Depreciation, Provisions and Reserves
What the domain tests
This section examines depreciation methods and accounting treatment, plus the distinction between provisions and reserves. Expect calculations under straight-line and written-down-value methods and classification questions.
Core rules
- Depreciation allocates the depreciable cost of a fixed asset over its useful life. It is a charge against profit, not a valuation of the asset.
- Straight-line method: (Cost - residual value) / useful life. Written-down-value method: a fixed percentage applied to the opening book value.
- Journal: Depreciation A/c Dr; To Asset A/c or Accumulated Depreciation A/c. Then Depreciation A/c Dr; To Profit and Loss A/c.
- A provision is a charge for a known liability or expected loss, such as provision for doubtful debts.
- A reserve is an appropriation of profit or a capital receipt, such as general reserve or capital reserve. It is not a charge against profit.
- Provision for doubtful debts is created after adjusting bad debts and is deducted from debtors in the balance sheet.
Worked example
A machine costs Rs. 1,00,000, has residual value Rs. 10,000 and useful life of 5 years. Straight-line depreciation = (1,00,000 - 10,000) / 5 = Rs. 18,000 each year. Under WDV at 10%, year 1 depreciation is Rs. 10,000; year 2 is 10% of Rs. 90,000 = Rs. 9,000. The straight-line charge is constant, while the WDV charge falls. In both cases the asset is shown at cost less accumulated depreciation.
Traps
Do not charge depreciation on residual value; do not treat a general reserve as a profit and loss charge; do not confuse provision for doubtful debts with provision for discount on debtors; and do not forget proportionate depreciation on assets bought during the year.