Depreciation, Provisions and Reserves
Depreciation
Depreciation is the systematic allocation of the depreciable amount of a tangible fixed asset over its useful life. It arises from factors such as wear and tear, passage of time and obsolescence.
Straight Line Method
Under SLM, the depreciable amount is allocated equally over the useful life. A simplified formula is: Annual depreciation = (Cost − Residual value) ÷ Useful life.
Written Down Value Method
Under WDV, depreciation is calculated at a fixed percentage on the book value at the beginning of each period. The depreciation amount therefore generally decreases over time.
Disposal of Asset
When an asset is sold, its cost and accumulated depreciation must be removed from the books and the difference between its book value and sale proceeds is recognised as profit or loss on disposal.
Provision vs Reserve
A provision is an amount set aside for a known liability or expected loss whose amount or timing may be uncertain. A reserve is an appropriation of profit retained in the business for a stated or general purpose.
Explained MCQs
- Why does SLM normally produce equal annual depreciation?
Answer: Because the depreciable amount is spread evenly across the useful life.
Explanation: The annual charge remains constant when cost, residual value and useful life remain unchanged. - Why does WDV depreciation usually fall each year?
Answer: Because the fixed rate is applied to a declining book value.
Explanation: As accumulated depreciation grows, the opening book value becomes smaller. - Is a reserve the same as a provision?
Answer: No.
Explanation: A provision is made to cover a known liability or anticipated loss; a reserve is generally an appropriation of profit.
Numerical Practice
Asset cost ₹1,00,000, residual value ₹10,000, useful life 5 years. Under SLM, annual depreciation = (₹1,00,000 − ₹10,000) ÷ 5 = ₹18,000. Students should always check whether the question supplies residual value and whether depreciation is for a full or partial period.