Depreciation, Provisions And Reserves

Depreciation can be defined as the share of the total asset that has been consumed by the company over a certain period of given time. The total number of profit and loss statement of depreciation is based on the usefulness of the fixed assets used in the accounting year.

Causes of Depreciation

  • By Constant Use- When the fixed assets like a motor vehicle, machinery are used for a good amount of time, it manages to wear out
  • By Expiry of Time- Due to natural calamities or elements of nature land may start to erode. Similarly, the machinery particles might start rusting
  • Outdated Technology- The machine and the technology used today might be outdated and might have to be discarded
  • Increase in production- The existing vehicle or machine used is not capable of taking bulk orders
  • By Depletion- Exhaustion of resources due to its constant use.

Also Read: What is Depreciation?

Importance of Depreciation

  • For Ascertaining the True Profit or Loss- The true profit of a company can be determined only when all the cost acquired is used to earn revenues is debited to the profit and loss account.
  • Showing Correct Financial Status- When the depreciation is not imposed, the asset is recorded in the balance sheet at an amount which is excess of their actual value. In this case, the balance sheet does not present the actual financial status of a company.
  • To avoid excess payment of Income Tax- Here, if the depreciation is not subtracted to profit and loss account, the net profit shown will be surplus to the actual profit. Therefore, the company will have to pay extra income tax.

Methods of Calculating Depreciation

  • Straight-line method
  • Written down method
  • Annuity method
  • Depreciation fund method
  • Insurance policy method
  • Revaluation method
  • Depletion method
  • Machine hour rate method

Meaning of Provision

Reserves refer to the amount that is set aside out of profits and other surpluses to meet future uncertainties. In other words, a reserve is meant for meeting any sort of an unknown liability or losses in the future.

Types of Reserve

  • Revenue Reserve- The share of the profits which is not paid to the owner or shareholders,and is kept reserved for operations or other demands, is known as a revenue reserve
  • General Reserve- Reserve which is kept for nothing specific, but for growing the financial status of a company is known as a general reserve.

Meaning of Provision

The amount retained by way of providing for any unknown liability of which the amount cannot be detained with substantial accuracy.

Features of Provision

  • Provision is arranged to meet a known liability
  • The liability is known but the amount of these liabilities cannot be ascertained with reasonable accuracy
  • Provision is a charge against profit and as such reduces the profits of the year in which it is created

The above mentioned is the concept, that is elucidated in detail about ‘Depreciation, Provision, and Reserves’ for the Commerce students. To know more, stay tuned to BYJU’S.

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