04/10/20 DEPRECIATION,PROVISIONS AND RESERVES 1

1 CONCEPT OF DEPRECIATION
2 CAUSES OF DEPRECIATION
3 NEED OF DEPRECIATION
4 BASIC FACTORS
5 METHODS OF DEPRECIATION
6 PROVISION AND RESERVES

04/10/20 DEPRECIATION,PROVISIONS AND RESERVES 3

DEFINITION
Depreciation is the permanent
decrease in the value of an asset due
to use and /or the lapse of the time.
CLMA, LONDON

DEPRECIATION,PROVISIONS AND
04/10/20 RESERVES 4
CAUSES OF
DEPRECIATION
Physical depreciation
Economic factors
Time factors
Depletion
Accident
NEED FOR CHARGING
DEPRECIATION

To calculation the profit .

True and fair view in balance
sheet.
Replacement of asset .
Saving in income tax.
Accurate ascertainment of cost.

04/10/20 DEPRECIATION,PROVISIONS AND RESERVES 6

BASIC FACTORS AFFECTING
DEPRECIATION

Cost of asset .
Estimated working life.
Salvage/Residual/Scrap value.
Legal provisions
Additions to assets
METHODS OF
DEPRECIATION
CHANGE
FIXED INSTALMENT MACHINE HOUR RATE

DIMINISHING BALANCE DEPLETION

SUM OF THE DIGITS REVALUATION

ANNUITY INSURANCE POLICY

DEPRECIATION FUND
STRAIGHT LINE METHOD
Under this method,a fixed asset in written off annually
so that,by the time asset is worn out ,its proportion
cost of the value in the book is reduced to zero.

FORMULA
 FIXED ASSET- ESTIMATED SCRAP VALUE
ESTIMATED LIFE OF ASSET

04/10/20 DEPRECIATION,PROVISIONS AND RESERVES 9

MERITS AND DEMERITS
MERITS-
1. Simple .
2. Asset is fully written off .
3. Knowledge of total depreciation charged .
4. Suitable for fixed life assets.
DEMERITS-
1. Interest on capital.
2. Reairs and maintenance
3. Income tax

04/10/20 DEPRECIATION,PROVISIONS AND RESERVES 10

QUESTION:- A trader bought machinery on 1st
jan , 2001 for Rs . 125000 whose useful life has
been estimated 5 years . After the expiry of
useful life , the scrap will realise Rs 25000.
ANNUAL DEPRECIATION
125000-25000 =5000
5
MACHINERY ACCOUNT
DATE PARTICULARS AMT DATE PARTICULA AMT
RS
2001 To bank a\c 125000 2001 By 20000
Jan 1 Dec 31 depreciation
a\c
Dec 31 By bal c\d 105000

125000 125000
2002 To bal b\d 105000 2002 By 20000
Jan 1 Dec 31 depreciation
a\c
Dec 31 By bal c\d 85000
 105000 105000
2003 To bal b\d 85000 2003 By depreciation 20000
Jan 1 Dec 31 a\c

