Depreciation, Provisions and

Reserves
 Chapter Objectives
 Understand the concept of depreciation
 Identify the causes of depreciation
 Explain the meaning of depreciation accounting
 Compute depreciation according to different
methods of providing depreciation
 Explain the role of depreciation policy

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 Depreciation
 Depreciation is defined as the gradual decrease
in the value of an asset.
 Causes of depreciation are:
 Wear and tear
 Obsolescence
 Efflux of time
 Accidents

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 Features of Depreciation
 It is applicable to all fixed assets except some
assets like land and antique.
 It is a charge against profits and true profit of a
business can only be computed after charging
depreciation.
 It differs from maintenance expenses, which
are incurred for keeping the machines in a
workable state.

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 Depreciation Accounting
 Depreciation accounting is concerned with
distributing the cost of a tangible asset over its
estimated useful life.
 Objectives of depreciation accounting are:
 To determine true profit of business
 To provide true financial position of business
 To provide funds for the purchase of new assets

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Fixation of Depreciation Amount
 Depreciation amount of a particular asset is
computed and is charged to the profit and loss
account.
 Depreciation amount in respect to a particular
asset depends upon the following factors:
 Cost of asset
 Estimated scrap value
 Estimated useful life

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 Methods of Recording Depreciation
 To record the depreciation in the books of
account, two methods are used:
 Using Provision for Depreciation account
 Without using Provision for Depreciation account

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 Methods of Recording Depreciation
(contd.)
 Using Provision for Depreciation account:
 The Provision for Depreciation account is credited with the
depreciation amount chargeable in a year.
 The Asset account provides the original cost of asset.
 The Provision for Depreciation account is transferred to the
Asset account, when the asset is sold.
 Without using Provision for Depreciation account:
 The Depreciation account is debited with the depreciation
amount chargeable in a year and the same amount is
credited to the Asset account.
 The Depreciation account is transferred to the Profit and
Loss account.

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 Methods of Recording Depreciation
(contd.)
 In both the methods, when the asset is sold:
 On profit, the balance of Asset account is
transferred to the Profit and Loss account.
 On loss, the amount realized on account of sale is
transferred to the Asset account.

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 Methods for Providing Depreciation
 The methods used for computing depreciation
are classified into two categories:
 Uniform charge methods
 Declining charge or accelerated depreciation
methods

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 Uniform Charge Methods
 In these methods a uniform depreciation
amount is charged every year.
 The various uniform charge methods are:
 Fixed installment method: It is also known as
Straight Line Method (SLM). It provides a fixed
amount of depreciation every year. In this,
depreciation is computed by dividing the
difference of original cost of asset and estimated
scrap value by the estimated life of the asset in
years.
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 Uniform Charge Methods (contd.)
 Depletion method: It is also known as productive
output method. In this, depreciation depends upon
the actual cost of the asset and actual and estimated
quantities of output to be produced using the asset.
 Machine hour rate method: It is also known as
service hours method. In this, depreciation depends
upon the running time of the asset. Depreciation is
computed by dividing the difference of asset and
scrap value by the life of the asset in hours.

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 Declining Charge Depreciation
Methods
 In these methods, the depreciation amount to
be charged decreases with the expected life of
the asset.
 The various declining charge depreciation
methods are:
 Diminishing balance method: Depreciation is
computed on the book value of the asset.
Depreciation rate is obtained using the formula:
1 – n ((net residual value/acquisition cost)

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 Depreciation Policy
 Objectives of depreciation policy:
 To recover the amount invested in purchasing an
asset before the expiry of the economic life of the
asset.
 To ensure that a uniform rate of return on
investment is achieved.
 To generate funds for purchasing of new asset after
the expiry of an old asset.
 To determine correct profit and loss information of
the business.
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 Summary
 In this chapter, you have:
 Understood the concept of depreciation
 Identified the causes of depreciation
 Explained the meaning of depreciation accounting
 Computed depreciation according to different
methods of providing depreciation
 Explained the role of depreciation policy

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 On April 01,2003, a firm purchased a machinery
for Rs. 200000. On October 01, in the same
accounting year, additional machinery costing
Rs. 100000 was purchased. On October 01,2004,
the machinery purchased on April 01, 2003,
having become obsolete, was sold off for Rs.
90000. On October 01,2005, new machinery was
purchased for Rs. 250000 while the machinery
purchased on October 01,2003, was sold for Rs.
85000 on the same day. The firm provides
depreciation on its machinery @ 10% p.a. on
the original cost on 31 March every year. Show
machinery account and Provision for
Depreciation account for the period of three
accounting years ending 31st March , 2006.
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 Machinery A/C
Date Particulars Amount Date Particulars Amount
1.04.2003 To cash -1 200000 31.03.2004 By bal c/d 300000
1.10.2003 To cash -2 100000
300000 300000
1.04.2004 To bal b/d 300000 1.10.2004 By machine disposal a/c -1 200000
31.03.2005 By bal c/d 100000
300000 300000
1.04.2005 To bal b/d 100000 1.10.2005 By Machine disposal a/c -2 100000
1.04.2005 To cash -3 250000 31.03.2006 By bal c/d 250000
350000 350000

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 Privision for Depreciation a/c
Date Particulars Amount Date Particulars Amount
31.03.2004 To bal c/d 25000 31.03.2004 By Depreciation 25000
25000 25000
1.04.2004 By bal b/d 25000
1.10.2004 To M/C Disposal a/c - 1 30000 1.10.2004 By Depreciation - 1 10000
31.03.2005 To bal c/d 15000 31.03.2005 By Depreciation - 2 10000
45000 45000
1.10.2005 To M/C Disposal a/c - 2 20000 1.04.2005 By bal b/d 15000
31.03.2006 To bal c/d 12500 1.10.2005 By Depreciation - 2 5000
31.03.2006 By Depreciation - 3 12500
32500 32500

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 Machine Disposal A/c
Date Particulars Amount Date Particulars Amount
1.10.2004 To Machine a/c -1 200000 1.10.2004 By cash 90000
1.10.2004 By prov. For Dep. a/c 30000
1.10.2004 By loss on sale 80000
200000 200000
1.10.2005 To Machine a/c -2 100000 1.10.2005 By cash 85000
1.10.2005 To profit on sale 5000 1.10.2005 By prov. For Dep. a/c 20000
105000 105000

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In the books of M/s A to Z, following balances appear
on January 1st , 2008:

Machinery Account Rs. 160000

Provision for Depreciation Account Rs. 72000

On July 01, 2008, the machinery purchased on 1st

January, 2004, for Rs. 32000 having become obsolete is
sold off for Rs. 10000. Depreciation is provided at 10%
per annum on the original cost on 31st December every
year. Show Machinery A/c, Machinery Disposal A/c
and Provision for Depreciation A/c for the year 2008.

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 Machinery A/C
Date Particulars Amount Date Particulars Amount
1.01.2008 To bal b/d 160000 1.07.2008 By machine disposal a/c 32000
31.12.2008 By bal c/d 128000
160000 160000

Privision for Depreciation a/c

Date Particulars Amount Date Particulars Amount
1.01.2008 By bal b/d 72000
1.07.2008 To M/C Disposal a/c - 14400 30.06.2008 By Depreciation 1600
31.12.2008 To bal c/d 72000 31.12.2008 By Depreciation 12800
86400 86400

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 Machine Disposal A/c
Date Particulars Amount Date Particulars Amount
1.07.2008 To Machine a/c 32000 1.07.2008 By cash 10000
1.07.2008 By prov. For Dep. a/c 14400
1.07.2008 By loss on sale 7600
32000 32000

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