Depreciation, Provisions, and Reserves
Depreciation is the decrease in the book value of the fixed assets due to normal wear and tear, the passage of time, changes in economic environment and expiration of legal rights.
Factors affecting the amount of Depreciation.
- Historical cost.
- Expected useful life.
- Estimated residual value.
Methods of charging Depreciation
|1. Straight Line Method|
|This method is also termed as Original cost method because depreciation is charged at
a fixed percentage on the original cost of the asset.
ü Equality of depreciation.ü Assets can be completely written off.
|ü Undue pressure in later years.
ü Unapproved by tax authorities.
|2. Diminishing Balance Method|
|This method is also termed as Written down value method because the value of
depreciation goes on decreasing year after year.
|ü Easy calculation.
ü Approved by tax authorities.
ü Equal charge against income.
ü Omission of the interest factor.
ü Knowledge of the original cost.
Difference Between Provision and Reserve
|Purpose||Created for a particular purpose.||Not necessarily created for a particular purpose.|
|Utilisation||Cannot be utilised for the payment of dividends.||Can be utilised for the payment of dividends.|
|Disclosure in Income
|Shown on the debit side of Profit & Loss Account.||Shown on the debit side of Profit & Loss Appropriation Account.|
|Disclosure in Balance
|Deducted from the amount of item from which it has been created.||Shown under Reserves and Surplus.|
Points to Remember
1. AS – 6 is applicable for Depreciation.
2) Expected useful life of a depreciable asset implies the expected number of years
which an asset will last.
3) Expected residual value implies the value expected to be realised on the sale of
an asset on the expiry of its useful life.
5) Straight line method is suitable for those assets whose repair charges are less
and the possibility of obsolescence is less.
6) Diminishing balance method is suitable for those assets whose repair charges
goes on increasing and possibility of obsolescence are more.