Depreciation, Provision and Reserves

Need for Depreciation and Factors Affecting Amount of Depreciation

When an accountant prepares the accounts of a firm and jots down the amount of depreciation, he brings down the potential gains of the firm. The amount of depreciation is an expense for an entity. Thus, it is imperative to make the correct and accurate calculations. Let us understand what is depreciation and why we need to provide for it.

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Need to Provide Depreciation

Depreciation needs to be provided because an asset is bound to undergo wear and tear over a period of time. This reduces the working capacity and effectiveness of the asset. Hence, this should reflect the value of the asset, at which it is carried in the books of accounts.

Also, every asset becomes obsolete over a period of time, as new technology and innovation take over. The value of the asset will hence decrease over time and this must be accounted for.

Browse more Topics under Depreciation Provision And Reserves

Moreover, in order to comply with the matching principle of accounts, it is ideal to provide depreciation. The Matching principle says that the expense of a period must be recognized in the same period in which we recognize it’s revenue. So an asset which generates income must be depreciated as per given provisions.

Factors Affecting Amount of Depreciation

Amount of Depreciation

The amount of depreciation is impacted by a number of factors. Let us take a look at some of them. There are four main factors to consider when calculating the depreciation expense are as follows:

  • The cost of the asset.
  • The estimated salvage value of the asset. Salvage value (also called residual value) is the amount of money that the company expects to recover, less the disposal costs, on the date the asset is scrapped, sold, or traded in.
  • Estimated useful life of the asset. Useful life refers to the window of time that a company plans to use an asset. Useful life can be expressed in years, months, working hours, or units produced.
  • Obsolescence should be considered when determining an asset’s useful life and will affect the calculation of depreciation. For example, a machine capable of producing units for 20 years may be obsolete in six years; therefore, the asset’s useful life is six years in this case.

A company is free to make use of the most appropriate depreciation method for its business operations. Accounting theory suggests that companies should make use of a depreciation method that closely reflects the company’s’ economic circumstances. Thus, companies can choose a method that allocates the asset cost to accounting periods according to benefits received from the use of the asset.

Most companies use the straight-line method for financial reporting purposes, but they may also use different methods for different assets. The most important criteria to follow is to Use a depreciation method that allocates asset cost to accounting periods in a systematic and rational manner.

Solved Question for You

Question: How do factors affecting depreciation impact the amount of depreciation?

Answer – This can be understood through the following example:

Assume a purchased truck is valued at INR 10,000, has a residual value of INR 5,000, and a useful life of 5 years. Its depreciation expense for year 1 is INR 10000−INR 5000 = INR 1000 INR 10000 – INR 5000/5 = INR 1000.

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6 responses to “Provisions”

  1. satish says:

    can we take certain/uncertain income in provision

    • asif says:

      Uncertain amount will be taken in provision. present obligation arising past event and second condition 50% probability and third amount will be perfect observation not randomly.

  2. Mostakim says:

    Tk. 50000 against audit and evaluation costs has been provisioned during 30th june 2019 whike settlement was made at actual taka 47500 as on 25th July 2019? please solve this journal..

    • Srikar says:

      On 30th June:
      1. Audit expense a/c dr 50000
      To Provision for Audit expense 50000
      (Being Provision created for Audit expenses)
      2. Profit and loss a/c dr 50000
      To Audit expense a/c 50000
      (Being Audit expense charged to Profit and loss a/c as an expense of
      current year on accrual basis)
      On 25th July, 2019:
      1. Provision for Audit expense a/c dr 47500
      To Cash/Bank 47500
      (Being payment made towards Audit expense charged to the Provision
      created previously)
      2. Provision for Audit expense a/c dr 2500(i.e,50000-47500)
      Profit and loss a/c 2500
      (Being excess provision reversed by charging to Profit and loss a/c)

  3. Hari Prasad says:

    We have made provision for Bad Debts by debiting P&L during the year 2016-17. The debtors balance is still debit in our Books. How to make write off entry?

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