Dec 31 By bal c\d 65000

85000 85000
2004 To bal b\d 65000 2004 By depreciation 20000
Jan 1 Dec 31 a\c

By bal c\d 45000

65000 65000
2005 To bal b\d 45000 2005 By depreciation 20000
Jan 1 Dec 31 a\c

Dec 31 By bal c\d 25000

45000 45000
DIMINISHING BALANCE
METHOD
Depreciation is calculated at a certain
percentage each year on the balance of the
asset which is brought forward from the
previous year. The amount of depreciation
charged in each period is not fixed but it
goes on decreasing gradually as the
beginning balance of the asset in each year
will reduce.
MERITS & DEMERITS
MERITS DEMERITS
1. Fresh 1.Its difficult to
calculation of determine the suitable
depreciation are not rate of depreciation.
necessary as and when 2. the
additions are made. original cost of the asset
2. this method is is altogether lost sight
recognized by the of in subsequent years
income tax authorities and the asset can never
in India. be reduced to zero.
QUESTION:- A company bought
machinery for Rs .400000, including a shaft Rs
. 40000. The machinery is subject to
dep at 10% by reducing instalment method . In
the beginning of the fifth year , the shaft became
obsolete and instalment method . In the
beginning of the fifth year , the shaft become
obsolete and was sold for Rs. 8000.Write up the
machinery account for five years .
MACHINERY ACCOUNT
DAT PARTICULAR AMT DATE PARTICULARS AMT
E S
1ST Yr To bank a\c 400000 1ST Yr. By depreciation 40000
a\c
By bal c\d 360000

400000 400000
2ND To bal b\d 360000 2ND By depreciation 36000
Yr Yr a\c @10% ON
360000
By bal c\d 324000
 360000 360000

3RD Yr. To bal b\d 324000 3rd Yr. By depreciation@10%ON 32400

Rs.324000

By bal c\d 291600

324000 324000
4TH Yr. To bal b\d 291600 4TH Yr. By depreciation@10%ON 29160
Rs.291600
By bal c\d 262440

291600 291600
5th Yr. To bal b\d 262440 5TH Yr. By bank a\c 8000
By profit & loss [Loss on 18244
sale of shaft]
By depreciation@10%ON 23620
Rs 236196
 By bal c\d 212576

262440 262440
SUM OF THE DIGITS
METHOD
This is a variant of the
reducing instalment or
diminishing balance method.
QUESTION:-Suppose machinery was purchased for Rs.
60000 on 1st jan,2003 and depreciation was charged
following the sum of the digits method assuming its
useful life to be 3 years. Depreciation for three years will
be calculated as under:
DEPRECIATION FOR THE
FIRST YEAR = 3 Rs.60000 =Rs.30000

3+2+1
SECOND YEAR = 2 Rs.60000=Rs.20000
6
THIRD YEAR = 1 Rs.60000 =Rs.10000
6
 ANNUITY METHOD
Under this ,amount spent on purchase of an asset is
regarded as an investment which is assumed to earn
interest at a certain rate.
The amount to be written off as depreciation is
calculated from annuity table , an extract of which is
given below :
Years 3% 3 1% 4% 4 1% 5%
2 2

3 0.353530 0.359634 0.360349 0.363773 0.367209

4 0.269027 0.272251 0.275490 0.278744 0.282012
5 0.218355 0.221481 0.224627 0.227792 0.230975
QUESTION:- A firm purchases a 5 yr lease
for Rs.40,000 on 1st jan . It decides to write
off depreciation on annuity method
,presuming the rate of interest to be 5% per
annum . The annuity tables show that a sum
of Rs. 9,239 should be written off every
year. Show the lease account for five yr
.calculation are to be made to the nearest –
rupee.
 LEASE ACCOUNT
DATE PARTICULARS AMT DATE PARTICULARS AMT

1st yr To cash 40000 1st yr By depreciation 9239

Jan 1 Dec 31 a\c
Dec 31 To interest 2000 Dec 31 By bal c\d 32761

42000 42000
2nd yr To bal b\d 32761 2nd yr By depreciation 9239
Jan 1 Dec 31 a\c

Dec 31 To interest 1638 Dec 31 By bal c\d 25160

34399 34399
3rd yr To bal b\d 25160 3rd yr By depreciation a\c 9239
Jan 1 Dec 31
Dec To interest 1258 Dec 31 By bal c\d 17179
31
26418 26418
4th yr To bal b\d 17179 4th yr By depreciation a\c 9239
Jan 1 Dec 31
Dec To interest 859 Dec 31 By bal c\d 8799
31
18038 18038
5th yr To bal b\d 8799 5th yr By depreciation a\c 9239
Jan 1 Dec 31
Dec To interest 440
31
9239 9239
DEPRECIATION FUND
METHOD
This method is implies that the amount written
off as depreciation should be kept aside and
invested in readily saleable securities. The
securities accumulate and when the life of
asset expires, the securities are sold and with
the sale proceeds a new asset is purchased.
The rate of interest which is easily calculated
from sinking fund tables , an extract of given
below :
SINKING FUND TABLE
years 3% 3 1% 4% 4 1% 5%
2 2

