Section - 1: Syllabus:

1. Depreciation: Meaning, definition of depreciation.

2. Features of depreciation
3. Causes for depreciation
4. Need for charging depreciation
5. Factors affecting the amount of depreciation
6. Methods of depreciation
a ) Straight line method: Meaning, merits, demerits and Problems
b) Diminishing balance method: Meaning, merits, demerits and problems
7. Difference between SLM and DBM
8. Provision and Reserves: Meaning and Importance
9. Difference between provision and reserves
10. Types of reserves-(Concepts only)
Section-2: Summary

1. Meaning of depreciation:
Depreciation means Reduction or Decrease in the value of the assets which are used in the business due to
wear and tear.

2. Definition of depreciation:
According to Institute of Cost and Management Accounting, London (ICMA) terminology “The
depreciation is the diminution in intrinsic value of the asset due to use and / or lapse of time.”

3. Features of depreciation / Characteristics of depreciation:

a. It is the decrease in the book value of asset.
b. The resultant decline in the value of old machine is caused by obsolescence.
c. It is a continuing process.
d. It is an expired cost and hence must be deducted before calculating taxable profits.
e. It is a non-cash expense.

4. Depreciation & other similar terms

a. Depletion
b. Amortisations

5. Causes for depreciation:

a. Wear and Tear due to use
b. Passage of time.
c. Obsolescence.
d. Permanent fall in the market value
e. Abnormal factors

6. Need for charging depreciation:

a. Matching of Costs and Revenue
b. Consideration of Tax
c. True and Fair Financial Position
d. Compliance with Law

7. Factors affecting the amount of depreciation(parameters):

a. Cost of Asset.
b. Estimated Net Residual Value
 c. Depreciable Cost
d. Estimated Useful Life

8. Methods of depreciation:
a. Straight Line Method
b. Diminishing balance Method / Written Down Value Method
A. Straight Line Method: Fixed Cost method or Original cost Method or Fixed Instalment method:
It means a fixed percentage of original cost of the asset is written off at the end of every year as
deprecation and charged to the account.

Formula of Straight line Method

Cost of the Asset - Scrap Value of the Asset

Depreciation =
Life of the Asset

Merits of Straight Line Method

a. Simple and easy to understand
b. Asset can be depreciated upto the net scrap value or zero value.
c. Every year, same amount is charged as depreciation in profit and loss account.
d. This method is suitable for those assets whose useful life can be estimated accurately

Demerits of Straight Line Method

a. This method is based on the faulty assumption of same amount.
b. With the passage of time, work efficiency of the asset decreases and repair and maintenance expense
increases.

B. Diminishing Balance Method: Reducing Balance method or Written Down Value Method
It means a fixed percentage of depreciation is charged on the reduced value of the Asset after the
depreciation at the end of every year and charged to account.

Merits of Written Down Value Method.

a. This method is based on a more realistic assumption.
b. The depreciation and repair expenses taken together every year on profit and loss account.
c. Income Tax Act accept this method for tax purposes.
d. As a large portion of cost is written-off in earlier years, loss due to obsolescence gets reduced.
e. This method is suitable for fixed assets which last for long

Demerits of Diminishing Balance Method:

 a. As depreciation is calculated at fixed percentage
b. Depreciable cost of the asset cannot be fully written-off.
c. The value of the asset can never be zero.
d. It is difficult to ascertain a suitable rate of depreciation.

9. Differences between SLM and WDV methods of depreciation

SL NO. POINT OF DIFFERENCE SLM METHOD WDV METHOD

1 Calculation Calculated on original cost Calculated on WDV of
of the asset the asset
2 Amount of depreciation It is fixed/ equal It is decreasing year after
year
3 Value of asset at the end of its It becomes NIL It never becomes NIL
life
4 Recognition Not recognised by income It is recognised the
tax authorities income tax authorities
10. Provisions & Reserves
a. Meaning of Provisions: Provision in accounting refers to money written off to cover possible depreciation
of assets and other liabilities.

b. Meaning of Reserves: A reserve is profits that have been appropriated for a particular purpose. Reserves
are sometimes set up to purchase fixed assets, pay an expected legal settlement, pay bonuses, pay off debt,
pay for repairs and maintenance, and so forth. This is done to keep funds from being used for other
purposes, such as paying dividends. The Board of directors will be authorized to create a reserve.

Importance of Reserve
a. Protecting Non –profit Organisations
b. Financial Stability and Longevity
c. To deal with operating deficits
d. To manage unexpected events of Losses
e. To protect economic uncertainties
f. To Manage lean funding period

11. Difference between provision and reserves

Basis of distinction Reserves Provisions

Mode of creation Created against the charge of the profit Created against the charge of the profit
&loss appropriation account &loss account
objectives To strengthen the financial position To meet the known losses & liabilities,
 &to meet future unknown losses and the amount which is not certain
liabilities
Accounting treatment Shown on the debit side of the profit Shown on the debit side of the profit &
&loss appropriation account& loss account & asset side of the balance
liabilities side of the balance sheet sheet as deduction from the concerned
asset.
Relation with profit Reserve is created when there is Provision is created even if there is loss
enough profit in the business in the business
Distribution Can be distributed to shareholders as Cannot be distributed to shareholders
dividend as dividend
Future requirement Is created without considering the Is created by estimating the future
future requirements of business requirements of business
Impact Will be on financial position Will be on profit & loss of the business

12. Types of reserves:

a. Revenue Reserves
b. Capital Reserves
c. General Reserves
d. Specific Reserves

a. Meaning of Revenue reserves: Profit earned by a business through its normal activities is determined at
the end of the year through profit and loss account. The portion of such profit which is not paid to the
proprietors but kept apart is known as revenue reserve.

b. Meaning of Capital reserves: Reserve which is created out of capital profits, for example profit on sale of
fixed assets, which is not available for distribution among the shareholders.

c. Meaning of General reserves: Reserve which is not created for any specific purpose, but for strengthening
the financial position of the business is known as general reserve like reserve fund etc.

d. Meaning of Special reserves: Reserve which is created for any specific purpose, the examples are dividend
equalisation fund, debenture sinking fund etc.