Depreciation is the fall in the value of a fixed asset from use, passage of time or obsolescence. It is charged so that the cost of the asset is matched with the revenue it helps to earn.
Methods
| Straight line method | Written down value method | |
|---|---|---|
| Charged on | Original cost | Book value at the start of the year |
| Amount each year | Same | Decreases |
| Formula | (Cost − Scrap value) ÷ Useful life | Book value × Rate ÷ 100 |
Recording
- Charging to the asset account: Depreciation A/c Dr. To Asset A/c.
- Provision for depreciation account: Depreciation A/c Dr. To Provision for Depreciation A/c; the asset stays at cost.
On sale of an asset, transfer its cost and accumulated depreciation to an Asset Disposal Account (when a provision is kept) and find the profit or loss on sale.
Provisions and reserves
| Provisions | Reserves |
|---|---|
| A charge against profit for a known liability or loss of uncertain amount | An appropriation of profit to strengthen the business |
| Example: provision for doubtful debts, provision for depreciation | Example: general reserve, capital reserve |
| Must be made even if there is a loss | Made only when there is a profit |
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