3 0.323540 0.321934 0.320349 0.318773 0.317208

4 0.239027 0.237251 0.235490 0.233741 0.232012

5 0.188350 0.186481 0.184627 0.182792 0.180975

QUESTION:- A company purchased a 3 years lease on
January 1,2007 for Rs. 25000. It is decided to provide for
the replacement of lease at the end of 3 years by setting
up a depreciation fund .It is expected that the
investments will fetch interest at 5%. Sinking fund table
show that to provide the requisite sum at 5% at the end
of 3 years an investment of Rs 7932 is required every
year. Investment are made to the nearest rupee. On 31st
Dec,2009 the investments were sold for Rs. 15250. on 1st
January,2010, the same lease was renewed for a further
period of 3 years by payment of Rs. 30000.
 DEPRECIATION FUND ACCOUNT
2007 To bal c\d 7932 2007 By depreciation a\c 7932

Jan 1 Dec
31
2008 To bal c\d 16261 2008 By bal b\d 7932
Dec
31 Jan 1
Dec By bank 397
31
Dec By depreciation a\c 7932
31
16261 16261
2009 To depreciation 1011 2009 By bal b\d 16261
Fund investment Jan 1
Dec a\c
31
Dec To lease a\c 25000 Dec 31 By bank [interest] 813
31
Dec 31 By depreciation a\c 7932

Dec 31 By profit & loss a\c 1005

26011 26011
 DEPRECIATION FUND
INVESTMENT ACCOUNT
2007 To bank 7932 2007 By bal c\d 7932
Dec Dec
31 31
2008 To bal b\d 7932 2008 By bal c\d 16261
jan 1 Dec 31
Dec 31 To bank 8329
16261 16261
2009 To bal b\d 16261 2009 By bank 15250
jan 1 Dec 31
Dec 31 By depreciation 1011
fund a\c [loss
transferred]
16261 16261
INSURANCE POLICY
METHOD
This method is similar to the depreciation
fund method but instead of making
investment , arrangement are made with an
insurance company which will receive
premiums annually and pay at the end of the
fixed period the required amount .
Premiums have to be paid at the beginning
of each year.
QUESTION:-On 1st jan. 2006,a lease of
premises is purchased for four years for
Rs.50000 and it is decided to make
provision for the replacement of the lease
by means of an insurance policy purchased
for an annual premium of Rs.12000.
show the necessary ledger
account for four years assuming that the
renewal of the lease costs Rs.50000 on 1-1
2010.
 LEASE ACCOUNT
2006 To bank a\c 50000 2006 By bal c\d 50000
Jan 1 dec31

2007 To bal b\d 50000 2007 By bal c\d 50000

jan 1 dec31

2008 To bal b\d 50000 2008 By bal c\d 50000

jan 1 dec31

2009 To bal b\d 50000 2009 By bal c\d 50000

jan 1 dec31
 DEPRECIATION RESERVE
ACCOUNT
2006 To bal c\d 12000 2006 By profit and 12000
Dec 31 Dec loss a\c
31
2007 To bal c\d 24000 2007 By bal b\d 12000
Dec 31 Jan 1
Dec 31 By profit and 12000
loss a\c
24000 24000
2008 To bal c\d 36000 2008 By bal b\d 24000
Dec 31 Jan 1
Dec 31 By profit and 12000
loss a\c
 36000 36000

