Quick Revision Notes

Class 11 Accountancy

Chapter: Depreciation, Provisions and Reserves

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1. Depreciation (मूल्यह्रास)

Definition

Depreciation is the permanent, continuous, and gradual decrease in the book value of a fixed asset due to wear and tear, passage of time, obsolescence, or accident.

Causes of Depreciation

1. Wear and Tear: Due to constant use.
2. Efflux of Time: With the passage of time, even if not used (e.g., leases, patents).
3. Obsolescence: Due to technological changes or new inventions.
4. Accident: Damage caused by unforeseen events.
5. Depletion: Exhaustion of natural resources like mines, oil wells, etc.

Key Factors determining Depreciation

• Cost of the Asset: Purchase price + installation, freight, and incidental expenses.
• Estimated Useful Life: Expected working life of the asset in years or output units.
• Estimated Residual Value (Scrap Value): Expected realization value of the asset at the end of its useful life.

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2. Methods of Calculating Depreciation

A. Straight Line Method (SLM) / Original Cost Method

• Concept: Depreciation is charged at a fixed percentage on the original cost of the asset every year. The amount of depreciation remains constant throughout the useful life.
• Formula: $$\text{Annual Depreciation} = \frac{\text{Original Cost of Asset} - \text{Estimated Scrap Value}}{\text{Estimated Useful Life}}$$
• Rate of Depreciation Formula: $$\text{Rate of Depreciation} = \left( \frac{\text{Annual Depreciation}}{\text{Original Cost}} \right) \times 100$$

B. Written Down Value Method (WDV) / Reducing Balance Method

• Concept: Depreciation is charged at a fixed percentage on the book value (Cost less Depreciation) of the asset every year. The amount of depreciation decreases every year.
• Formula: $$\text{Depreciation} = \text{Book Value at the beginning of the year} \times \text{Rate of Depreciation}$$

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3. Difference between SLM and WDV

Basis	Straight Line Method (SLM)	Written Down Value Method (WDV)
Basis of Charge	Calculated on original cost.	Calculated on written down (book) value.
Amount of Depreciation	Remains constant every year.	Decreases every year.
Book Value of Asset	Can be reduced to zero.	Can never be reduced to zero.
Suitability	Suitable for assets where repairs are less (e.g., Patents, Leases).	Suitable for assets requiring heavy repairs in later years (e.g., Plant & Machinery, Vehicles).

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4. Accounting Treatment (Journal Entries)

When Provision for Depreciation Account is NOT Maintained:

1. For charging depreciation: $$\text{Depreciation A/c} \quad \text{Dr.}$$ $$\quad \text{To Fixed Asset A/c}$$
2. For transferring depreciation to Profit & Loss A/c: $$\text{Profit & Loss A/c} \quad \text{Dr.}$$ $$\quad \text{To Depreciation A/c}$$
3. On sale of asset:
   • For sale proceeds: $$\text{Bank A/c} \quad \text{Dr.}$$ $$\quad \text{To Fixed Asset A/c}$$
   • For Profit on sale: $$\text{Fixed Asset A/c} \quad \text{Dr.}$$ $$\quad \text{To Profit & Loss A/c}$$
   • For Loss on sale: $$\text{Profit & Loss A/c} \quad \text{Dr.}$$ $$\quad \text{To Fixed Asset A/c}$$

When Provision for Depreciation Account IS Maintained:

1. For charging depreciation: $$\text{Depreciation A/c} \quad \text{Dr.}$$ $$\quad \text{To Provision for Depreciation A/c}$$
2. On sale of asset (transferring original cost to Asset Disposal A/c): $$\text{Asset Disposal A/c} \quad \text{Dr.}$$ $$\quad \text{To Fixed Asset A/c}$$
3. Transferring accumulated depreciation to Asset Disposal A/c: $$\text{Provision for Depreciation A/c} \quad \text{Dr.}$$ $$\quad \text{To Asset Disposal A/c}$$

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5. Provisions (प्रावधान)

Definition

A provision means any amount written off or retained by way of providing for depreciation, renewal, or diminution in the value of assets, or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.

Key Features

• Created for a known liability or loss.
• Exact amount may not be known, but it is estimated with reasonable accuracy.
• It is a charge against profits (debited to P&L A/c).
• Examples: Provision for Bad and Doubtful Debts, Provision for Discount on Debtors, Provision for Depreciation.

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6. Reserves (संचय)

Definition

Reserves refer to the amount set aside out of profits and other surpluses to strengthen the financial position of the business. It is not meant to cover any known liability or depreciation.

Types of Reserves

1. General Reserve (सामान्य संचय): Created for no specific purpose; can be used for any future contingency or expansion.
2. Specific Reserve (विशिष्ट संचय): Created for a specific purpose (e.g., Dividend Equalization Reserve, Plant Replacement Reserve) and can be used only for that purpose.
3. Revenue Reserve (आगम संचय): Created out of normal operating profits of the business.
4. Capital Reserve (पूंजी संचय): Created out of capital profits (e.g., profit on sale of fixed assets, premium on issue of shares). It is generally not available for distribution as dividend.
5. Secret Reserve (गुप्त संचय): A reserve that does not appear on the face of the balance sheet. Created by understating assets or overstating liabilities.

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7. Difference between Provision and Reserve

Basis	Provision	Reserve
Nature	Created for a known liability or loss.	Created to strengthen financial position / general savings.
Accounting	It is a charge against profits (Debited to P&L A/c).	It is an appropriation of profits (Debited to P&L Appropriation A/c).
Presentation	Shown on the liability side (deducted from concerned asset) or as a liability.	Shown on the liability side under Reserves and Surplus.
Use for Dividend	Cannot be used for distribution of dividend.	Free reserves can be used for distribution of dividend.