Chapter 7: Depreciation, Provisions and Reserves

1. Depreciation

Permanent, continuous, and gradual shrinkage in the book value of a fixed asset.

• Causes: Wear and tear, efflux of time, obsolescence, accident.
• Objectives: To ascertain true profit/loss, show true financial position, replacement of asset.

2. Methods of Calculating Depreciation

• Straight Line Method (SLM): Depreciation is charged on the original cost. Amount remains constant every year. (Also called Fixed Installment Method).
• Written Down Value Method (WDV): Depreciation is charged on the reducing balance (book value) of the asset. Amount decreases every year. (Also called Diminishing Balance Method).

3. Provisions

Amount set aside out of profit to meet a known liability, amount of which cannot be determined with accuracy.

Example: Provision for Depreciation, Provision for Bad Debts.

4. Reserves

Amount set aside out of profit to strengthen the financial position or meet unknown liabilities.

Example: General Reserve, Capital Reserve.