2009 To lease a\c 50000 2009 By bal b\d 36000

Dec 31 jan 1
Dec 31 By profit and loss 12000
a\c

Dec 31 By depreciation 2000

insurance policy
a\c [profit on the
realisation of
policy]
50000 50000
REVALUATION METHOD
Under this , the asset is revalued at the
end of the accounting year and this
value is compared with the value of the
asset at the beginning of the year . The
difference is treated as depreciation
.this method is used in case of bottles,
corks, crates or etc
QUSETION:- A company manufactures
loose tools for its own use .At the end
of each year, depreciation is charged on
revaluation method. From the following
particulars show the loose tools
account :
Year ended 31-12-2006-loose tools
manufactured Rs .5000
[revalued on 31-12-2006:Rs.4100]
Year ended 31-12-2007-loose tools
manufactured :Rs. 2700
[revalued on 31-12-2007:Rs5700]
Year ended 31-12-2008-loose tools
manufactured :Rs.1000 [revalued on
31-12-2009:Rs.6000] Year ended 31-
12-2009-loose tools manufactured
:Rs.1500
[revalued on 31-12-2009: Rs.5100]
 LOOSE TOOLS ACCOUNT
2006 TO COST OF 5000 2006 BY DEP A\C 900
PRODUCTION [Bal .fig.]
A\C
BY BAL C\D 4100

5000 5000
2007 TO BAL B\D 4100 2007 BY DEP A\C 1100
[Bal .fig.]
TO COST OF 2700 BY BAL C\D 5700
PRODUCTION
A\C
 6800 6800
2008 To bal b\d 5700 2008 By depreciation a\c 700

To cost of 1000 By bal c\d 6000

production a\c
6700 6700
950

250

1200
DEPLETION METHOD
This method is mostly used in case of mine,
quarries; etc. from which certain quantity of
output is expected to be obtained . The value of
mine depends only upon quantity of minerals that
can be obtained .when the whole quantity is
taken ,the mine loses its value .the rate of
depreciation is worked out only so much per
tonne. It is simply dividing the cost of the mine by
the total quantity of the minerals expected to be
available.
QUESTION:-A mine was acquired at a cost of
Rs.20,00,000 on 1st July 2007. It was
expected it would yield 2,00,000 tons of
minerals in all. The actual output was 2007-
10,000 tons ,2008-40,000 tons and 2009-
32,000 tons. Write up the mine account for
the above years using depletion method of
charging depreciation.
Rate of depreciation =Rs.10 per ton
MINE ACCOUNT
2007 To bank a\c 2000000 2007 By depreciation 100000
July 1 Dec a\c
31
Dec3 By bal c\d 1900000
1
2000000 2000000
2008 To bal b\d 1900000 2008 By depreciation 400000
Jan 1 Dec3 a\c
1
Dec3 By bal c\d 15000000
1
 1900000 1900000
2009 To bal b\d 1500000 2009 By depreciation 320000
Jan 1 Dec 31 a\c
Dec 31 By bal c\d 1180000

1500000 1500000
2010 To bal b\d 1180000
Jan 1
MACHINE HOUR RATE
METHOD
This method is useful in case of machines
.The life of machine is fixed in terms of
hours . Hourly rate of depreciation is
worked out by dividing the cost of the
machine by the total number of hours for
which the machine is expected to be used
.depreciation to be written off in a year will
be ascertained by multiplying the hourly
rate of depreciation by the number of hours
that the machine actually runs in the year.
QUESTION:- A machine was acquired on 1st
April,2008 at a cost of Rs 90,000, the cost of
installation being Rs. 10000. It is expected
that its total life will be 20,000 hours.
During 2008 it worked for 5,000 hours and
during 2009 for 8,000 hours. Write up the
machinery account for 2008 & 2009.
Machine hour rate= Rs 5 per hour
 MACHINERY ACCOUNT
2007 To bank a\c [cost 100000 Dec 31 By depreciation 25000
Ap 1 and installation a\c
charges]
Dec31 By bal c\d 75000

