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Depreciation, Provisions, and Reserves Textbook With Solution PDF Free Download
Chapter 7: Depreciation, Provisions and Reserves
Matching principle requires that the revenue of a given period is matched against the expenses for the same period.
This ensures ascertainment of the correct amount of profit or loss.
If some cost is incurred whose benefit extend to more than one accounting period, it is not justified to charge the entire cost as expense in the year in which it is incurred.
In fact, such a cost must be spread over the periods in which it provides benefits.
Depreciation, on fixed assets, which is the main subject matter of the present chapter, deals with such a situation.
Further, it may not always be possible to ascertain with certainty the amount of some particular expense.
Recall the principle of conservatism (prudence) which requires that instead of ignoring such items of costs, adequate provision must be made and charged against profits of the current period.
Moreover, a part of profit may be retained in the business in the form of reserves to provide for growth, expansion or meeting certain specific needs of the business in future.
This chapter deals with two distinct topics and hence is being presented in two different sections.
First section deals with depreciation and second section deals with provisions and reserves. Now you are aware that fixed assets are the assets which are used in business for more than one accounting year.
Fixed assets (technically referred to as “depreciable assets”) tend to reduce their value once they are put to use.
In general, the term “Depreciation” means decline in the value of a fixed assets due to use, passage of time or obsolescence.
In other words, if a business enterprise procures a machine and uses it in production process then the value of machine declines with its usage.
Even if the machine is not used in production process, we can not expect it to realise the same sales price due to the passage of time or arrival of a new model (obsolescence).
It implies that fixed assets are subject to decline in value and this decline is technically referred to as depreciation.
As an accounting term, depreciation is that part of the cost of a fixed asset which has expired on account of its usage and/or lapse of time. Hence, depreciation is an expired cost or expense, charged against the revenue of a given accounting period.
For example, a machine is purchased for `1,00,000 on April 01, 2017. The useful life of the machine is estimated to be 10 years.
It implies that the machine can be used in the production process for next 10 years till March 31, 2016. You know that by its very nature, ` 1,00,000 is a capital expenditure during the year 2017-18.
However, when income statement (Statement of Profit and Loss) is prepared, the entire amount of `1,00,000 can not be charged against the revenue for the year 2017-18, because of the reason that the capital expenditure amounting to `1,00,000 is expected to derive benefits (or revenue) for 10 years and not one year.
Therefore, it is logical to charge only a part of the total cost say `10,000 (one tenth of ` 1,00,000) against the revenue for the year 2017-18.
This part represents the expired cost or loss in the value of machine on account of its use or passage of time and is referred to as ‘Depreciation’.
The amount of depreciation, being a charge against profit, is debited to Income Statement (Statement of Profit and Loss).
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NCERT Solutions Class 11 Accountancy Chapter 7 Depreciation, Provisions and Reserves
Any fixed asset that is acquired by a business is subjected to wear & tear and obsolescence over time. This decrease in monetary value is calculated by a measure in accounting referred to as depreciation.
2. State briefly the need for providing depreciation.
Depreciation is needed for the following reasons:
1. Determining actual profit or loss: Actual profit and loss can be determined only when all expenditures and losses are added to P & L Account.
Assets in business are used to earn revenues; the corresponding cost gets charged as depreciation in P & L Account (Profit & Loss Account).
2. Provide unbiased view of financial statements: Assets will be shown at inflated values when depreciation do not get charged, so it will lead to balance sheet not showing the fair view of the financial statements.
3. Cost of production: Production cost includes the depreciation charged on machinery and plant and other similar assets. When depreciation is not charged production cost will be uneven which will reduce the profit.
4. Distribution of dividend from profit: If no depreciation is charged then overestimation of profit takes place which causes profit to be distributed as dividend. It results in movement of capital away from the business.
5. Funds used for asset replacement: Depreciation charged for assets will help in meeting the expense for replacing the asset in future.
6. Tax consideration: The P & L account will reflect less profit if depreciation is charged, which results in paying less taxes for the business.
3. What are the causes of depreciation?
The major causes of depreciation are listed below:
1. Regular use: Regular use of assets leads to decrement that reduces the value of such assets.
- Expiry with time: Assets whether used or not, will show a decline in their effective life with the passage of time. Rain, wind and other Natural forces bring about deterioration of the asset.
- Obsolescence: Technological advances will make the current assets obsolete in future
4. Legal rights expiry: An assets value becomes zero after its useful life. This is known as depreciation in accounting terms.
- Accident: The value of an asset can be permanently reduced due to some accident which can include fire, natural calamity etc.
NCERT Class 11 Accountancy Textbook Chapter 7 Depreciation Provisions and Reserves With Answer PDF Free Download