Depreciation, Provisions and Reserves — Class 11 (Accountancy)
A delivery van costing ₹8,00,000 will not be worth that after five years of hard use — it wears out. Ignoring this fall in value would overstate both profit and assets. Depreciation spreads an asset's cost over its useful life, while provisions and reserves set aside profit for known and unknown future needs. This chapter keeps the accounts realistic.
1. Depreciation — meaning and causes
Depreciation is the gradual, permanent fall in the value of a fixed asset due to use, wear and tear, passage of time or obsolescence. It is a non-cash expense charged to the Profit & Loss Account.
Causes: wear and tear from use, efflux of time, obsolescence (new technology), depletion (for natural resources), and accidents.
Why charge it? — to (i) show the true profit (matching cost to revenue), (ii) show the true value of the asset in the balance sheet, and (iii) provide funds for replacement.
Related terms: amortisation (intangibles), depletion (natural resources).
2. Methods of calculating depreciation
Straight-Line Method (SLM / Fixed Installment)
The same amount is charged every year: Value reaches (near) zero at end of life; simple; suited to assets that give even service.
Written-Down-Value Method (WDV / Diminishing Balance)
A fixed percentage is charged on the book value each year, so the amount decreases over time. Value never fully reaches zero. Suited to assets needing more repairs as they age (repairs rise as depreciation falls, evening out the total charge).
| Feature | SLM | WDV |
|---|---|---|
| Base | original cost | book value |
| Annual amount | constant | decreasing |
| Asset value | reaches zero | never zero |
3. Recording depreciation
Two approaches:
- Charge to the asset account — depreciation reduces the asset account directly; the asset appears at its reduced (net) value.
- Provision for Depreciation Account — depreciation is accumulated in a separate account; the asset stays at cost, and accumulated depreciation is deducted in the balance sheet.
Entry (method 1): Depreciation A/c Dr; To Asset A/c. Then Depreciation A/c is closed to P&L. On sale of an asset, compare sale proceeds with book value → profit or loss on sale goes to P&L.
4. Provisions
A provision is an amount set aside out of profits to meet a known liability or expected loss whose amount is uncertain — e.g. provision for doubtful debts, provision for repairs, provision for tax. It is a charge against profit (made before calculating profit), governed by the prudence concept, and is created whether or not there is a profit.
5. Reserves
A reserve is an amount set aside out of profits to strengthen the financial position or meet future needs/contingencies — e.g. general reserve. It is an appropriation of profit (a distribution of profit), made only if there is a profit.
- Revenue reserves (from normal profits — general reserve, dividend equalisation) vs capital reserves (from capital profits — e.g. profit on sale of a fixed asset; not for dividends).
- Secret reserve — a reserve not disclosed in the balance sheet (understates assets/overstates liabilities); improves apparent stability but reduces transparency.
Provision vs Reserve: a provision is for a known/expected liability and is a charge against profit (compulsory); a reserve is for general strengthening and is an appropriation of profit (only if profits exist).
6. Closing thought
Depreciation realistically writes down assets over their life (SLM = constant, WDV = reducing); provisions cover known/expected losses (a charge, e.g. doubtful debts); reserves strengthen the business (an appropriation, e.g. general reserve). Learn the two depreciation formulas, the recording methods, profit/loss on sale, and the provision-vs-reserve distinction. In the board exam depreciation problems and the provision/reserve distinction are reliable, high-value questions.