100000 100000
2009 To bal b\d 75000 2009 By depreciation 40000
Jan 1 Dec31 a\c

Dec31 By bal c\d 35000

75000 75000
2010 To bal b\d 35000
Jan 1
CHANGE OF METHOD
Sometimes the method is changed either
from straight line method to diminishing
balance method or from diminishing balance
method to straight line method with effect
from the current year or with retrospective
effect .if the change is from current year then
there will be no problem but simply to
change the method of depreciation .
QUESTION:- Plant and machinery account of a company
had a debit balance of Rs. 1,47,390 on 1st jan ,2009.The
company was incorporated in 2006 and has been
following the practice of charging full year, depreciation
every year on diminishing balance system @15%. In
2009 it was, however decided to change the method
from reducing system to straight line with retrospection
effect from 2006 and to give effect of the change while
preparing the final accounts for the year ended 31st
dec,2009, the rate of depreciation remaining same as
before. In 2009, new machineries
were purchased at a cost of Rs.50,000. All the other
machineries were acquired in 2006.
Show Plant and machinery account from 2006 to 2009.
PLANT AND MACHINERY
ACCOUNT
2006 TO BANK A\C 240000 2006 BY DEP A\C 36000
[15% on Rs
Jan 1 Dec31 240000]
Dec31 BY BALC\D 204000

240000 240000
2007 TO BAL B\D 204000 2007 BY DEP A\C 30600
Jan 1 Dec31 [15% on
Rs204000
Dec31 BY BAL C\D 173400
 204000 204000
2008 To bal b\d 173400 2008 By depreciation a\c 26010
Jan Dec [15% on
1 31 Rs173400
Dec By bal c\d 147390
31
173400 173400
2009 To bal b\d 147390 2009 By profit and 15390
Jan 1 Dec loss a\c
31 [additional dep] 2

Jan 1 To bank a\c 50000 Dec3 By depreciation a\c 43500

[Additions] 1 [15%on
240000+50000]
 Dec 31 By bal c\d 138500

197390 197390
PROVISIONS AND
RESERVES
MEANING OF PROVISIONS
The term “provision” means any amount
written off or retained by way of providing
depreciation ,renewals or diminution in the
value of assets or retained by way of
providing for any know liability the amount
of which may not be determined with
substantial accuracy
Question:- A firm desires to debit its profit
and loss account with a uniform figure
every year in respect of repairs and
renewals. It expects that considering the life
of the asset in question Rs.10,000 will be
the average amount to spent per year.
Actual repairs are Rs.1,000 in the first year,
Rs.2,300 in the second year and Rs.3,700 in
the third year. Show the provision for
repairs and renewals account.
FOR REPAIRS AND
RENEWALS ACCOUNT
YEAR To bank [Repairs] 1000 YEAR By profit and 10000
1 1 loss a\c
To bal c\d 9000

10000 10000
2 To bank [Repairs] 2300 2 By bal b\d 9000

To bal c\d 16700 By profit and 10000

loss a\c
19000 19000
3 To bank [Repairs] 3700 3 By bal b\d 16700

To bal c\d 23000 By profit and 10000

loss a\c
26700 26700
 MEANING OF RESERVE
Any sum which is appropriated out of
profit and loss appropriation account
and is not meant to cover up
liability,contingency,commitment,or
reduction in the value of an asset is a
reserve.
QUESTION:- Show the distinction between
sinking fund to repay a liability and sinking
fund to replace a wasting asset by the
operation of ledger account at the end of
five years in the following cases:
1. sinking fund to
replace leasehold property valued Rs.
900000 at the end of five years .
2. sinking fund to repay Rs. 900000
debentures at the end of five years .
1. Sinking fund [to replace an asset at the end of five years]
To old lease a\c 900000 By bal b\d 900000
[transfer]

OLD LEASE ACCOUNT

To bal b\d 900000 By sinking fund a\c 900000

[transfer]
NEW LEASE ACCOUNT

To bank a\c 900000

2. Sinking fund [to repay a liability at the end of five years]

To reserve fund 900000 By bal b\d 900000

[transfer]
DEBENTURES ACCOUNT
To bank a\c 900000 By bal b\d 900000