Oil well.
Amortisation: - The process of writing off
intangible assets such as goodwill, pateats, and trademarks etc.is called Amortisation.
Dilapidation: - The term Dilapidation reduces to damage done
to a building or other property during tendency.
Obsolescence: - When an asset becomes out
dated due to new or improved technology or invention, this is called obsolescence.
Explain the basic factors on which the calculation of depreciation depends?
Ans. For determining the
amount of depreciation on fixed assets, following factors should be considered:
Original cost of assets.
scraps value of assets.
useful life of assets.
are various method of Depreciation?
Ans. Methods of Depreciation classified under the
Fixed installment method.
Machine hour rate method
(2)Declining charged method:-
of years Digit method.
system of Depreciation
Explain fixed installments and Diminishing balance method.
installments method: - Under this method depreciation is charged on
original cost of the assets on uniform basis. The value of the assets can be
reduced to ‘O’ under this method.
It is simplest to understand and easy to apply.
value of the assets can be reduce to zero under this method.
Under this method, same amount of Depreciation is charged from year to year,
irrespective of use of the assets.
the passage of time efficiency of assets decreases but the amount of
Depreciation remains the same.
Balance method:-Under this method a fixed rate of depreciation is
charged each year on the diminishing value of the assets till the amount is
reduced to scrap value.
The amount of depreciation decreases continuously with the decrease in the life
High amount of Depreciation is provided in earlier year thus reducing the impact
The book value of assets can never be zero.
determination of a suitable rate of Depreciation is also difficult.
Q.N.7 Distinguish between Fixed installment method and
reducing Installment method (Diminishing Balance method).
rate and amount of depreciation remains the same each year under fixed
installment method. But The rate remains the same, but amount of Depreciation
reduces each year under reducing balance method.
is calculated on original cost under fixed installment method. But, Depreciation
is charged on the diminishing value of assets under reducing Balance Method.
book value of assets reduces to zero under straight line method. But, The book
value of assets can never be zero under reducing balance method.
Q.N.8 Define the following terms:-
(1)Reserve: - Reserve is an amount set aside out of profits
which are not designed to meet any obligation .It is an appropriation of
(2)Capital Reserve: - Profits which
may arises from a source other than normal trading activities are called
capital reserve e.g. profit on sale of fixed assets.
(3)Revenue Reserve :-( same as
(4)General reserve:-Reserve which
is created out of not for any specific purposes but for strengthening financial
position is called General Reserve.
created for any special purpose is known a specific reserve i.e. dividend
(6)Sinking Fund: - It is a fund
that is created for the purpose of replacement of a long term liability either
charged against profit or by way of appropriation of profits.
provided for there possible less or liability which cannot be determined
exactly e.g. provision of doubtful debts.
(8)Secret Reserve: - A reserve
which is not disclosed on the face of balance sheet but is hidden in various
items of balance sheet is called "SecretReserve”.e.g.creating more provision,
charging more depreciation
Q.N.9 Distinguish between Provision and Reserve.
is a charged against profits. But, Reserve is an appropriation of profit.
(2)Provisions must be created
irrespective of whether there is profit or loss. But, Reserve cannot be created
unless there is sufficient profit.
(3)Dividend cannot be paid out
of provisions. But, Dividend can be paid out of reserve.
Q.N.10 Short questions :-( Fill in the blanks.)
the straight line method of charging depreciation, Depreciation remains the same
amount of Depreciation charged on machinery will be debited to Depreciation
The lesson of plant and Machinery should be written off against Depreciation
is process do valuation.
sale value of an asset after it becomes useless is called Scrap value.
rise or fall in the price of an asset is called fluctuation.
method of depreciation is used for wasting assets.